Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following data is derived from audited financial statements.
Effective July 1, 2002, our subsidiary, First Professionals, entered into a finite quota share reinsurance agreement with Hannover Re. In accordance with the agreement, First Professionals ceded quota share portions of its 2002, 2003 and 2004 direct premiums written, net of other reinsurance. The agreement was terminated effective June 30, 2004 and commuted effective December 31, 2006. As a result of the commutation, we no longer incurred the finance charges previously associated with funds withheld under the agreement.
We operate in the MPL insurance sector of the property and casualty insurance industry. Our primary insurance products provide protection for physicians, dentists and other healthcare providers as individual practitioners or as members of practice groups. Our insurance protects policyholders against losses arising from professional liability claims and the related defense costs with respect to injuries alleged to have been caused by medical error or malpractice. Optional coverage is available for professional corporations under which physicians or dentists practice. We are the largest provider of MPL insurance in Florida, the fourth largest provider in Texas and have top five market positions in Georgia and Arkansas. In all, we currently write MPL insurance in 13 states and are licensed to write in 32 states. Based on 2008 premiums reported by SNL Financial LC, Florida and Texas are the fifth and eighth largest markets, respectively, for MPL insurance in the United States in terms of direct premiums written. We focus on selected markets where we believe we have advantages in terms of our market knowledge, well-established reputation, meaningful market presence and resources.
In November 2009, we acquired all of the issued and outstanding stock of Advocate, MD, which then became a wholly owned subsidiary of First Professionals. In connection with the acquisition, we paid cash consideration of $33.6 million at closing, and may pay up to $12.0 million in additional consideration depending on the performance of Advocate, MD during the two-year period following closing. In connection with the transaction, we also retired all of Advocate MD’s outstanding bank debt, totaling $9.0 million. Advocate, MD is the fourth largest provider of MPL insurance in Texas and also writes MPL insurance in Mississippi. We intend to operate Advocate, MD through its current management team and facilities in Austin, Texas.
Our former insurance management operations, which provided insurance management services in New York and Pennsylvania, were discontinued in September 2006 in connection with the sale of these operations to a private investor. Our former TPA operations, which provided administrative and claims management services to employers, primarily in Florida, were sold in 2005. For additional information on our discontinued operations, see Note 20, Discontinued Operations to the consolidated financial statements included elsewhere herein.
We continued our target market focus in 2009. Nationally and in our core market of Florida, policyholder retention was 95 percent for 2009 compared to national and Florida policyholder retention of 96 percent in 2008.
For a discussion of industry factors affecting us, see Item 1. Business - Industry Overview.
In addition, our insurance subsidiaries may become subject to claims for extra-contractual obligations or risks in excess of policy limits in connection with their insurance claims, particularly in Florida. These claims are sometimes referred to as “bad faith” actions as it is alleged that the insurance company acted in bad faith in the administration of a claim against an insured. Bad faith actions generally occur in instances where a jury verdict exceeds the insured’s policy limits. Under such circumstances, it is routinely alleged that the insurance company failed to negotiate a settlement of a claim in good faith within the insured’s policy limit. When establishing our liability for losses and LAE, we take our exposure for ECO/XPL claims into consideration, including with respect to payments in excess of policy limits that may be made in order to address potential future ECO/XPL exposure. Within the Florida market for MPL insurance, the magnitude of ECO/XPL payments has increased in recent years and is expected to continue to be a significant source of uncertainty in establishing reserves. An award against us for extra-contractual liability or a significant jury award, or series of awards, against one or more of our insureds could ultimately result in the payment by us of potentially significant amounts in excess of the related policy limits, reserves and reinsurance coverage and could have a material adverse impact on our financial condition, results of operations or cash flows.
Using internal actuarial staff, we analyze and develop projections of ultimate losses that are evaluated and considered in establishing our carried reserves. In performing our review, we separate reserves by line of business, coverage type, layer of coverage, geography and accident year. By doing so, we are able to evaluate the unique patterns of development and trends for each line of business. We then select a point estimate for each line of business with due regard for the age, characteristics and volatility of the portion of the business, the volume of data available for review and past experience with respect to the accuracy of estimates for business of a similar type. This series of selected point estimates, along with other relevant quantitative and qualitative information, is then evaluated by management to produce our best estimate of our total liability for losses and LAE.
We also utilize and evaluate calculations contained in an actuarial study performed by an independent actuarial firm to corroborate the adequacy of our carried reserves. Our best estimate may differ from the selected reserve estimate of our independent actuary because of differences in evaluating such things as the impact of historical experience, legal and regulatory changes, expectations about future claim results and trends and certain other factors as discussed below. While our best estimate may differ, our carried reserves remain within a reasonable actuarial range of the independent actuary’s selected reserve estimate. The independent review of our reserves plays an important role in our overall assessment of the adequacy of our reserves. A typical range of reasonable values for MPL business is considered to be as wide as 15 percent. Therefore, in addition to the performance of the business itself, our financial condition, results of operations and cash flows are sensitive to our reserve estimates and judgments. Our range developed for our loss and LAE reserves, net of reinsurance, at December 31, 2009 was $362.9 million to $431.6 million with management’s best estimate of loss and LAE reserves at $425.8 million. The reserve opinions of our independent actuary for the years ended December 31, 2009 and 2008 have been filed with state insurance regulators along with the statutory financial statements of our insurance companies.
Losses and LAE incurred related to the current year decreased approximately 5 percent and 13 percent in 2009 and 2008, respectively. As noted in our discussion of results of operations below, our net premiums earned declined 9 percent in 2009 and 13 percent in 2008. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) related to the current year (excluding prior year development) was 71.0 percent, 67.5 percent, and 67.3 percent for 2009, 2008 and 2007, respectively. Our current year loss ratio has increased in recent years as a result of lower premium rates, following several years of overall favorable claims trends.
The net cumulative redundancy / (deficiency) shown in the table below for each year end includes accident year development for all years leading up to that year. For example, for the year ended December 31, 2009, there was $19.0 million of favorable development for calendar year 2008 reserves, including all accident years leading up to and including 2008. This favorable development consists of $12.0 million of favorable development for accident years 2006 and earlier and $7.0 million of favorable development for accident year 2007. Further, the net cumulative redundancy / (deficiency) shown in the table below also includes development for multiple calendar years. For example, the $36.0 million cumulative redundancy in 2007 consists of $19.0 million of favorable development during calendar year 2009 and $17.0 million of favorable development during calendar year 2008.
For accident years 1999 through 2002, we experienced adverse development in our core Florida book primarily due to increases in ALAE for those report years as a result of the stricter claims handling philosophy implemented in 2001. This philosophy resulted in increases in ALAE costs for open claims including claims for prior accident years. Although our claims handling philosophy has positively impacted our overall loss costs, it had an adverse affect on older accident years where higher loss adjustment expenses were not entirely offset by lower indemnity expenses for those years.
Quoted Prices in Active Markets for Identical Assets: Level 1 includes unadjusted quoted prices for identical assets or liabilities in active markets.
On a quarterly basis, we obtain and review the pricing methodology of our pricing service to ensure that our fair value designations are classified in accordance with the accounting guidance on Fair Value Measurements. Our pricing service provides a single price per security. We review the results of our pricing service for reasonableness each quarter by comparing market values reported on individual cusip basis and an overall portfolio basis to those obtained from our external investment manager to determine that the market value reported by our pricing service appears reasonable. In addition, an annual SAS 70 report that describes procedures surrounding the compilation and reporting of security prices obtained from our pricing service is provided to us. We may adjust the valuation of securities from the independent pricing service if we believe a security’s price does not fairly represent the market value of the investment. For example, when market observable data is not as readily available or if the security trades in an inactive market, the valuation of financial instruments becomes more subjective and could involve substantial judgment resulting in Level 3 pricing. To date, we have not adjusted any prices supplied by our pricing service.
Fixed income securities for which pricing is based solely on non-binding broker / dealer quotes with inputs less observable are classified within Level 3.
Our invested assets comprise our largest single asset class and consist primarily of investment securities in the form of fixed income securities. Our fixed income securities, equity investments and short-term investments are carried at their fair values and accounted for $676.9 million or 99 percent of our total investments and 66 percent of our total assets as of December 31, 2009, compared to $648.1 million or 99 percent of our total investments and 65 percent of our total assets as of December 31, 2008. Unrealized gains or losses in their fair values are recorded directly in shareholders’ equity, net of tax effects, as a component of accumulated other comprehensive income (loss). Gross unrealized investment gains were $24.3 million and gross unrealized investment losses were $6.3 million as of December 31, 2009 compared to $11.8 million and $24.3 million, respectively, as of December 31, 2008.
If an investment’s fair value declines below cost, we determine if there is adequate evidence to overcome the presumption that the decline is other-than-temporary. Supporting evidence could include a recovery in the investment’s fair value subsequent to the date of the statement of financial position, a return of the investee to profitability and the investee’s improved financial performance and future prospects (such as earnings trends or recent dividend payments), or the improvement of financial condition and prospects for the investee’s geographic region and industry.
Issuer-specific considerations, including an event of missed or late payment or default, adverse changes in key financial ratios, an increase in nonperforming loans, a decline in earnings substantially below that of the investee’s peers, downgrading of the investee’s debt rating or suspension of trading in the security;
For fixed income securities, the other-than-temporarily impaired amount is separated into the amount related to a credit loss as a charge to realized investment gains (losses) included in our earnings, and the amount related to all other factors, which is recognized in other comprehensive income. The credit loss component is calculated using our best estimate of the present value of cash flows expected to be collected from the fixed income security. Subsequent to recognition of a credit related impairment loss, the difference between the new cost basis and the cash flows expected to be collected is accreted as interest income.
We estimate and recognize deferred tax assets and liabilities for future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We determine deferred tax assets and liabilities separately for each tax-paying component (an individual entity or group of entities that is consolidated for tax purposes) in each tax jurisdiction. Our continuing practice is to recognize interest accrued related to unrecognized tax benefits and any applicable penalties in income tax expense.
We make an annual assessment of goodwill and intangible assets by reporting unit to determine whether the value of our goodwill and intangible assets is impaired. We use both a market-based approach and an income approach to estimate the fair value of each reporting unit. Changes to our assumptions could significantly lower our estimates of fair value and result in a determination that goodwill or intangible assets have suffered impairment in value. In November 2009, we completed the acquisition of Advocate, MD. The acquisition resulted in $10.2 million of additional goodwill and the recording of $7.3 million of intangible assets. We completed our annual assessment of goodwill and intangible assets in 2009, 2008 and 2007 and concluded that the value of our goodwill and intangible assets was not impaired. For additional information on the additions to goodwill and intangible assets as a result of the Advocate, MD acquisition, see Note 7, Goodwill and Intangible Assets to the consolidated financial statements included elsewhere herein.
For additional information on our share-based compensation plans, see Note 15, Share-Based Compensation Plans to the consolidated financial statements included elsewhere herein.
We recognize as an asset or liability the over-funded or under-funded status of our defined benefit plans for the difference between the plan’s projected benefit obligation and the fair value of plan assets. We also record all unrecognized prior service costs and credits, unrecognized actuarial gains and losses and any unrecognized transition obligations or assets in accumulated other comprehensive income (loss). Such amounts are reclassified into earnings as components of net periodic benefit cost. We measure plan assets and benefit obligations as of the date of our statement of financial position. Effective January 1, 2008, we elected the "two measurement approach" for current year-end measurement calculations. Under this approach we have appropriately recorded the net benefit expense for the transition period to retained earnings as of January 1, 2008. Additionally, changes in the value of plan assets and benefit obligations that occurred in the transition period between October 1, 2007 and December 31, 2007 were recorded to accumulated other comprehensive income (loss), net of tax, at the beginning of the year. A second measurement was performed at January 1, 2008 to produce twelve months of net benefit expense to record during 2008. The impact of adopting the measurement date provisions is shown in the table below:
The accounting for defined benefit plans is dependent on actuarial estimates, assumptions and calculations that result from a complex series of judgments about future events and uncertainties. The assumptions and actuarial estimates required to estimate the employee benefit obligations for our defined benefit plans include discount rate; expected salary increases; certain employee-related factors, such as turnover, retirement age and mortality (life expectancy); and expected return on plan assets. Our assumptions reflect our historical experiences and our best judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our defined benefit plans may impact our results of operations. Consequently, we often obtain assistance from actuarial experts to aid in developing reasonable assumptions and cost estimates.
Our assumption for the expected long-term rate of return on plan assets in our pension plans, which impacts net periodic benefit cost, is 6.8% for 2009, 2008 and 2007. The assumption for the expected return on plan assets for our defined benefit plans reflects our long-term assessment of forward-looking return expectations by asset class, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The following table shows the expected versus actual rate of return on plan assets for our defined benefit plans.
Consolidated income from continuing operations was $33.6 million for 2009, or $4.57 per diluted common share, an increase of 5 percent and 24 percent, respectively, compared to $32.1 million for 2008, or $3.69 per diluted common share for 2008. Consolidated income from continuing operations for 2009, includes $0.5 million (excluding acquisition related costs) contributed by the operations of Advocate, MD since its acquisition in November 2009. The remainder of the increase in income from continuing operations is primarily due to net realized investment gains compared with net realized investments losses in the prior period, partially offset by lower net premiums earned and net investment income and a higher combined ratio in the current year. The decline in net premiums earned for 2009 is primarily the result of lower rates in our Florida market and a prior shift in business mix, offset to some extent by an increase in professional liability policyholders and premiums earned as a result of the acquisition of Advocate, MD. Other underwriting expenses for 2009 and 2008 were affected by the state insurance guaranty assessments and recoveries as discussed below. Net losses and LAE incurred in 2009 include favorable prior year loss development of $19.0 million compared to $17.0 million in 2008. The increase in consolidated income from continuing operations was partially offset by an increase in other expenses primarily as a result of transaction costs incurred in connection with the acquisition of Advocate, MD. Share repurchases under our stock repurchase program were a major contributor to the growth in earnings per common share during 2009.
Consolidated income from continuing operations was $32.1 million for 2008, or $3.69 per diluted common share, a decline of 37 percent and 29 percent, respectively, compared to $51.1 million, or $5.20 per diluted common share, for 2007. The decline in income from continuing operations for 2008 was primarily due to an increase in net realized investment losses associated with other-than-temporary impairments of securities and lower net premiums earned partially offset by lower net losses and LAE and other underwriting expenses. Net income for 2007 also includes an after-tax gain of $9.7 million on the reinsurance commutation between First Professionals and PRI. Other underwriting expenses for 2008 and 2007 were affected favorably and unfavorably, respectively, by the state insurance guaranty assessments and recoveries discussed below. The lower net losses and LAE in 2008 include favorable prior year loss development of $17.0 million compared to $16.0 million in 2007, excluding the PRI commutation. The decline in net premiums earned for 2008 is primarily the result of lower rates in our Florida market and to a lesser extent, lower policy limits and a change in business mix to lower risk specialties.
Our business is comprised of our insurance operations through insurance subsidiaries domiciled in Florida, Missouri and Texas. We currently engage only in insurance operations. Financial and selected other data, including professional liability claims data, related to our continuing operations as of December 31 and for the years then ended is summarized in the table below.
Other underwriting expenses includes a guaranty fund assessment of $1.2 million offset by $1.2 million in recoveries in 2009, recoveries of $2.7 million in 2008 related to previous assessments and charges of $3.5 million (net of $0.7 million in recoveries) related to an assessment levied in 2007.
Comparison of Results for the Years Ended December 31, 2009 and 2008
Net realized investment gains for 2009 were $2.6 million and include other-than-temporary impairment charges of $2.1 million related to three non-agency mortgage-backed securities, one commercial mortgage-backed security and two corporate securities. We do not expect to fully collect our amortized value on these securities. During 2008, net realized investment losses were $13.6 million and included other-than-temporary charges of $13.5 million primarily related to corporate securities that were adversely affected by the challenging economic environment and related financial market turmoil.
Selected information concerning our professional liability insurance claims data for the years then ended is summarized in the table below.
Selected professional liability insurance claims data. Net paid losses and LAE, excluding assumed reinsurance contracts in run-off, was relatively flat for 2009 compared with the same period in 2008 with an increase in net paid indemnity being almost entirely offset by a decline in paid LAE. The increase in net indemnity paid is primarily due to a higher number of claims with an indemnity payment. The average payment severity of our claims remains within our expectations. For the year ended December 31, 2009, the CWIP ratio was 37 percent and the CWIP ratio, including incidents, was 19 percent, compared to 36 percent and 19 percent, respectively, for the same period in 2008. The slightly higher CWIP ratios, excluding incidents, is the result of a lower number of reported claims in recent years. Excluding claims reported at Advocate, MD, claims and incidents reported decreased 2 percent. As claims frequency decreases, there is a general expectation that the CWIP ratio will be higher. The CWIP ratios remain within our expectations. Our inventory of open claims and incidents increased during 2009 due to the acquisition of Advocate MD and inclusion of their open claims as of December 31, 2009. Excluding open claims and incidents of Advocate, MD, professional liability claims and incidents that remained open declined 2 percent. It is not unusual for our claims data to fluctuate from period to period, and our claims data remains within our expectations.
Income tax expense decreased 3 percent for 2009 compared to 2008. Our effective tax rate was 31.6 percent for 2009 compared to 33.2 percent for 2008. Income tax expense for 2008 includes a valuation allowance against deferred taxes of $0.7 million associated with realized investments losses. The valuation allowance was recorded against deferred tax expense. In 2009, the valuation allowance was deemed no longer necessary as a result of the increase in the fair value of our investment portfolio. Excluding the valuation allowance, our effective tax rate was 33.0 percent for 2009 compared to 31.8 percent for 2008. The change in our effective tax rate reflects changes in the proportion of tax-exempt investment income to taxable income.
Net premiums earned declined 13 percent for 2008 compared to 2007. The decline is primarily the result of lower rates in our Florida market and to a lesser extent, lower policy limits and a change in business mix to lower risk specialties.
Net realized investment losses increased for 2008 compared to 2007. We recognized $13.5 million in impairment charges for investments deemed other-than-temporarily impaired. For additional information on our other-than-temporary impairments, see Note 6, Investments to the consolidated financial statements included elsewhere herein. Our fixed income investment portfolio had an average Moody’s credit quality rating of Aa2 (High quality).
Other underwriting expenses decreased 15 percent for 2008 compared to 2007. Other underwriting expenses for 2007 include charges of $3.5 million (net of a recovery of $0.7 million) for state-levied insurance guaranty fund assessments and a $1.7 million reduction in expenses as a result of the PRI reinsurance commutation. Other underwriting expenses for 2008 include a $2.7 million recovery of the insurance guaranty fund assessment from policyholders. Excluding the impact of the assessments, including recoveries, and the PRI reinsurance commutation, other underwriting expenses decreased 6 percent for 2008 compared to 2007 primarily due to higher ceding commissions received by us. Our expense ratio (defined as the ratio of other underwriting expenses to net premiums earned) was 22.0 percent and 22.6 percent for 2008 and 2007, respectively. Excluding the impact of the assessments, including recoveries, and the PRI commutation, our expense ratio was 23.5 percent for 2008 compared to 21.7 percent for 2007. The increase in the expense ratio is driven primarily by lower net premiums earned in 2008 compared to 2007.
For additional information on our discontinued operations, see Note 20, Discontinued Operations to the consolidated financial statements included elsewhere herein.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. As a holding company, we possess assets that consist primarily of the stock of our subsidiaries and of other investments. The sources of liquidity available to us for the payment of operating expenses, taxes, debt-related amounts and to fund our share repurchase program include management fees and dividends from our insurance subsidiaries. Management fees from our insurance subsidiaries are based upon agreements in place with First Professionals and APAC, pursuant to which we provide substantially all management and administrative services. In accordance with limitations imposed by state insurance laws, our insurance subsidiaries are permitted, within insurance regulatory guidelines, to pay us dividends of approximately $27.3 million during 2010 without prior regulatory approval. As of December 31, 2009, the holding company held cash and liquid investments of $4.9 million.
Under the terms of the management agreements with First Professionals and APAC, we receive management fees equal to 115 percent of the costs incurred. The additional 15 percent provision in the First Professionals and APAC management fees is intended to cover overhead, corporate expenses and profit and is eliminated in the consolidated financial statements. In the case of the agreement with APAC, the total annual management fees are also limited to an amount not to exceed those that would have been paid under the terms of its former management agreement. The payment of losses and LAE and insurance operating expenses (including reinsurance costs) in the ordinary course of business are the principal needs for our insurance subsidiaries’ liquid funds. The principal sources of cash from their operations to meet ongoing liquidity requirements are the premiums collected for the insurance sold and income on the investment of those funds.
A number of factors could cause unexpected changes in our consolidated liquidity and capital resources, including, but not limited to, the following:
Unexpected changes in premium revenue, due to higher or lower than expected new business or retention of insurance policies in force or the impact of any future adverse legislative, regulatory or other such actions on our premium rates, resulting in unanticipated changes in liquidity provided by our insurance subsidiaries;
Unexpected changes in the amounts needed to defend and settle claims at our insurance subsidiaries;
Sources of liquidity include cash from operations and routine sales of investments and financing arrangements. As reported in the consolidated statement of cash flows, net cash provided by operating activities was $6.7 million for 2009 compared to net cash provided by operating activities of $21.1 million for 2008 and net cash used in operating activities of $31.4 million for 2007. The decline in net cash provided by operating activities is primarily due to lower premium receipts.
Net cash flows used in financing activities was $38.5 million, $59.1 million and $48.5 million for 2009, 2008 and 2007, respectively. The decrease in net cash used in financing activities for 2009 was primarily due to the lower repurchases of common shares under our stock repurchase program, which totaled $43.0 million, $68.1 million and $50.7 million for 2009, 2008 and 2007, respectively.
During 2003, we completed the placement of $10.0 million in senior notes and created three trusts that issued 30-year trust-preferred securities for which the proceeds from such issuances together with cash previously contributed to the trusts were used to purchase junior subordinated debentures from FPIC totaling $36.1 million. The debentures that we issued, which are reported as long-term debt in the consolidated statements of financial position, to the three trusts are subordinated to all senior indebtedness, including the senior notes, and are equal in standing with one another. In accordance with the accounting guidance on variable interest entities, we have not consolidated these subsidiary trusts.
We purchase reinsurance from a number of companies to mitigate concentrations of credit risk. Our reinsurance broker assists us in the analysis of the credit quality of our reinsurers. We base our reinsurance buying decisions in part on an evaluation of the then current financial strength and stability of prospective reinsurers. However, the financial strength of our reinsurers and their corresponding ability to pay us may change in the future due to forces or events we cannot control or anticipate. At December 31, 2009 our receivables from reinsurers, net of amounts due, totaled $146.2 million. We have not experienced difficulty in collecting amounts from reinsurers due to the financial condition of the reinsurers. Should future events lead us to believe that any reinsurer is unable to meet its obligation, adjustments to the amounts recoverable would be reflected in the results of current operations. We hold collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not designated as authorized reinsurers by the applicable departments of insurance of the states that have jurisdiction over the underlying business. The table below identifies our reinsurers from which our recoverables (net of amounts due to the reinsurer) are $5.0 million or more as of December 31, 2009 and 2008.
Deferred income taxes decreased 35 percent to $26.3 million as of December 31, 2009 from $40.6 million as of December 31, 2008. The decrease in deferred income taxes is primarily a result of our investment portfolio being in a net unrealized gain position compared to 2008 when the portfolio was in a net unrealized loss position. In addition, we recorded additional deferred tax liabilities associated with the acquisition of Advocate, MD.
Goodwill and intangible assets increased $17.4 million to $28.2 million as of December 31, 2009 from $10.8 million as of December 31, 2008. The increase in goodwill and intangible assets is directly related to the acquisition of Advocate, MD in November 2009. Goodwill of $10.2 million was calculated as the purchase premium after adjusting for the fair value of net assets acquired and consists largely of the synergies and economies of scale resulting from the combination of FPIC and Advocate, MD. All of the goodwill was assigned to our insurance segment. None of the goodwill recognized is expected to be deductible for income tax purposes. Intangible assets of $7.3 million were also recognized in connection with the acquisition. These intangible assets included state licenses, the trade name “Advocate, MD”, non-compete agreements and customer relationships.
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also have items that represent contractual obligations, commitments and contingent liabilities that are not recorded or that are considered to possess off-balance sheet risks beyond their respective amounts otherwise reflected in our consolidated financial statements. These include: (1) derivative financial instruments, which are used to hedge interest rate risk, (2) employee benefit plans and (3) guarantees by us and contractual obligations related to the trust-preferred securities issued by separately created, unconsolidated trusts. These items are discussed further below. We were not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2009 that would give rise to previously undisclosed market, credit or financing risk.
Employee benefit plan obligations are comprised of proposed plan contributions and our unfunded obligation as of December 31, 2008.
(1) Derivative financial instruments - During May and November 2008, we entered into four interest rate swaps with SunTrust Banks, Inc. (“SunTrust”) to mitigate our floating rate interest risk on our long-term debt. Each swap contract contains customary representations, warranties and covenants and has a termination date either three or five years from its respective effective date. We are required during the term of each of the swaps to make certain fixed rate payments to SunTrust calculated on the notional amount in exchange for receiving floating payments based on the three-month LIBOR rate for the same amount. The interest rate swaps, during their terms, fix the annual interest rate payable on our trust-preferred indebtedness at 8.14 percent for $20 million of the indebtedness, 7.97 percent for $15 million and 6.94 percent for $10 million. For additional information on our derivative instruments, see Note 11, Derivative Instruments and Hedging Activities, included elsewhere herein.
(2) Employee benefit plans - We provide pension benefits to eligible employees through defined benefit plans that we sponsor. For additional information about our employee benefit plans, see Note 16, Employee Benefit Plans to the consolidated financial statements included elsewhere herein.