conjunction with other cautionary statements that are included herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s analysis only as of the date they are made. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
We are an insurance holding company based in Bermuda owned by 1,929 accounting firms, persons associated with accounting firms, and individual CPA practitioners. We were formed in response to concerns about the pricing and availability of accountants’ professional liability insurance in a difficult or “hard” market. Our mission is to be a Company that provides availability of insurance for the Certified Public Accountant (“CPA”) profession, and that engages in investment activities. We conduct our reinsurance business through AMIC Ltd., our wholly-owned subsidiary, which is a registered insurer in Bermuda. We are prepared, subject to obtaining the required licenses and registrations, to act as a direct issuer of accountants’ professional liability insurance policies. Our investment portfolio is held in and managed by Investco, which is a subsidiary of AMIC Ltd.
We have satisfied our mission by reinsuring accountants professional liability insurance issued under a plan sponsored by the AICPA since 1989. This plan currently insures approximately 24,000 accounting firms and individual CPAs in all 50 states of the United States, representing a broad cross section of small and mid-size firms. However, as further discussed under Item I - business - CNA Agreement, CNA, through whom we have access to the AICPA Plan, has notified us in writing of its intent not to renew its agreement with us after the end of 2009. The Company is currently in commutation and rescission negotiations with CNA, but the outcome is uncertain.
In an effort to maximize the value of our shares, we have been looking at ways to expand our business, including possibly entering into other lines of insurance business. During 2003 we provided reinsurance for attorneys’ professional liability policies provided by Professionals Direct Insurance Company. That activity was not a significant portion of our business in 2003 and was terminated at the end of that year. Effective June 1, 2005, we wrote a 5% share in CAMICO Mutual Insurance Company’s first excess layer of $2,000,000 excess of $1,000,000. CAMICO is a California based writer of accountants’ professional liability business. Effective June 1, 2006 the contract renewed for similar terms and conditions. At the June 1, 2007 renewal we wrote a 2.5% share of a $4 million excess $1 million layer. Effective June 1, 2008, the contract renewed for similar expiring terms. The premiums under the CAMICO treaty vary with the losses incurred, between a minimum and a maximum.
AmerInst has entered into confidentiality agreements with several investment banking organizations.
The amount that we record as our liability for loss and loss adjustment expenses is a major determinant of net income each year. As discussed in more detail below under the heading “Losses and Loss Adjustment Expenses,” the amount that we reserve is based on actuarial estimates which are prepared as of June 30 and December 31 each year. Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a “low,” “central” and “high” estimate of the loss and loss adjustment expenses. As at December 31, 2008, the range of actuarially determined liability for loss and loss adjustment expense reserves was as follows: the low estimate was $15.1 million, the high estimate was $24.4 million, and the central estimate was $19.1 million. We selected reserves of $24.4 million as of December 31, 2008, which is at the high end of the range. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management’s policy has been to reserve conservatively at the higher end of the actuarial estimates.
The decrease in net income from 2007 to 2008 is primarily due to net realized loss on investments of $4,558,251, compared to net realized gain on investments of $921,029 in 2007. Net realized loss on investments includes other than temporary impairment charges of $5,271,859 in 2008 and $1,096,246 in 2007. Offsetting the impact of the realized loss is the decrease in losses and loss adjustment expenses primarily due to the reduction of loss reserves by $4.6 million in 2008 compared to a reduction in loss reserves in 2007 by $2.8 million. The favorable loss development in both 2008 and 2007 reflected the recognition of better than expected loss emergence in the prior policy years rather than explicit changes to our actuarial assumptions. Due to the uncertainty inherent in the reinsurance policies written by the Company, we have always adopted a conservative policy concerning our loss reserving. Our actuary determined in the course of its analysis that experience under the CNA plans has been more favorable than industry performance reflected in the reserves we established for our reinsurance of the plans. In light of this new information, we believed it was appropriate to reduce the 2008 loss reserves by $4.6 million and for 2007 the reduction in loss reserves was $2.8 million. Our loss reserves continue to be reserved at the high end of the reserve range provided by the actuary, which is consistent with our long established loss reserving philosophy. The Company will continue to review loss reserves periodically and, based on the actuarial projections, determine whether reserves are required to be increased or decreased.
Net premiums earned increased by 4.9% in 2008 to $8,367,209 from $7,973,646 in 2007. The increase in net premiums earned during 2008 was due to an adjustment in 2007 for premiums over ceded to AmerInst in prior years.
Net investment income includes amounts earned on the Company’s investment portfolio and cash equivalents, and dividends on equity investments, net of investment expenses. Net investment income decreased by $129,211, or 8.0%, in 2008 to $1,483,173 from $1,612,384 in 2007. The primary reason for the decrease was the decline in dividend income earned during the year.
impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the fair value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
The composition of the investment portfolio at December 31, 2008 and 2007 is as follows:
Policy acquisition costs of $2,379,800 were expensed in 2008 compared to $2,269,322 in 2007, an increase of 4.9%. Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. Such costs as a percentage of premiums earned were 28.4% in 2008 and 28.5% in 2007.
Total operating and management expenses were $2,284,767 for 2008 compared to $2,187,072 for 2007, an increase of $97,695, primarily due to an increase in director fees and expenses and an increase in management and professional fees. The operating and management expenses relating to the RINITS™ segment spent in the development phase were $467,745 in 2008 and $703,609 in 2007, a decrease of $235,864 primarily due to a decrease in legal fees.
Further, on a quarterly basis, we evaluate whether the fair value of the securities held in our investment portfolio are other-than-temporarily impaired when fair value is below amortized cost. To make this assessment we consider several factors, including (i) the time period during which there has been a decline below cost, (ii) the extent of the decline below cost, (iii) our intent and ability to hold the security, (iv) the potential for the security to recover in value, (v) an analysis of the financial condition of the issuer, and (vi) an analysis of the collateral structure and credit support of the security, if applicable. If we conclude a security is other-than-temporarily impaired, we write down the amortized cost of the security to fair value, with a charge to net realized
investment gains (losses) in the Consolidated Statement of Operations. Gross unrealized losses on the investment portfolio as of December 31, 2008 amounted to $33,016 compared to $39,542 as of December 31, 2007. The unrealized losses from these securities were not as a result of credit, collateral or structural issues. As a result of the decline in fair value below cost, the Company recorded a total other-than-temporary impairment charge of $5,271,859 and $1,096,246 on 47 and 10 equity securities during the year ended December 31, 2008 and 2007, respectively.
To validate prices, we complete quantitative analyses to compare the performance of the overall investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.
There have been no material changes to any of our valuation techniques from what was used as of December 31, 2007. Since the fair value of a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets or transfer our liabilities in an orderly transaction between participants at the measurement date.
Current market conditions and the instability in the global credit markets present additional risks and uncertainties for our business. In particular, continued deterioration in the public debt and equity markets could lead to additional investment losses. The severe downturn in the public debt and equity markets, reflecting uncertainties associated with the mortgage crisis, worsening economic conditions, widening of credit spreads, bankruptcies and government intervention in large financial institutions, has resulted in significant realized and unrealized losses in our investment portfolio. Depending on market conditions going forward, particularly if current market conditions do not improve in the near future, we could incur substantial additional realized and unrealized losses in future periods, which could have an adverse impact on our results of operations and financial condition. The current market volatility may also make it more difficult to value certain of our securities if
As of December 31, 2008, our total investments were $46,034,924, a decrease of $7,585,104, or 14.1%, from $53,620,028 at December 31, 2007. The decrease was primarily due to a decline in the fair value of the investments, which resulted from the unprecedented events and severe dislocation in the world’s financial markets. These events in the capital or credit markets may continue to adversely affect the fair value of our investments in the future. The cash and cash equivalents balance decreased from $1,778,798 at December 31, 2007 to $887,107 at December 31, 2008, a decrease of $891,691, or 50.1%. The amount of cash and cash equivalents varies depending on the maturities of fixed term investments and on the level of funds invested in money market mutual funds. The restricted cash and cash equivalents balance decreased from $841,602 at December 31, 2007 to $316,841 at December 31, 2008, a decrease of $524,761. The decrease is due to the timing of sales and maturities of investments held as restricted cash at December 31, 2008 that have not yet been reinvested. The ratio of cash and total investments to total liabilities at December 31, 2008 was 1.65:1, compared to a ratio of 1.79:1 at December 31, 2007.
Deferred policy acquisition costs, which represent the deferral of ceding commission expense related to premiums not yet earned, increased from December 31, 2007 along with the increase in unearned premiums. The current ceding commission rate, which became effective August 1, 1995, is 28.5% for CNA. The ceding rate for the carrier for the CAMICO treaty we began reinsuring in 2005 is 10% and for the attorneys’ professional liability we reinsured in 2003 was 10%. In addition a federal excise tax of 1% is applied on premiums earned. The 0.2% increase in deferred policy acquisition costs in 2008 was due to the increase in unearned premiums compared to the prior year.
Total dividends declared were $673,514 and $1,209,850 in 2008 and 2007, respectively. Continuation of dividend payments is subject to the Board of Directors’ continuing evaluation of our level of surplus compared to our capacity to accept more business. One of our objectives is to build surplus to retain flexibility for future business expansions.
AMIC Ltd.’s ability to pay dividends to AmerInst is subject to the provisions of the Bermuda insurance and companies laws. Under the Companies Act, AMIC Ltd. would be prohibited from declaring or paying a dividend at December 31, 2008 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. As at December 31, 2008, approximately $20 million was available for the payment of dividends to shareholders. In addition, AMIC Ltd. must be able to pay its liabilities as they come due after the payment of a dividend. Our ability to pay dividends to common shareholders and to pay our operating expenses is dependent on cash dividends from our subsidiaries. The payment of such dividends by AMIC Ltd., including its subsidiary, Investco, to us is also limited under Bermuda law by the Insurance Act and Related Regulations which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2008 and 2007 these requirements have been met as follows:
Because AMIC Ltd. is not admitted as an insurer in Illinois, CNA has the right to annually require AMIC Ltd. to provide security by a U.S. bank in an amount equal to the total unearned premiums for the fiscal year plus CNA’s share of AMIC Ltd.’s loss reserves.
The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. Future average severity is projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. These anticipated trends are monitored based on actual developments and are modified as necessary.
In preparing ultimate loss and allocated loss adjustment expenses, the Company’s actuary examined a variety of methods. The actuary applied traditional loss development and generalized “Cape Cod” methods separately to case incurred loss and allocated loss adjustment expense data and to paid loss and allocated loss adjustment expense data.
Twice a year, the actuary makes recommendations of a range of the ultimate loss estimate to our Board of Directors, which for each period has selected ultimate loss estimates that fall within that range. Based on this practice, the estimated loss ratio has been updated by the Board of Directors at least once each year, and has historically been near the high end of the range.
The above table of losses re-estimated has been prepared on a net basis-i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up. The table has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the costs of providing such information relative to any benefits of providing it.
The above table presents the development of balance sheet liabilities for 1998 through 2008 as of year-end 2008. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all prior years, both paid and unpaid at the balance sheet date, including losses that had been incurred, but not yet reported, to the Company. The upper portion of the table shows the experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
The amounts included for unpaid losses and loss adjustment expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, see “Losses and Loss Adjustment Expenses” beginning page 25. Due to the inherent uncertainty in the process of estimating the timing of these payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash, investments and future premium income.
AmerInst Insurance Group, Ltd., (“AmerInst” or the “Company”) was formed under the laws of Bermuda in 1998. The Company, through its wholly-owned subsidiary AmerInst Insurance Company, Ltd. (“AMIC Ltd.”) and its predecessor AmerInst Insurance Company, Inc. (“AIIC Inc.”), has been engaged in the reinsurance of claims-made insurance policies of participants in an American Institute of Certified Public Accountants (“AICPA”) sponsored insurance program that provides accountants’ professional liability insurance coverage (“AICPA Plan”).
However, as further discussed under Note 12 -Subsequent Events, CNA, through whom we have access to the AICPA Plan, has notified us in writing of its intent not to renew its agreement with us after the end of 2009. The Company is currently in commutation and rescission negotiations with CNA, but the outcome is uncertain.
AMIC Ltd. entered into an excess of loss arrangement with Professional Direct Insurance Company (“PDIC”) for a 15% quota share participation in the 1st excess layer of $500,000 excess of $500,000 of the attorneys’ professional liability coverage provided by PDIC. The participation commenced January 1, 2003 and terminated December 31, 2003.
Effective June 1, 2005, AMIC Ltd. entered into a 5% share in CAMICO Mutual Insurance Company’s first excess layer of $2,000,000 excess of $1,000,000. CAMICO is a California-based writer of accountants’ professional liability business. This contract renewed on June 1, 2006 and further renewed on June 1, 2007 with AMIC Ltd. entering into a 2.5% share of the $4 million excess $1 million layer of risk. Effective June 1, 2008, the contract renewed for similar expiring terms.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of AmerInst and its operating wholly-owned subsidiaries, AmerInst Mezco, Ltd. (“Mezco”), AMIC Ltd. and AmerInst Investment Company, Ltd. (“Investco”). Intercompany accounts and transactions have been eliminated on consolidation.
The availability of observable inputs can vary from investment instrument to investment instrument and is affected by a wide variety of factors, including, for example, the type of investment, whether the investment is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified between levels.
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133 (“FAS 161”). FAS 161 expands the disclosure requirements of FAS 133 and requires the reporting entity to provide enhanced disclosures about the objectives and strategies for using derivative instruments, quantitative disclosures about fair values and amounts of gains and losses on derivative contracts, and credit-risk related contingent features in derivative agreements. FAS 161 will be effective for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of FAS 161 is not expected to have a significant impact on our financial statements.
In February 2007, FASB issued FAS 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. The fair value option established will permit all entities to choose to measure eligible items at fair value at specified election dates. An entity shall record unrealized gains and losses on items for which the fair value option has been elected through net income in the statement of operations at each subsequent reporting date. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company decided not to adopt FAS 159.
Pursuant to the reinsurance agreements, AMIC Ltd. is required to provide the ceding companies with collateral for AMIC Ltd.’s liabilities to them. At December 31, 2008 and 2007 $113,382 was held in deposits pursuant to the 2003 excess reinsurance agreement with PDIC. Also at December 31, 2008 and 2007, the carrying value of investments in a trust account held by Bank of New York pursuant to reinsurance agreements in effect from 1989 to mid-1993 was $2,256 and $2,038, respectively. Additionally, at December 31, 2008 and 2007, AMIC Ltd. had provided CNA with a Section 114 Trust, held by JPMorgan Chase Bank, with restricted cash and cash equivalents and investments with a carrying value of $24,343,002 and $23,160,559, respectively. At December 31, 2008 and 2007 AMIC Ltd. provided CAMICO with a Letter of Credit held by National City Bank with supporting investments with a carrying value of $4,019,995 and $4,370,598, respectively.
The cost or amortized cost, gross unrealized holding gains and losses, and estimated fair value of investments in fixed maturity investments, by major security type, and equity securities at December 31, 2008 and 2007 are as follows:
Details of the liability for unpaid losses and loss adjustment expenses and related reinsurance recoveries receivable at December 31, 2008 and 2007 are as follows:
Premiums written were $8,393,705 and $7,681,860 during 2008 and 2007, respectively.
AmerInst, AMIC Ltd., Mezco and Investco have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. Cedar Management Limited provides AmerInst and AMIC Ltd. certain management, administrative and operations services under the direction of AmerInst’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party upon not more than 90 days nor less than 60 days prior written notice. Mr. Grayston, a director and President of the Company, and Mr. McMahon, Vice President and Treasurer of the Company, are Vice President and President of Cedar Management Limited, respectively. The company paid $265,000 and $235,000 in fees pursuant to this agreement during 2008 and 2007, respectively. Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $590,115 in 2008 and $507,648 in 2007.
Under the Bermuda Companies Act, AmerInst is prohibited from declaring or paying a dividend as at December 31, 2008 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. In addition, it must be able to pay its liabilities as they come due after the payment of a dividend. As at December 31, 2008, approximately $20 million was available to shareholders in accordance with these provisions.
AmerInst’s ability to pay common shareholders’ dividends and its operating expenses is dependent on cash dividends from AMIC Ltd. including its subsidiary, Investco (collectively the “reinsurance subsidiaries”). The payment of such dividends by the reinsurance subsidiaries to AmerInst is limited under Bermuda law by the Bermuda Insurance Act 1978 and Related Regulations, as amended, which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2008 and 2007 these requirements have been met. The minimum required statutory capital and surplus was $3,662,424 and $4,111,443 and actual statutory capital and surplus was $24,632,564 and $25,135,361 at December 31, 2008 and 2007, respectively. The minimum required level of relevant assets was $29,227,476 and $32,946,033 and actual relevant assets was $66,540,279 and $69,063,405 at December 31, 2008 and 2007, respectively. Statutory income for the years ended December 31, 2008 and 2007 was $4,668,499 and $2,440,824.
AmerInst has two operating segments: 1) reinsurance activity and 2) RINITS™, its insurance financing product, which is in the marketing phase of development. The results for the reinsurance activity were as follows:
The RINITS™ segment offers a mechanism to securitize insurance and reinsurance risk, involving property, casualty, life and health lines of insurance. This segment as of December 31, 2008, had generated no revenue. Operating and management expenses are as follows: