Kemper leases facilities with an aggregate square footage of approximately 237,000 at 8 locations in 8 states. The latest expiration date of the existing leases is in September of 2018.
Fireside Bank leases 3 facilities, of which 2 are occupied, with an aggregate square footage of approximately 92,000 in 2 states. The latest expiration date of the existing leases is in August of 2016.
Unitrin Direct leases facilities with an aggregate square footage of approximately 321,000 at 12 locations in 8 states. The latest expiration date of the existing leases is in September of 2015.
Kemper, Unitrin Specialty and Unitrin Direct share leased facilities with an aggregate square footage of approximately 99,000 at 3 locations in 3 states. The latest expiration date of the existing leases is in September of 2018.
(a) In 2007, the Company’s Shareholders’ Equity was decreased by $3.2 million for the Company’s pro rata share of the impact of Intermec’s (the Company’s Investee) changes in measuring and reporting postretirement benefits plans and accounting for uncertain income taxes.
(b) In 2006, the Company’s Shareholders’ Equity was decreased by $7.3 million due to changes in measuring and reporting postretirement benefits plans.
Net Income was $164.7 million ($2.64 per unrestricted common share) for the year ended December 31, 2009, compared to Net Loss of $29.6 million ($0.47 per unrestricted common share) for the year ended December 31, 2008. Net income from Continuing Operations was $162.2 million ($2.60 per unrestricted common share) in 2009, compared to Net loss from Continuing Operations of $38.0 million ($0.60 per unrestricted common share) in 2008. As discussed throughout this MD&A, results from continuing operations increased for the year ended December 31, 2009 due primarily to higher segment operating results in the aggregate, including lower catastrophe losses and higher Net Investment Income, and lower Net Impairment Losses Recognized in Earnings, partially offset by lower Net Realized Gains on Sales of Investments. Catastrophe losses from continuing operations were $43.5 million before tax for the year ended December 31, 2009, compared to $144.9 million for the same period in 2008. The Company reported Income from Discontinued Operations of $2.5 million and $8.4 million for the years ended December 31, 2009 and 2008, respectively.
Earned Premiums were $2,455.5 million in 2009, compared to $2,376.6 million in 2008, an increase of $78.9 million. Earned Premiums increased primarily in the Unitrin Direct, which includes premiums from the acquisition of Direct Response, and Unitrin Specialty segments and decreased in the Life and Health Insurance segment.
Automobile Finance Revenues decreased by $63.8 million in 2009, compared to 2008, due to Fireside Bank’s plan to exit the automobile finance business.
Catastrophe reinsurance premiums for the Company’s primary reinsurance programs and the FHCF reduced earned premiums for the years ended December 31, 2009, 2008 and 2007 by the following:
Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $18.4 million for the year ended December 31, 2009. Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed adversely by $4.8 million for the year ended December 31, 2008. Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $4.6 million for the year ended December 31, 2007. No major hurricanes that significantly impacted the Company made landfall in the United States during 2009 or 2007. In the third quarter of 2008, three major hurricanes that significantly impacted the Company (Dolly, Gustav and Ike) made landfall in the United States. A summary of the Company’s estimated losses and LAE, net of reinsurance recoveries, from Hurricanes Dolly, Gustav and Ike reported in the Company’s Consolidated Statements of Operations for the year ended December 31, 2008 by business segment were:
Net Investment Income in the Kemper Segment increased by $23.0 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher net investment income from Equity Method Limited Liability Investments, partially offset by a lower level of investments. The Kemper segment reported net investment income of $7.0 million from Equity Method Limited Liability Investments for the year ended December 31, 2009, compared to net investment losses of $17.4 million in 2008.
Homeowners insurance catastrophe losses and LAE (excluding loss and LAE reserve development) were $38.8 million for the year ended December 31, 2009, compared to $90.4 million for the same period in 2008. Catastrophe losses and LAE decreased for the year ended December 31, 2009 due primarily to no major hurricanes occurring in 2009, compared to the aforementioned major hurricanes in 2008, and, to a lesser extent, a decrease in the frequency and severity of wind and hail storms in the first half of 2009, compared to the same period in 2008. Favorable catastrophe loss and LAE reserve development was $17.5 million for the year ended December 31, 2009, compared to a favorable development of $5.2 million for the same period in 2008. Catastrophe loss and LAE reserve development for the year ended December 31, 2009 included favorable development of $8.7 million on Hurricanes Ike and Gustav, both of which occurred in 2008, and $3.1 million of higher subrogation recoveries from certain California wildfires, which occurred in 2007.
Automobile insurance incurred losses and LAE were $409.6 million for the year ended December 31, 2009, compared to $393.5 million for the same period in 2008. Automobile insurance incurred losses and LAE increased due primarily to lower favorable loss and LAE reserve development and higher incurred non-catastrophe losses and LAE, partially offset by lower catastrophe losses and LAE (excluding loss and LAE reserve development). Loss and LAE reserve development on automobile insurance had a favorable effect of $32.5 million for the year ended December 31, 2009, compared to a favorable effect of $48.2 million for the same period in 2008. Non-catastrophe losses and LAE increased due primarily to higher severity on automobile liability claims. Automobile insurance catastrophe losses and LAE (excluding loss and LAE reserve development) were $6.6 million for the year ended December 31, 2009, compared to $8.8 million for the same period in 2008.
Net Investment Income in the Kemper segment decreased by $24.9 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to lower net investment income from Equity Method Limited Liability Investments. The Kemper segment reported a net investment loss of $17.4 million from Equity Method Limited Liability Investments for the year ended December 31, 2008, compared to net investment income of $2.4 million for the same period in 2007.
Operating Profit in the Kemper segment decreased by $80.6 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to higher incurred losses and LAE and lower Net Investment Income.
Incurred Losses and LAE increased for the year ended December 31, 2008, compared to the same period in 2007, due primarily to higher catastrophe losses and LAE, partially offset by lower non-catastrophe losses and LAE and higher favorable loss and LAE reserve development. Catastrophe losses and LAE (including development) were $97.4 million for the year ended December 31, 2008, compared to $27.8 million for the same period in 2007. The Kemper segment recognized catastrophe losses, totaling $40.6 million, from Hurricanes Dolly, Gustav and Ike in 2008. There were no major hurricane catastrophe losses in 2007. Catastrophe losses for the year ended December 31, 2008 also increased due to higher frequency and severity of wind and hail storms in the first half of 2008, compared to the same period in 2007. Loss and LAE reserve development had a favorable effect of $61.0 million (including favorable development of $5.8 million for catastrophes for the year ended December 31, 2008), compared to a favorable effect of $54.2 million (including favorable development of $11.6 million for catastrophes) for the same period in 2007.
primarily to the aforementioned hurricanes and increased frequency and severity of wind and hail storms. Loss and LAE reserve development on homeowners insurance had a favorable effect of $13.5 million (including favorable development of $5.2 million for catastrophes) for the year ended December 31, 2008, compared to a favorable effect of $22.5 million (including favorable development of $10.6 million for catastrophes) in 2007.
Earned Premiums in the Unitrin Specialty segment increased by $33.5 million for the year ended December 31, 2009, compared to the same period in 2008, due to higher earned premiums on personal automobile insurance, partially offset by lower earned premiums on commercial automobile insurance. Personal automobile insurance earned premiums increased by $57.5 million for the year ended December 31, 2009, compared to the same period in 2008, due to higher volume, partially offset by lower average earned premium rates. Personal automobile insurance volume increased due primarily to a higher level of renewal policies resulting from the Unitrin Specialty segment’s significant growth in 2008 in California. Unitrin Specialty’s growth rate in personal automobile insurance volume has slowed and management expects that earned premiums will decrease slightly in 2010 due to lower volume during the latter part of 2009 and lower volume expected during the first half of 2010. Commercial automobile insurance earned premiums decreased by $24.0 million for the year ended December 31, 2009, compared to the same period in 2008, due to lower volume, partially the result of increased competition and, to a lesser extent, lower average earned premium rates. In the fourth quarter of 2008 and throughout 2009, Unitrin Specialty implemented several initiatives targeted to stabilize commercial automobile premium volume, including the introduction of a new commercial insurance product for light commercial vehicles, a reduction in down payment requirements for certain commercial automobile insurance risks and the introduction of improved internet-enabled commercial lines rating technology. While these initiatives appear to have stabilized new business production, commercial automobile insurance premium volume decreased for the year ended December 31, 2009, compared to the same period in 2008, due primarily to a lower level of renewal policies. Unitrin Specialty’s management expects commercial automobile insurance earned premiums to continue to decline in 2010, but at a slower pace than experienced in 2009.
Net Investment Income in the Unitrin Specialty segment increased by $12.2 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher net investment income from Equity Method Limited Liability Investments. The Unitrin Specialty segment reported net investment income of
$3.5 million from Equity Method Limited Liability Investments for the year ended December 31, 2009, compared to net investment losses of $7.9 million for the same period in 2008.
Commercial automobile insurance operating profit increased by $8.4 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher favorable loss and LAE reserve development, higher net investment income allocated to commercial automobile insurance and lower incurred losses and LAE (excluding development) as a percentage of commercial automobile insurance earned premiums. Loss and LAE reserve development on commercial automobile insurance had a favorable effect of $5.4 million for the year ended December 31, 2009, compared to a favorable effect of $1.3 million for the same period in 2008. Net investment income allocated to commercial automobile insurance increased by $2.9 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher investment returns on Equity Method Limited Liability Investments partially offset by lower levels of investments. Incurred losses and LAE (excluding development) as a percentage of commercial automobile insurance earned premiums decreased for the year ended December 31, 2009, compared to the same period in 2008, due primarily to lower severity and, to a lesser extent, lower frequency of losses.
Net Income in the Unitrin Specialty segment increased by $13.4 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to the higher operating profit. The Unitrin Specialty
segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.5 million for the year ended December 31, 2009, compared to $11.2 million for the same period in 2008.
Earned Premiums in the Unitrin Specialty segment increased by $44.7 million for the year ended December 31, 2008, compared to the same period in 2007, due to higher earned premiums on personal automobile insurance, partially offset by lower earned premiums on commercial automobile insurance. Personal automobile insurance earned premiums increased by $70.7 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to higher volume, partially offset by lower average earned premium rates. Personal automobile insurance volume increased due primarily to lower overall premium rates in the state of California. Commercial automobile insurance earned premiums decreased by $26.0 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to lower volume resulting from increased competition.
Operating Profit in the Unitrin Specialty segment decreased by $25.1 million for the year ended December 31, 2008, compared to 2007, due primarily to higher incurred losses and LAE as a percentage of earned premiums in both personal automobile insurance and commercial automobile insurance and the lower Net Investment Income. Unitrin Specialty’s incurred losses related to Hurricanes Dolly, Gustav and Ike were $1.5 million. See MD&A, “Catastrophes,” and Note 22, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for additional information on Hurricanes Dolly, Gustav and Ike and the Company’s catastrophe reinsurance programs.
Net Income in the Unitrin Specialty segment decreased by $16.9 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to the lower Operating Profit. The Unitrin Specialty segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.2 million for the year ended December 31, 2008, compared to $11.4 million for the same period in 2007.
On February 13, 2009, the Company completed its acquisition of Direct Response in a cash transaction. Direct Response specializes in the sale of personal automobile insurance through direct mail and the Internet through web insurance portals and its own websites, Response.com and Teachers.com. The results for Direct Response are included in the Unitrin Direct business segment from the date of acquisition. Direct Response had earned premiums of $115.2 million from the date of acquisition through December 31, 2009. Unitrin Direct is in the process of combining its existing back office operations with those of Direct Response to further improve Unitrin Direct’s operating efficiencies over time. See Note 3, “Acquisitions of Businesses,” to the Consolidated Financial Statements for additional information pertaining to the acquisition of Direct Response.
Excluding the impact of the Direct Response acquisition, Earned Premiums in the Unitrin Direct segment decreased by $60.1 million for the year ended December 31, 2009, compared to the same period in 2008. During the second half of 2008, the Unitrin Direct segment began to moderate its marketing spending while modifying its direct mail marketing program to target a better response rate from customers with more favorable risk characteristics and place greater emphasis on improving Incurred Losses and LAE as a percentage of Earned Premiums through improved premium rate adequacy and improved insurance risk selection. The Unitrin Direct segment has implemented and continues to implement rate increases in most states, with more significant rate increases to be implemented for the Direct Response book of business. The Unitrin Direct segment has temporarily suspended writing new business using Direct Response’s distribution channels and insurance products until certain rate increases and product changes are implemented. The Unitrin Direct segment expects that its earned premiums will decline 10% to 20% in 2010 due largely to its efforts to improve premium rate adequacy and risk selection.
The Unitrin Direct segment reported an Operating Loss of $12.6 million for the year ended December 31, 2009, compared to an Operating Loss of $52.5 million for the same period in 2008. The operating loss for Direct Response was $7.0 million from the date of acquisition through December 31, 2009, which includes restructuring costs of $6.5 million and a charge of $1.5 million to write off goodwill. Excluding the impact of the Direct Response acquisition, the Unitrin Direct segment’s Operating Loss was $5.6 million for the year ended December 31, 2009, compared to an Operating Loss of $52.5 million for the same period in 2008. Excluding the impact of the acquisition of Direct Response, operating results in the Unitrin Direct segment improved for the year ended December 31, 2009, compared to the same period in 2008, due primarily to lower volume of unprofitable business, lower Incurred Losses and LAE and higher Net Investment Income.
Response acquisition) as a percentage of earned premiums improved in 2009 due primarily to the impact of the premium rate increases implemented in 2008 and 2009. Incurred Losses and LAE, excluding the impact of the Direct Response acquisition, decreased by $77.2 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to the lower volume of earned premiums and, to a lesser extent, the favorable impact of loss and LAE reserve development in 2009, compared to 2008, and the lower percentage of incurred losses and LAE to earned premiums. Favorable loss and LAE reserve development for the Unitrin Direct segment was $12.1 million for the year ended December 31, 2009, compared to adverse development of $3.2 million for the same period in 2008. See MD&A, “Critical Accounting Estimates,” for additional information pertaining to the Company’s process of estimating property and casualty insurance reserves for losses and LAE, development of property and casualty insurance losses and LAE and estimated variability of property and casualty insurance reserves for losses and LAE. Catastrophe losses and LAE, excluding the impact of the Direct Response acquisition, for the Unitrin Direct segment were $2.5 million for the year ended December 31, 2009, compared to $3.1 million for the same period in 2008. Catastrophe loss and LAE for Direct Response were $0.9 million from the date of acquisition through December 31, 2009.
Unitrin Direct reported a Net Loss of $5.3 million for the year ended December 31, 2009, compared to a Net Loss of $32.0 million for the same period in 2008. Excluding a net loss of $4.4 million from Direct Response from the date of the acquisition through December 31, 2009, the Unitrin Direct segment recorded a net loss of $0.9 million for the year ended December 31, 2009, compared to a net loss of $32.0 million for the year ended December 31, 2008. Net results in the Unitrin Direct segment improved due primarily to the improvements in operating results. Unitrin Direct’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $9.9 million for the year ended December 31, 2009, compared to $6.1 million for the same period in 2008.
As discussed above, the Unitrin Direct segment has implemented and continues to implement several initiatives to improve its operating results. As the Unitrin Direct book of business matures and premium rate increases for it and the Direct Response book of business are implemented at renewal dates and earned over the terms of the policies, the Company expects that Incurred Losses and LAE as a percentage of Earned Premiums for the renewal book of business will decrease. Unitrin Direct also continues to modify its marketing to attract customers with more favorable risk characteristics. Unitrin Direct anticipates its marketing spending will increase moderately in 2010, compared to 2009. The Unitrin Direct segment continues to adjust its operating scale by eliminating redundant back office operations and reducing staff. Unitrin Direct has closed certain office locations and also reduced staff, including staff at Direct Response, by approximately 30% in 2009. Total restructuring costs incurred related to these expense savings initiatives were $7.2 million for the year ended December 31, 2009. The Unitrin Direct segment anticipates that these initiatives will improve its operating results in 2010, compared to 2009. The Company expects Unitrin Direct to be profitable for the full year in 2010.
Insurance Expenses in the Unitrin Direct segment increased by $12.5 million in 2008 due primarily to the inclusion of a full year of expenses from the Merastar acquisition, costs associated with closing redundant back office operations and higher bad debt expense related to premium receivables.
Excluding the impact of the Primesco acquisition, Earned Premiums in the Life and Health Insurance segment decreased by $23.4 million for the year ended December 31, 2009, compared to the same period in 2008. Earned premiums on life insurance decreased by $8.6 million for the year ended December 31, 2009, due primarily to lower volume, partially offset by higher average premium rates. Earned premiums on accident and health insurance decreased by $2.8 million for the year ended December 31, 2009, as the volume of limited benefit medical and Medicare supplement products declined by $9.0 million, while higher average premium rates for those same products increased earned premiums by $6.2 million. Earned premiums on property insurance sold by the Life and Health Insurance segment’s career agents decreased by $12.0 million for the year ended December 31, 2009 due primarily to lower volume, due in part to the Life and Health Insurance segment’s strategy to reduce its catastrophe exposure through the non-renewal of dwelling coverage in certain coastal areas and the continued run-off of dwelling coverage in all other markets, partially offset by lower catastrophe reinsurance premiums.
Both the U. S. House of Representatives and the U.S. Senate passed separate, but not identical, bills in late 2009 which could effect sweeping changes to the American health care system. The Company currently estimates that more than half of its accident and health insurance earned premiums could be adversely affected in the event that some version of these bills is enacted into law. In particular, Reserve National’s business model, which focuses on providing limited health insurance coverages to persons who lack access to traditional private options, would likely be adversely affected. Depending on the provisions of any such law ultimately enacted, Reserve National might suffer significant loss of revenue and might not be able to compete effectively in the markets that it has historically served. In particular, a provision in both of the bills passed by the House and Senate which would establish minimum loss ratios for health insurance policies significantly above the levels historically experienced by Reserve National could adversely impact Reserve National’s ability to achieve an adequate return and may result in a significant loss of business for Reserve National. A significant loss of business could have a material adverse effect on the financial condition and results of operations of Reserve National and could adversely
Net Investment Income in the Life and Health Insurance segment increased by $63.2 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher net investment income from Equity Method Limited Liability Investments and $5.4 million of net investment income from Primesco in the first quarter of 2009 with no corresponding amount in same period in 2008, partially offset by lower net investment income from investments in fixed maturities and short-term investments due in part to lower volume resulting from extraordinary dividends paid by Unitrin’s Subsidiaries, Union National Life and Reliable, to Unitrin and certain other intercompany transactions in 2009. The Life and Health Insurance segment reported net investment income of $31.6 from Equity Method Limited Liability Investments for the year ended December 31, 2009, compared to net investment losses of $38.3 million for the same period in 2008.
Operating Profit in the Life and Health Insurance segment increased by $89.2 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to the higher net investment income and lower catastrophe losses and LAE, net of reinsurance, on property insurance sold by the Life and Health Insurance segment’s career agents, and lower insurance expenses partially offset by higher policyholders’ benefits and incurred losses as a percentage of earned premiums on life insurance and, to a lesser extent, Medicare supplement products. Policyholders’ Benefits and Incurred Losses and LAE decreased by $23.9 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to lower catastrophe losses and LAE, net of reinsurance, on property insurance, partially offset by higher policyholders’ benefits and incurred losses as a percentage of earned premiums on life insurance and, to a lesser extent, accident and health insurance. Catastrophe losses and LAE, net of reinsurance, (including development) were $6.6 million for the year ended December 31, 2009, compared to $41.5 million for the same period in 2008. No hurricanes occurred during 2009 that impacted the Life and Health Insurance segment. Catastrophe losses and LAE, net of reinsurance, for the year ended December 31, 2008 included losses of $22.8 million from three hurricanes (Dolly, Gustav and Ike) that occurred in the third quarter of 2008. Adverse loss reserve development on property insurance was $2.6 million (including favorable development of $0.1 million on catastrophes) for the year ended December 31, 2009, compared to adverse development of $13.7 million (including adverse development of $11.0 million on catastrophes) in the same period in 2008. The Life and Health Insurance segment has a number of pending legal matters related to catastrophes and storms, including Hurricanes Dolly, Rita, Katrina and Ike, and could continue to report either favorable or unfavorable catastrophe reserve development in future periods depending on the resolution of these matters. See Note 25, “Contingencies, to the Consolidated Financial Statements.” Policyholders’ benefits and incurred losses as a percentage of earned premiums on life insurance increased due to a lower level of policy lapses for the year ended December 31, 2009, compared to the same period in 2008. When a life insurance policy lapses, the reserve for future policyholder benefits reported on the balance sheet is reduced and a corresponding reduction in policyholders’ benefits expense is reported on the income statement.
Insurance Expenses in the Life and Health Insurance segment decreased by $13.3 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to lower amortization of policy acquisition costs, due in part to the lower level of policy lapses, and lower expense related to home and field office operations, partially offset by the inclusion of insurance expense from Primesco in the first quarter of 2009 with no corresponding amount in the first quarter of 2008. After the 2008 acquisition of Primesco, the Life and Health Insurance segment incurred certain redundant expenses associated with maintaining Primesco’s home office and has focused on eliminating these redundant expenses by consolidating the Primesco home office operations into the Career Agency Companies home office. The consolidation of the two home offices was substantially completed during the first quarter of 2009 and has resulted in lower home office expenses as a percentage of earned premiums from the additional scale provided by the acquisition.
Excluding the impact of the Primesco acquisition, Earned Premiums in the Life and Health Insurance segment decreased by $29.7 million for the year ended December 31, 2008, compared to the same period in 2007. Earned premiums on life insurance decreased by $18.6 million for the year ended December 31, 2008 due primarily to lower volume. Earned premiums on accident and health insurance decreased by $3.2 million for the year ended December 31, 2008, as the volume of limited benefit medical and Medicare supplement products declined by $8.2 million, while higher average premium rates for those same products increased earned premiums by $5.0 million. Earned premiums on property insurance sold by the Life and Health Insurance segment’s career agents decreased by $7.9 million for the year ended December 31, 2008 due primarily to lower volume, due in part to the Company’s strategy to reduce coastal exposures, and higher catastrophe reinsurance premiums. As discussed above, the Life and Health Insurance segment has taken several actions to reduce its exposure to catastrophe risks over the past several years. Catastrophe reinsurance premiums, which reduce the Life and Health Insurance segment’s earned premiums on property insurance, included a reinsurance premium of $4.4 million in 2008 to reinstate catastrophe reinsurance coverage following Hurricanes Dolly, Gustav and Ike. Excluding the impact of the reinsurance reinstatement premium, catastrophe reinsurance premiums decreased by $2.7 million due primarily to the Company’s strategy to reduce costal exposures.
On March 24, 2009, Unitrin announced that Fireside Bank would be suspending all new lending activity as part of a plan to exit the automobile finance business. The exit plan envisions an orderly wind-down of Fireside Bank’s operations over the next several years. Fireside Bank will continue to collect outstanding loan balances and make interest payments and redemptions on outstanding certificates of deposits in the ordinary course of business. Following the announcement, Fireside Bank ceased accepting new loan applications. Fireside Bank also has ceased opening new certificate of deposit accounts. Fireside Bank closed all of its branch offices during 2009. Fireside Bank’s remaining operations are conducted from its home office housing a collection call center
While in its early stages, the exit plan thus far has favorably exceeded the Company’s expectations. Net Automobile Loan Receivables Outstanding has declined steadily to $744.1 million at December 31, 2009 from $1,125.2 million at March 31, 2009, while Certificates of Deposits declined to $682.4 million at December 31, 2009 from $1,054.4 million at March 31, 2009. Fireside Bank’s cash and investments totaled $214.0 million, or 31.4% of Certificates of Deposits at December 31, 2009, compared to $204.7 million, or 19.4% of Certificates of Deposits at March 31, 2009. The Company expects that the amount of Automobile Loan Receivables and the amount of Certificates of Deposits outstanding will decline substantially in 2010 while the Fireside Bank segment records approximately break-even bottom line results. Fireside Bank’s ratio of Tier 1 capital to total average assets increased from 15.6% at March 31, 2009 to 21.3% at December 31, 2009. The Company expects Fireside Bank’s ratio of Tier 1 capital to total average assets will continue to remain well above regulatory requirements throughout 2010.
continue to decline as the loan portfolio declines, delinquency as a percentage of loans outstanding may increase compared to the same periods in prior years. Fireside Bank has historically had many customers who have fallen behind one or two loan payments, but have continued to make regular monthly payments. Fireside Bank expects that the number of these delinquent, but regularly paying, customers will decline at a slower pace than the overall loan portfolio and, accordingly, will comprise a greater percentage of the loan portfolio over time. The Reserve for Loan Losses as a percentage of Net Automobile Loan Receivables was 11.2% at December 31, 2009, compared to 10.0% at December 31, 2008. The Reserve for Loan Losses was $83.3 million at December 31, 2009, while Delinquent Loan Balances 30 Days or greater totaled $76.1 million. The Reserve for Loan Losses was $120.1 million at December 31, 2008, while Delinquent Loan Balances 30 Days or greater totaled $147.8 million.
Interest Expense on Certificates of Deposits decreased by $15.2 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to lower levels of deposits.
The Fireside Bank segment reported a Net Loss of $5.3 million for the year ended December 31, 2009, compared to a Net Loss of $22.3 million in 2008. Income tax expense for the year ended December 31, 2009 included tax expense of $6.0 million for an increase in the valuation allowance for deferred state income taxes, net of federal benefit, due primarily to the decision to exit the automobile finance business. Income tax expense for the year ended December 31, 2008 included tax expense of $3.6 million to establish a valuation allowance for deferred state income taxes, net of federal benefit. The Fireside Bank segment’s effective tax rate differs from the Federal statutory tax rate due primarily to state income taxes and also the write-off of Goodwill in 2008.
The Provision for Loan Losses decreased by $56.8 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to the reduced level of Automobile Loan Originations, partially offset by the impact of additions to the Reserve for Loan Losses for automobile loans originated in prior years.
The Fireside Bank segment reported an Operating Loss of $25.3 million in 2008, compared to an Operating Loss of $66.0 million in 2007. The Provision for Loan Losses was $110.0 million in 2008, compared to $166.8 million in 2007.
Net Loss in the Fireside Bank segment declined from $38.8 million for the year ended December 31, 2007 to $22.3 million for the year ended December 31, 2008 due to the lower operating loss. Income tax expense for the year ended December 31, 2008 included tax expense of $3.6 million to establish a valuation allowance for deferred state income taxes, net of federal benefit. The Fireside Bank segment’s effective tax rate differs from the Federal statutory tax rate due primarily to state income taxes and also the write-off of goodwill in 2008.
Total Comprehensive Investment Gains (Losses) are comprised of Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Operations and unrealized investment gains and losses that are not reported in the Consolidated Statements of Operations, but rather are reported in the Consolidated Statements of Comprehensive Income (Loss). The components of Total Comprehensive Investment Gains (Losses) for the years ended December 31, 2009, 2008 and 2007 were:
The Company’s fixed maturity investment portfolio is comprised primarily of high-grade municipal, corporate and agency bonds. At December 31, 2009, nearly 95% of the Company’s fixed maturity investment portfolio was rated investment grade, which is defined as a security having a rating of AAA, AA, A or BBB from S&P; a rating of Aaa, Aa, A or Baa from Moody’s; or a rating from the NAIC of 1 or 2. The Company has not made significant investments in securities that are directly or indirectly related to sub-prime mortgage loans including, but not limited to, collateralized debt obligations and structured investment vehicles.
The following table summarizes the fair value of the Company’s investments in Fixed Maturities by industry at December 31, 2009 and 2008:
The Company has exposure to the residential mortgage industry primarily by virtue of its investments in Government National Mortgage Association (“Ginnie Mae”), Fannie Mae, Federal Home Loan Banks (“FHLB”), U.S. Department of Housing and Urban Development (“HUD”) and Freddie Mac. The fair value of the Company’s investments in fixed maturities issued by Ginnie Mae, Fannie Mae, FHLB, HUD and Freddie Mac were $270.3 million, $104.7 million, $62.3 million, $16.6 million and $4.3 million, respectively, at December 31, 2009. Fannie Mae, FHLB and Freddie Mac are each U.S. government-sponsored and federally-chartered entities, which were privately capitalized, whereas HUD and Ginnie Mae are U.S. government-owned corporations. Securities issued by HUD and Ginnie Mae are backed by the full faith and credit of the U.S. government. On September 7, 2008, Fannie Mae and Freddie Mac were placed in conservatorship. Approximately 72% of the Company’s investments in the fixed maturities of Fannie Mae, FHLB and Freddie Mac are in general obligations issued by Fannie Mae, FHLB and Freddie Mac, with the balance invested in various mortgage-backed securities (“MBS”). While each general obligation is fixed in its maturity, 88% of the Company’s investments in these general obligations are callable by the issuer prior to their maturity. In contrast, principal payments of MBS securities vary with the underlying mortgages associated with them. The Company has no exposures to interest-only or principal-only investment strips. The Company’s investments in Ginnie Mae securities consist of various mortgage pools and pass-through certificates. Ginnie Mae guarantees the payment of principal and interest on these securities, which vary with the underlying mortgages. In addition to the Company’s investments in Fannie Mae, Ginnie Mae, FHLB, HUD and Freddie Mac securities, the Company had investments in other U.S. government sponsored or owned corporations totaling $12.4 million at December 31, 2009. At December 31, 2009, the Company also owned $5.0 million of MBS issued by private companies, of which $1.6 million where the underlying collateral may be considered sub-prime.
products and services are used by customers in many industries to improve productivity, quality and responsiveness of business operations, from supply chain management and enterprise resource planning to field sales and service. Intermec’s products and services are sold globally to a diverse set of customers in markets such as manufacturing, warehousing, direct store delivery, retail, consumer goods, field services, government, security, healthcare, transportation and logistics. Based on shares outstanding reported in Intermec’s quarterly report on Form 10-Q for the quarter ended September 30, 2009, the Company owned 20.3% of Intermec’s common stock at December 31, 2009. Accordingly, the Company accounts for its investment in Intermec under the equity method of accounting. The Company reports its investment in Intermec at cost plus accumulated undistributed comprehensive earnings, rather than fair value, in the Consolidated Balance Sheet. The fair value of the Company’s investment in Intermec exceeded this carrying value by $64.4 million at December 31, 2009.
Highbridge is a limited partnership that specializes in arbitrage and absolute return investment strategies in the global equity and corporate debt securities markets and indirectly invests in funds that purchase and sell equities, futures, swaps, forward currency contracts, exchange traded and over-the-counter options, warrants, and both convertible and non-convertible corporate bonds. On October 23, 2008, the Company submitted a full redemption notice to the Highbridge general partner. On November 21, 2008, the general partner notified the Company that the general partner was imposing a restriction on the redemption of certain assets representing 70% of the Company’s investment in Highbridge and that such assets would not be redeemed currently, but rather would be redeemed over several periods. The Company’s investment in Highbridge, which is reported in Equity Securities in the Consolidated Balance Sheet, was $17.7 million at December 31, 2008. During 2009, the Company received redemption proceeds from the Highbridge general partner totaling $15.8 million, of which $5.4 million were proceeds representing the Company’s share of the unrestricted assets of Highbridge and $10.4 million were proceeds representing the Company’s share of the restricted assets of Highbridge. The Company reported a realized gain on the redemptions of $0.9 million for the year ended December 31, 2009.
In addition, at December 31, 2009 the Company had unfunded commitments of $65.9 million for investments in limited liability investment companies and limited partnerships that are not accounted for under the equity method of accounting.
Interest and Other Expenses was $61.9 million, $58.5 million and $66.9 million for the years ended December 31, 2009, 2008 and 2007, respectively. Interest expense, excluding interest on a mortgage note payable included in real estate investment expense, was $32.5 million, $32.2 million and $33.2 million for the years ended December 31, 2009, 2008 and 2007, respectively. Other Corporate Expenses were $29.4 million, $26.3 million and $33.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. Other Corporate Expenses increased by $3.1 million for the year ended December 31, 2009, compared to the same period in 2008, due primarily to higher compensation and higher interest cost on projected benefit obligations of postretirement benefit plans, net of expected return on plan assets. Other Corporate Expenses decreased by $7.4 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to lower compensation and employee benefit costs.
On June 24, 2005, Unitrin entered into the 2010 Credit Agreement, a five-year, $325 million, unsecured, revolving credit agreement, expiring June 30, 2010, with a group of financial institutions. The 2010 Credit Agreement was terminated on October 30, 2009 and replaced with the 2012 Credit Agreement described below. The 2010 Credit Agreement provided for fixed and floating rate advances for periods up to one year at various interest rates. The 2010 Credit Agreement also contained various financial covenants, including limits on total debt to total capitalization and minimum risk-based capital ratios for Unitrin’s largest insurance subsidiaries. Unitrin had no outstanding advances under the 2010 Credit Agreement at December 31, 2008. Undrawn letters of credit issued pursuant to the 2010 Credit Agreement were $13.1 million at December 31, 2008. Accordingly, the amount available for future borrowing was $311.9 million at December 31, 2008.
The lenders participating in the 2012 Credit Agreement, as of December 31, 2009, and their aggregate commitments are presented below:
On May 11, 2007, Unitrin issued $360 million of its 6.00% Senior Notes due May 15, 2017 for an effective yield of 6.19%. The 6.00% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at Unitrin’s option at specified redemption prices. Unitrin used the proceeds from the sale of the notes to repay the $300 million principal aggregate amount of its 5.75% Senior Notes which was due on July 1, 2007 and for general corporate purposes. Interest expense under the 6.00% Senior Notes was $22.0 million, $22.0 million and $14.1 million for the years ended December 31, 2009, 2008 and 2007, respectively.
In 2003, Unitrin issued $200 million of its 4.875% senior notes due November 1, 2010 (the “4.875% Senior Notes”) for an effective yield of 5.04%. The 4.875% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Unitrin’s option at specified redemption prices. Interest expense under the 4.875% Senior Notes was $10.1 million, $10.0 million and $10.0 million for the years ended December 31, 2009, 2008 and 2007, respectively.
Various state insurance laws restrict the ability of Unitrin’s insurance subsidiaries to pay dividends without regulatory approval. Such insurance laws generally restrict the amount of dividends paid in an annual period to the greater of statutory net income from the previous year or 10% of statutory capital and surplus. Unitrin’s direct insurance subsidiaries paid dividends consisting of $118.4 million in cash to Unitrin during 2009. In 2010, Unitrin estimates that its direct insurance subsidiaries would be able to pay $133 million in dividends to Unitrin without prior regulatory approval.
Fireside Bank also has ceased opening new certificate of deposit accounts. Unitrin currently expects to recover its $233 million investment in Fireside Bank over the next several years. Fireside Bank has agreed not to pay dividends without the prior approval of the FDIC and the CDFI. Fireside Bank is considering requesting approval to pay a dividend of approximately $75 million during the second half of 2010. The amount of dividend requested is subject to various factors including, but not limited to, Fireside Bank’s ratio of Tier 1 capital to total average assets, liquidity and continued success of its plan to exit the automobile finance business. The Company cannot give any assurance that any such dividend request will be approved.
Unitrin directly held cash and investments totaling $92.4 million at December 31, 2009, compared to $23.3 million at December 31, 2008. Unitrin intends to repay its 4.875% Senior Notes due November 1, 2010 in cash and reduce its leverage accordingly. Sources available for the repayment of indebtedness, future shareholder dividend payments, the repurchase of common stock and the payment of interest on Unitrin’s senior notes include cash and investments directly held by Unitrin, receipt of dividends from Unitrin’s subsidiaries and borrowings under the 2012 Credit Agreement.
At December 31, 2009, there were approximately 1.4 million shares of Unitrin’s outstanding common stock that could be repurchased under Unitrin’s outstanding repurchase authorization. Common stock may be repurchased in the open market or in privately negotiated transactions from time to time subject to market conditions and other factors. Unitrin did not repurchase shares of its common stock in 2009. Unitrin repurchased and retired approximately 2.0 million shares of its common stock in 2008 at a cost of $69.0 million. Unitrin’s has repurchased and retired approximately 62.8 million shares of its common stock in open market transactions at an aggregate cost of approximately $1.8 billion since 1990.
The primary sources of funds for Unitrin’s insurance subsidiaries are premiums and investment income. The primary uses of funds are the payment of policyholder benefits under life insurance contracts, claims under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses and the purchase of investments. Generally, there is a time lag between when premiums are collected and when policyholder benefits and insurance claims are paid. Accordingly, during periods of growth, insurance companies typically experience positive operating cash flows and are able to invest a portion of their operating cash flows to fund future policyholder benefits and claims. During periods in which premium revenues decline, insurance companies may experience negative cash flow from operations and may need to sell investments to fund payments to policyholders and claimants. In addition, if the Company’s property and casualty insurance subsidiaries experience several significant catastrophic events over a relatively short period of time, investments may have to be sold in advance of their maturity dates to fund payments, which could either result in investment gains or losses. Management believes that its property and casualty insurance subsidiaries maintain adequate levels of liquidity in the event that they experience several future catastrophic events over a relatively short period of time. The primary sources of funds for Fireside Bank are the repayments of automobile loans, interest on automobile loans and investment income. The primary uses of funds for Fireside Bank are the repayment of customer deposits, interest paid to depositors and general expenses.
Net Cash Used by Financing Activities increased by $145.9 million for the year ended December 31, 2009, compared to the same period in 2008. The Company has funded its Automobile Loan Receivables through the issuance of Certificates of Deposits. Net cash used by Certificates of Deposits withdrawals, net of Certificates of
Net Cash Provided by Investing Activities was $356.2 million for the year ended December 31, 2008, compared to Net Cash Used by Investing Activities of $222.9 million for the same period in 2007. Purchases of Fixed Maturities exceeded Sales of Fixed maturities by $237.6 million in 2008, while Sales and Maturities of Fixed Maturities exceeded purchases of fixed maturities by $179.0 million in 2007. Net cash provided by dispositions of short-term investments was $132.3 million for the year ended December 31, 2008, compared to net cash used to acquire short-term investments of $184.0 million for the same period in 2007. Cash used to acquire Equity Method Limited Liability Investments decreased by $9.6 million in 2008, compared to 2007. Automobile Loan Originations decreased by $247.2 million in 2008, compared to 2007. The repayment of automobile loan receivables decreased by $72.8 million in 2008, compared to 2007. Cash provided by sales of equity securities increased by $533.4 million in 2008, compared to 2007, due primarily to sales of the Company’s investments of Northrop common stock and the vast majority of other common stocks as the Company reduced its equity risk to further declines in the stock market in 2008. Cash used to purchase equity securities increased by $42.6 million in 2008, compared to 2007. The Company received proceeds of $68.8 million related to the disposition of its
Amounts included in Life and Health Insurance Policy Benefits within the contractual obligations table above represent the estimated cash payments to be made to policyholders and beneficiaries. Such cash outflows are based on the Company’s current assumptions for mortality, morbidity and policy lapse, but are undiscounted with respect to interest. Policies must remain in force for the policyholder or beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. The Company estimates that future cash inflows would total $3.9 billion using the same assumptions used to estimate the cash outflows. The Company’s Life Insurance Reserves in the Company’s Consolidated Balance Sheet are generally based on the historical assumptions for mortality and policy lapse rates and are on a discounted basis. Accordingly, the sum of the amounts presented above for Life and Health Insurance Policy Benefits significantly exceeds the amount of Life and Health Insurance Reserves reported on the Company’s Consolidated Balance Sheet at December 31, 2009.
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $116.7 million at December 31, 2009. The funding of such investment commitments is dependent upon a number of factors, the timing of which is indeterminate. The contractual obligations reported above also exclude the Company’s liability of $11.7 million for unrecognized tax benefits. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability. Other Contractual Obligations Reflected in Long Term Liabilities on the Consolidated Balance Sheet under GAAP primarily consist of interest obligations related to Long Term Debt Obligations and Certificates of Deposits.
Unitrin’s subsidiaries conduct their businesses in three industries: property and casualty insurance, life and health insurance and automobile finance. Accordingly, the Company is subject to several industry-specific accounting principles under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The process of estimation is inherently uncertain. Accordingly, actual results could ultimately differ materially from the estimated amounts reported in a company’s financial statements. Different assumptions are likely to result in different estimates of reported amounts. The Company’s critical accounting policies most sensitive to estimates include the valuation of investments, the valuation of property and casualty insurance reserves for losses and LAE, the valuation of the reserve for loan losses, the assessment of recoverability of goodwill and the valuation of pension benefit obligations.
The reported value of the Company’s investments was $6,023.8 million at December 31, 2009, of which $4,761.4 million, or 79%, was reported at fair value, $383.9 million, or 6%, was reported under the equity method of accounting, $223.6 million, or 4%, was reported at unpaid principal balance, $654.9 million, or 11%, was reported at cost or depreciated cost. Investment securities, in general, are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility risk. Accordingly, it is reasonably possible that changes in the fair values of the Company’s investments reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the financial statements. Also, it is reasonably possible that changes in the carrying values of the Company’s Equity Method Limited Liability Investments will occur in the near term and such changes could materially affect the amounts reported in the financial statements because these issuers follow specialized industry accounting rules which require that they report all of their investments at fair value.
The Company regularly reviews its investments for factors that may indicate that a decline in the fair value of an investment below its cost or amortized cost is other than temporary. Such reviews are inherently uncertain in that the value of the investment may not fully recover or may decline further in future periods resulting in realized losses. Some factors considered for fixed maturity and equity securities in evaluating whether or not a decline in fair value is other than temporary include, but are not limited to the following.
The Company determined whether declines in the fair values of investments below their cost or amortized cost were other than temporary based on these factors at December 31, 2009. Changes in these factors in future periods could result in additional impairments. Accordingly, the Company cannot anticipate when or if investment impairment losses may occur in the future.
The Company’s Property and Casualty Insurance Reserves are reported using the Company’s estimate of its ultimate liability for losses and LAE for claims that occurred prior to the end of any given accounting period but have not yet been paid. The Company had $1,211.3 million and $1,268.7 million of gross loss and LAE reserves at December 31, 2009 and 2008, respectively. Property and Casualty Insurance Reserves for the Company’s business segments at December 31, 2009 and 2008 were:
For each accident quarter, the point estimate selected by the Company’s actuaries is not necessarily one of the points produced by any particular one of the methodologies utilized, but often is another point selected by the Company’s actuaries, using their professional judgment, that takes into consideration each of the points produced by the several loss reserving estimation methodologies used. In some cases, for a particular product, the current accident quarter may not have enough paid claims data to rely upon, leading the Company’s actuaries to conclude that the incurred loss development methodology provides a better estimate than the paid loss development methodology. Therefore, the Company’s actuaries may give more weight to the incurred loss development methodology for that particular accident quarter. As an accident quarter ages for that same product, the actuary may gain more confidence in the paid loss development methodology and begin to give more weight to the paid loss development methodology. The Company’s actuaries’ quarterly selections are summed by product and/or coverage levels to create the actuarial indication of the ultimate losses. More often than not, the actuarial indication for a particular product line and accident quarter is most heavily weighted towards the incurred loss development methodology, particularly for short-tail lines such as personal automobile insurance. Historically, the incurred loss development methodology has been more reliable in predicting ultimate losses for
Medical costs including, but not limited to, the ability to assess the extent of injuries and the impact of inflation;
Repair costs including, but not limited to, the impact of inflation and the availability of labor and materials;
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s senior actuary and senior management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns, changes in the mix of business, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools. Total recorded reserves for property and casualty insurance losses and LAE were 0.9%, 1.2% and 2.0% higher than the actuarial indication of reserves at December 31, 2009, 2008 and 2007, respectively. Total recorded reserves for property and casualty insurance losses and LAE as a percentage of the actuarial indication of reserves decreased in 2009 and 2008 due primarily to the Company’s senior actuary and senior management placing greater reliance on the actuarial indications in determining the appropriate estimated level of reserves, due in part to the continued improvement in the actuarial indications in some product lines.
The Company’s goal is to ensure its total reserves for property and casualty insurance losses and LAE are adequate to cover all costs, while sustaining minimal variation from the time reserves for losses and LAE are initially estimated until losses and LAE are fully developed. Changes in the Company’s estimates of these losses and LAE over time, also referred to as “development,” will occur and may be material. Favorable development is recognized and reported in the consolidated financial statements when the Company decreases its previous estimate of ultimate losses and LAE and results in an increase in net income in the period recognized, whereas adverse development is recognized and reported in the consolidated financial statements when the Company increases its previous estimate of ultimate losses and LAE and results in a decrease in net income. The Company reported total favorable development of $80.9 million, $79.3 million and $101.1 million before tax for the years ended December 31, 2009, 2008 and 2007, respectively. Development for each of the Company’s continuing business segments and Unitrin Business Insurance for the years ended December 31, 2009, 2008 and 2007, was:
The Company’s actuaries use various generally accepted actuarial incurred and paid loss development methodologies to estimate unpaid losses and LAE. The key assumption in these estimation methodologies is that patterns observed in prior periods are indicative of how losses and LAE are expected to develop in the future and that such historical data can be used to predict and estimate ultimate losses and LAE. However, changes in a the Company’s business processes, by their very nature, are likely to affect the development patterns, which generally results in the historical development factors becoming less reliable over time in predicting how losses and LAE will ultimately develop. The ultimate impact of a single change in a business process is difficult to quantify and detect, and even more difficult if several changes to business processes occur over several years. Initially after a change is implemented, there are fewer data points, as compared to the historical data, for the Company’s actuaries to analyze. With fewer data points to analyze, the Company’s actuaries can not be certain
that observed differences from the historical data trends are a result of the change in business process or merely a random fluctuation in the data. As the Company’s actuaries observe more data points following the change in business process, the Company’s actuaries can gain more confidence in whether the change in business process is affecting the development pattern. The challenge for the Company’s actuaries is how much weight to place on the development patterns based on the older historical data and how much weight to place on the development patterns based on more recent data.
In 2005, a second wave of new claims handling procedures, which emphasized greater case reserve adequacy earlier in the lifecycle of a claim, began to occur in Kemper’s claims organization. The impact of this second wave of new claims handling procedures became visible in Kemper’s reserving data in late 2006 and early 2007 as evidenced by a dramatic rise in individual case loss reserve changes in excess of $100,000 at early claims maturity valuation points. The second wave of new claims handling procedures had the effect of producing higher average paid and incurred loss amounts for recent accident quarters than historical averages would otherwise indicate. This second wave of new claims handling procedures compounded the effects of the improvements from the first wave of changes in claims handling procedures on the emerging loss development patterns.
Kemper’s actuaries typically use a variety of five generally accepted actuarial loss reserving estimation methodologies-the incurred loss development methodology, the paid loss development methodology, the Bornhuetter-Ferguson incurred loss development methodology, Bornhuetter-Ferguson paid loss development methodology and the frequency and severity methodology. Kemper continues to experience various changes which impact numerous variables that are difficult to quantify and/or impact the predictive value of prior development patterns. Accordingly, in some cases, Kemper’s actuaries must make adjustments to these loss reserving estimation methodologies or use additional generally accepted actuarial loss reserving estimation methodologies until the development patterns fully emerge and Kemper’s actuaries can fully rely on the unadjusted methodologies. These changes have occurred over several years and the impact of some changes is more fully developed than it is for other changes. Accordingly, Kemper’s actuaries in some cases continue to place greater weight on certain emerging loss development trends, while in other cases placed greater weight on the adjusted loss reserving estimation methodologies or additional generally accepted actuarial loss reserving estimation methodologies in their actuarial indications. Beginning in 2007, the Company’s senior actuary and senior management began placing greater reliance on the actuarial indications in determining the appropriate estimated level of reserves.
In 2005, the personal lines claims function of Unitrin’s Multilines Insurance (“MLI”) unit was combined into the Kemper segment’s claims function. In September 2005, Kemper converted all open MLI personal lines claims to its claims system and began including new claims from the MLI business in its claim system.
Although development will emerge in all of Unitrin’s personal lines’ product lines, development in Kemper’s personal automobile insurance product line could have the most significant impact. To further illustrate the sensitivity of Kemper’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries estimated the impact of decreases in the cumulative development factors used in the incurred loss development methodology. For the most recent quarterly evaluation period, the Company assumed an average decrease of 10.9% in the cumulative development factor, gradually declining to an average decrease of 3.3% over the next 8 older evaluation quarters, gradually declining to average decrease of 0.4% over the next 15 older evaluation quarters and then gradually declining to 0.0% thereafter. Assuming that Kemper’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed decreases in the cumulative development factors, the Company estimates that Kemper’s automobile insurance loss and LAE reserves would have decreased by $72.0 million at December 31, 2009 for all accident years combined.
To further illustrate the sensitivity of Kemper’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries also estimated the impact of increases in the cumulative development factors used in the incurred loss development methodology. For the most recent quarterly evaluation period, the Company assumed an average increase of 10.9% in the cumulative development factor, gradually declining to an average increase of 3.3% over the next 8 older evaluation quarters, gradually declining to an average increase of 0.4% over the next 15 older evaluation quarters and then gradually declining to 0.0% thereafter. Assuming that Kemper’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed increases in the cumulative development factors, the Company estimates that Kemper’s automobile insurance loss and LAE reserves would have increased by $72.0 million at December 31, 2009 for all accident years combined.
actual loss developing closer to, or even below, the lower end of the Company’s estimated reserve variability. Significant negative changes in one or more factors will lead to negative loss reserve development, which could result in the actual loss developing closer to, or even above, the higher end of the Company’s estimated reserve variability. Accordingly, due to these factors and the other factors enumerated throughout the MD&A and the inherent limitations of the loss reserving estimation methodologies, the estimated and illustrated reserve variability may not necessarily be indicative of the Company’s future reserve variability, which could ultimately be greater than the estimated and illustrated variability. In addition, as previously noted, development will emerge in all of Unitrin’s product lines over time. Accordingly, the Company’s future reserve variability could ultimately be greater than the illustrated variability.
Additional information pertaining to the estimation of and development of the Company’s Property and Casualty Insurance Reserves is contained in Item 1 of Part I of this 2009 Annual Report on Form 10-K under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
Fireside Bank’s principal business was the financing of used automobiles through the purchase of sub-prime retail installment contracts from automobile dealers. Approximately 65% of Fireside Bank’s automobile loan portfolio is concentrated in loans to borrowers residing in California. The Reserve for Loan Losses is estimated using a variety of methodologies to project the ultimate charge-offs and recoveries of loans and is based on past experience adjusted for current economic conditions and regulatory requirements. Such charge-offs and recoveries emerge over a period of years. Accordingly, the Company’s actual ultimate net charge-offs could differ materially from the Company’s estimate due to a variety of factors including, but not limited to, trends and future conditions in the macroeconomic, socioeconomic and regulatory environment, the timing of charge-offs and recoveries, the value of collateral and changes in the overall credit quality of the loan portfolio. Actual net charge-off patterns may also differ materially from historical net charge-off patterns if there is a change in collection practices, the mix of loans or the credit quality of borrowers. A 100-basis point increase in the Company’s estimated ultimate rate of net charge-off would increase the Company’s Reserve for Loan Losses at December 31, 2009 by $15.3 million.
The process of determining whether or not an asset, such as Goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Such projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. In evaluating the recoverability of Goodwill, the Company performs a discounted cash flow analysis for each of the Company’s reporting units. The discounted cash value may be different from the fair value that would result from an actual transaction between a willing buyer and a willing seller. Such analyses are particularly sensitive to changes in discount rates and investment rates. Changes to these rates might result in material changes in the valuation and determination of the recoverability of Goodwill. For example, an increase in the rate used to discount cash flows will decrease the discounted cash value. There is likely to be a similar, but not necessarily as large as, increase in the investment rate used to project the cash flows resulting from investment income earned on the Company’s investments. Accordingly, an increase in the investment rate would increase the discounted cash value.
Goodwill for the Life and Health Insurance segment at December 31, 2009 includes goodwill of $14.8 million related to the Company’s Reserve National reporting unit. Reserve National focuses on providing limited health insurance coverages to persons who lack access to traditional private options. The U. S. House of Representatives and the U.S. Senate have passed separate, but not identical, bills in late 2009 which would effect sweeping changes to the American health care system. In the event that some version of these bills is enacted into law, the legislation could have a material adverse effect on the financial condition and results of operations of Reserve National and could impact the recoverability of the related goodwill. See MD&A, “Life and Health Insurance” and Note 7, “Goodwill,” to the Consolidated Financial Statements for a discussion of the potential impacts of health care reform legislation on Reserve National.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a one-percentage point decrease in the Company’s estimated discount rate would increase the pension benefit obligation at December 31, 2009 by $54.0 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2009 by $43.8 million. A one-percentage point decrease in the Company’s estimated long-term rate of return on plan assets would increase the pension expense for the year ended December 31, 2009 by $3.5 million, while a one-percentage point increase in the rate would decrease pension expense by $3.5 million for the same period.
On July 1, 2009, FASB Accounting Standards Codification™ (“ASC”) became the sole source of authoritative GAAP recognized by the Financial Accounting Standards Board (“FASB”) to be applied by nongovernmental entities for financial statements issued for interim and annual periods ending after September 15, 2009. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Except applicable SEC rules and regulations and a limited number of grandfathered standards, all other sources of GAAP for nongovernmental entities were superseded by the issuance of ASC. ASC did not change GAAP, but rather combined the sources of GAAP and the framework for selecting among those sources into a single source. Accordingly, the adoption of ASC had no impact on the Company.
FSP SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (codified into ASC Topic 320, Investments-Debt and Equity Securities);
SFAS No. 141(R), Business Combinations (codified into ASC Topic 805, Business Combinations);
FSP SFAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (codified into ASC Topic 805, Business Combinations);
SFAS No. 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60 (codified into ASC Topic 944, Financial Services-Insurance);
SFAS No. 165, Subsequent Events (codified into ASC Topic 855, Subsequent Events);
SFAS No. 166, Accounting for Transfers of Financial Assets-an amendment of FASB Statement No. 140 (a grandfathered standard under ASC);
SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (a grandfathered standard under ASC);
Consolidated Statements of Operations for the Years Ended December 31, 2009, 2008 and 2007
Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the Years Ended December 31, 2009, 2008 and 2007
Investments in Equity Securities include common and non-redeemable preferred stocks and other equity interests. Other equity interests primarily consist of partnership interests in limited liability partnerships which the Company’s interest is deemed minor. Investments in Equity Securities are classified as available for sale and reported at fair value.
Investment in Investee (Intermec) is accounted for under the equity method of accounting. The Company’s voting percentage and share of earnings or losses of an investee is determined using the most recent and sufficiently timely publicly available audited financial statements and subsequent unaudited interim reports, which results in accounting on a three-month-delay basis.
Gains and losses on sales of investments are computed on the specific identification method and are reported in the Consolidated Statements of Operations in the period in which the sales occur. The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Losses are computed on the specific identification method and reported in the Consolidated Statements of Operations in the period that the decline is determined to be other than temporary.
The Company accounts for the present value of the future profits embedded in life insurance in force acquired (“Life VIF”) based on actuarial estimates of the present value of estimated net cash flows. Life VIF is included in Deferred Policy Acquisition Costs in the Company’s Consolidated Balance Sheets. Life VIF is amortized using the effective interest method using interest rates consistent with the rates in the underlying insurance contracts. The Company estimates that it will record Life VIF amortization, net of interest, of $2.4 million, $2.2 million, $2.0 million, $1.8 million and $1.6 million in each of the next five years.
The cost of an acquired entity over the fair value of net assets acquired is reported as Goodwill. Goodwill is not amortized, but rather is tested annually for recoverability or when certain triggering events require testing.
Other Receivables primarily include amounts due from policyholders, reinsurance recoverables and accrued investment income. Other Assets primarily include property and equipment, prepaid expenses and the value of insurance licenses acquired. Accrued Expenses and Other Liabilities primarily include outstanding checks, accrued salaries and commissions, pension benefits, postretirement medical benefits and accrued taxes, licenses and fees.
Property and casualty insurance and health insurance premiums are deferred when written and recognized and earned ratably over the periods to which the premiums relate. Unearned Premiums represent the portion of the premiums written which has been deferred related to the unexpired portion of policies in force and is reported as a liability.
In the normal course of business, Unitrin’s insurance subsidiaries reinsure certain risks above certain retention levels with other insurance enterprises. These reinsurance agreements do not relieve Unitrin’s insurance subsidiaries of their legal obligations to the policyholder. Amounts recoverable from reinsurers for benefits and losses are included in Other Receivables.
Prior to the adoption of ASC, the Company adopted various standards which have been codified into ASC. A discussion of these standards, along with a reference to the ASC topics into which they have been codified and the effect of adoption on the Company follows.
In April 2009, the FASB issued FASB Staff Position (“FSP”) SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (codified into ASC Topic 320, Investments-Debt and Equity Securities). The standard amends the OTTI guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements. The standard does not amend existing recognition and measurement guidance related to OTTI of equity securities. On April 1, 2009, the Company adopted the standard and applied it prospectively. Accordingly, the Company recognized the cumulative effect of adoption as an increase of $2.9 million, net of tax of $1.6 million, to the Company’s Retained Earnings with an offsetting amount to the Company’s Accumulated Other Comprehensive Loss at the date of adoption. The effect of adoption had no impact on Total Shareholders’ Equity.
The following individual line items in the Consolidated Balance Sheet at December 31, 2009 were affected by the change in accounting principle:
In December 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (codified into ASC Topic 805, Business Combinations). The standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree and recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase. The standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. On January 1, 2009, the Company adopted the standard. Accordingly, the standard was applied by the Company to the acquisition of Direct Response (see Note 3, “Acquisitions of Businesses,” to the Consolidated Financial Statements). In April 2009, the FASB issued FSP SFAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (codified into ASC Topic 805, Business Combinations).
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (codified into ASC Topic 810, Consolidation). SFAS No. 160 establishes accounting and reporting standards that change the presentation and reporting for ownership interests in subsidiaries. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company does not have a noncontrolling interest in one or more subsidiaries. Accordingly, the adoption of the standard did not have an impact on the Company.
In May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60 (codified into ASC Topic 944, Financial Services - Insurance). The standard applies to financial guarantee insurance contracts (“GIC’s”), including the recognition and measurement of premium revenue and claim liabilities and requires expanded disclosures about GIC’s. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2008 and all interim periods within those fiscal years. The Company adopted the standard on January 1, 2009. The Company does not issue GIC’s and therefore the initial application of the standard had no impact on the Company.
In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (codified into ASC Topic 260, Earnings per Share). The standard clarified that all outstanding share-based payment awards that contain a right to receive nonforfeitable dividends participate in the undistributed earnings with common shareholders, and therefore, the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share. No. 128, Earnings per Share (codified into ASC Topic 260, Earnings per Share). The Company adopted the standard on January 1, 2009 and applied its provision retrospectively. The adoption of the new standard did not have a material impact on the financial statements of the Company.
On December 30, 2008, the FASB issued FSP FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets (codified in ASC 715-20, Compensation - Retirement Benefits), which requires more detailed
disclosures about employers’ plan assets, including employers’ investment strategies, major categories of plan assets, concentrations of risk within plan assets and fair value measurements for recording plan assets. The Company adopted the disclosure standards beginning with these financial statements.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (codified into ASC Topic 855, Subsequent Events), which provides guidance on management’s accounting for and disclosure of events that occur after the balance sheet date, but before financial statements are issued or are available to be issued. The standard is effective for interim or annual financial periods ending after June 15, 2009. The initial application of the standard had no impact on the financial results of the Company. The Company evaluates subsequent events through the date and time of the filing of the applicable periodic report with the SEC.
In September 2009, the FASB issued ASU 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), to provide guidance on measuring the fair value of investments in entities that calculate net asset value. The standard amends ASC Topic 820, Fair Value Measurements and Disclosures. The amendment permits, as a practical expedient, a reporting entity to measure the fair value of an investment, which is within the scope of the standard, on the basis of net asset value per share of the investment (or its equivalent). The amendment also requires disclosures by major category of investment about the attributes of investments, such as the nature of any restrictions on the investor’s ability to redeem its investments at the measurement date, any unfunded commitments and the investment strategies of the investees. The guidance in the standard is effective for interim and annual periods ending after December 15, 2009. The Company adopted the new standard beginning with these financial statements. The impact of adoption was not material.
In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, a grandfathered standard under ASC. The standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The standard must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and for interim periods within that first annual reporting period. The Company does not anticipate that the adoption of the standard will have a material impact on the Company.
In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), a grandfathered standard under ASC, to amend the consolidation guidance that applies to variable interest entities. The standard is effective for the Company beginning in 2010. The Company does not anticipate that the adoption of the standard will have a material impact on the Company.
On February 13, 2009, Unitrin’s subsidiary, Trinity completed its acquisition of Direct Response in a cash transaction for a total purchase price of $201.6 million. The results of Direct Response are included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Unitrin Direct segment. The final allocation of the purchase price to the fair values of the assets acquired and liabilities assumed is presented below:
On June 29, 2007, Trinity acquired Merastar in a cash transaction for a total purchase price of $47.9 million, including transaction costs of $0.7 million. The results of Merastar are included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Unitrin Direct segment. Merastar provides automobile and homeowners insurance and is licensed in 48 states. The fair value of the net assets acquired exceeded the purchase price. Accordingly, such excess has been allocated to reduce the fair value of non-financial assets acquired. Based on the Company’s final allocation of the purchase price to the assets acquired and liabilities assumed is presented below:
On June 3, 2008, the Company completed its previously disclosed sale of its Unitrin Business Insurance operations to AmTrust Financial Services, Inc. (“AmTrust”) for total consideration of $101.8 million. Total consideration consisted of cash, other receivables of $10.9 million, with an outstanding balance of $0.7 million at December 31, 2008, and a note receivable from AmTrust valued at $25.1 million. The note receivable is payable in four equal annual installments of $7.5 million, beginning June 1, 2009, and is non-interest bearing. Net proceeds were $94.5 million, including $7.3 million of early contract termination fees and other transaction related costs. AmTrust acquired the renewal rights to the Unitrin Business Insurance book of business, certain legal entities, selected other assets, and the workforce that the Company employed to underwrite and process its products. The Company retained Property and Casualty Insurance Reserves for unpaid insured losses that occurred prior to June 1, 2008, the effective date of the sale. Property and Casualty Insurance Reserves reported in the Company’s Consolidated Balance Sheets include $203.5 million and $261.1 million at December 31, 2009 and 2008, respectively, for the retained liabilities. In accordance with GAAP, changes in the Company’s estimate of such retained liabilities after the sale are reported as a separate component of the results of discontinued operations.
Included in the fair value of Mortgage and Asset Backed investments at December 31, 2009 are $1.6 million of non-governmental residential mortgage-backed securities, $3.4 million of commercial mortgage-backed securities, $5.9 million of collateralized debt obligations and $2.3 million of other asset-backed securities.
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2009 by contractual maturity were:
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at December 31, 2008 were:
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other-than-temporary. The portion of the declines in the fair values of investments that are determined to be other-than-temporary are reported as losses in the Consolidated Statement of Operations in the period when such determination is made. Based on the Company’s evaluations at December 31, 2009 of the prospects of the issuers, including, but not limited to, the credit ratings of the issuers of the investments in the fixed maturities shown in the second preceding table, and the Company’s intention to not sell and its determination that it would not be required to sell before recovery of the amortized cost of such investments at December 31, 2009, the Company concluded that the declines in the fair values of the Company’s investments in fixed maturities presented in the second preceding table were temporary at the evaluation date. Based on the Company’s evaluations at December 31, 2008 of the prospects of the issuers, including, but not limited to, the credit ratings of the issuers of the investments in the fixed maturities shown in the second preceding table, and the Company’s ability and intent to hold to recovery at December 31, 2008, the Company concluded that the declines in the fair values of the Company’s investments in fixed maturities presented in the preceding table were temporary at the evaluation date.
Unrealized losses on fixed maturities, which the Company has determined to be temporary at December 31, 2009, were $57.2 million, of which $38.8 million is related to fixed maturities that were in an unrealized loss position for more than 12 months. Included in Second Preceding table under the heading “12 Months or Longer” are unrealized losses of $0.6 million related to securities for which the Company has recognized credit losses in earnings. Investment-grade fixed maturity investments comprised $42.3 million and below-investment-grade fixed maturity investments comprised $14.9 million of the unrealized losses at December 31, 2009. For below-investment-grade fixed maturity investments, the unrealized loss amount, on average, was less than 10% of the amortized cost basis of the investment. At December 31, 2009, the Company did not have the intent to sell these investments and it was not more likely than not that the Company would be required to sell these investments before recovery of its amortized cost basis, which may be maturity. The Company concluded that the impairments were temporary at December 31, 2009.
For equity securities, the Company considers various factors when considering if a decline in the fair value is other-than or temporary including, but not limited to:
The carrying value, fair value and approximate voting percentage for the Company’s investment in the common stock of Intermec, which is accounted for under the equity method of accounting and reported as Investment in Investee in the Company’s Consolidated Balance Sheets, at December 31, 2009 and 2008 were:
The carrying values of the Company’s Other Investments at December 31, 2009 and 2008 were:
Automobile Loan Receivables consists primarily of sub-prime loans, which are secured by automobiles, to residents of California and other western and midwestern states. Automobile Loan Receivables is stated net of unearned discount, loan fees and reserve for loan losses.
The components of Automobile Loan Receivables at December 31, 2009 and 2008 were:
Activity in the Reserve for Loan Losses for the years ended December 31, 2009, 2008 and 2007 was:
The Company tests goodwill for recoverability on an annual basis in the first quarter and, if circumstances or events indicate that the fair value of a reporting unit may have declined below its carrying value, such tests are performed at intervening interim periods. The quoted value of Unitrin’s common stock was significantly below the book value per share of the Company at the end of each interim period during 2009. Accordingly, the Company tested the goodwill associated with each of its reporting units at March 31, 2009, June 30, 2009, September 30, 2009 and December 31, 2009 for recoverability at such dates. The Company used discounted projections of future cash flows to estimate the fair value of all reporting units tested for recoverability of goodwill. No goodwill was associated with Fireside Bank on such dates. Accordingly, no testing for recoverability of goodwill was performed for Fireside Bank. Excluding goodwill associated with the Company’s Direct Response reporting unit, the estimated fair value exceeded the carrying value of the reporting unit at the date tested, and the Company concluded that the associated goodwill was recoverable.
Goodwill activity by business segment for the year ended December 31, 2008 is presented below.
Goodwill for the Life and Health Insurance segment increased in 2008 by $29.1 million due to the acquisition of Primesco. See Note 3, “Acquisitions of Businesses,” to the Consolidated Financial Statements for additional information pertaining to the acquisition of Primesco.
reserves developed favorably by $72.3 million and commercial lines insurance losses and LAE reserves developed favorably by $8.6 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2007, 2006 and 2005 accident years due to the improvements in the Company’s claims handling procedures and due to favorable development on catastrophes.
In 2008, the Company reduced its property and casualty insurance reserves by $79.3 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance losses and LAE reserves developed favorably by $45.8 million and commercial lines insurance losses and LAE reserves developed favorably by $33.5 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2006 and 2005 accident years due to the improvements in the Company’s claims handling procedures, partially offset by adverse development of $8.9 million related to certain re-opened claims from Hurricane Rita in the 2005 accident year. The commercial lines insurance losses and LAE reserves developed favorably primarily in the Company’s discontinued operations. During the fourth quarter of 2008, the Company’s actuaries conducted their regular reserve review of retained insurance reserves of discontinued operations for all traditional reserving groups. In addition, the Company’s actuaries updated certain commercial property and liability analyses using A.M. Best’s latest industry study to re-estimate asbestos and environmental liabilities and a more detailed review by peril of other general liabilities, including construction defect liabilities. These additional procedures, along with the actuaries’ regular quarterly reserve reviews during 2008, resulted in favorable reserve development of $29.7 million.
The weighted-average interest rates on Certificates of Deposits were 4.99% and 4.78% at December 31, 2009 and 2008, respectively. The range of interest rates on Certificates of Deposits was 0.05% to 5.85% at both December 31, 2009 and 2008. Certificates of Deposits are generally fixed in maturity. The contractual maturities of Certificates of Deposits at December 31, 2009 and 2008 were:
Interest Expense, including facility fees and accretion of discount, for the years ended December 31, 2009, 2008 and 2007 was:
On October 30, 2009, Unitrin entered into the 2012 Credit Agreement, a new three-year, $245 million, unsecured, revolving credit agreement, expiring October 30, 2012, with a group of financial institutions. The 2012 Credit Agreement replaced the 2010 Credit Agreement, which was a $325 million, unsecured, revolving credit agreement scheduled to expire on June 30, 2010 and was terminated on October 30, 2009. There were no borrowings under the 2010 Credit Agreement at its termination. The 2012 Credit Agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The 2012 Credit Agreement contains various financial covenants, including limits on total debt to total capitalization, consolidated net worth and minimum risk-based capital ratios for Unitrin’s largest insurance subsidiaries, United Insurance and Trinity. Proceeds from advances under the 2012 Credit Agreement may be used for general corporate purposes, including repayment of existing indebtedness.
Unitrin had no outstanding advances under the 2012 Credit Agreement and the 2010 Credit Agreement at December 31, 2009 and 2008, respectively. The amount available for borrowing under the 2012 Credit Agreement was $245.0 million at December 31, 2009. Undrawn letters of credit issued pursuant to the 2010 Credit Agreement were $13.1 million at December 31, 2008. Accordingly, the amount available for future borrowing under the 2010 Credit Agreement was $311.9 million at December 31, 2008.
Future minimum lease payments under operating leases at December 31, 2009 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $13.3 million at December 31, 2009. Capital leases were not material.
Unitrin is authorized to issue 20 million shares of $0.10 par value preferred stock and 100 million shares of $0.10 par value common stock. No preferred shares were issued or outstanding at December 31, 2009 and 2008. There were 62,357,016 shares and 62,314,503 shares of common stock outstanding at December 31, 2009 and 2008, respectively. Common stock outstanding included 202,916 shares and 196,307 shares at December 31, 2009 and 2008, respectively, that have been issued, subject to certain vesting and other requirements, in connection with one of the Company’s long-term equity compensation plans. See Note 13, “Long Term Equity Compensation,” to the Consolidated Financial Statements for an additional discussion of the restrictions and vesting provisions.
Various state insurance laws restrict the amount that an insurance subsidiary may pay in the form of dividends, loans or advances without the prior approval of regulatory authorities. Also, that portion of an insurance
Unitrin’s insurance subsidiaries are required to file financial statements prepared on the basis of statutory insurance accounting practices which is a comprehensive basis of accounting other than GAAP.
Statutory capital and surplus for the Company’s life and health insurance subsidiaries was approximately $295 million and was $333.0 million at December 31, 2009 and 2008, respectively. Statutory capital and surplus for the Company’s property and casualty insurance subsidiaries was approximately $890 million and was $833.8 million at December 31, 2009 and 2008, respectively. Statutory net income for the Company’s life and health insurance subsidiaries was income of approximately $78 million, was income of $15.0 million and was income of $58.5 million for the years ended December 31, 2009, 2008 and 2007, respectively. Statutory net income for the Company’s property and casualty insurance subsidiaries was income of approximately $77 million, was loss of approximately $57.3 million and was income of $119.4 million for the years ended December 31, 2009, 2008 and 2007, respectively. Statutory capital and surplus and statutory net income exclude Fireside Bank and parent company operations.
Options outstanding and available for future grants under all of the Company’s stock option plans at December 31, 2009 are:
The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom options are granted, the number of shares covered by such options and the exercise price, vesting and expiration dates of such options. Options are non-transferable and are exercisable in installments. Stock options to purchase Unitrin’s common stock are granted at prices equal to the fair value of Unitrin’s common stock on the date of grant. Prior to 2003, only non-qualified stock options had been granted.
Prior to February 3, 2009, all of the Company’s stock option plans included provisions, subject to certain limitations, to automatically grant restorative, or reload stock options (“Restorative Options”), to replace shares of previously owned Unitrin common stock that an exercising option holder surrenders, either actually or constructively, to satisfy the exercise price and/or tax withholding obligations relating to the exercise. Restorative Options are subject to the same terms and conditions as the original options, including the expiration date, except that the exercise price is equal to the fair value of Unitrin common stock on the date of grant and cannot be exercised until six months after the date of grant. The grant of a Restorative Option does not result in an increase in the total number of shares and options held by an employee, but changes the mix of the two. Beginning February 3, 2009, the 1995 Director Plan and the 2002 Stock Option Plan were amended to eliminate the restorative feature in the plans prospectively. Accordingly, Restorative Options are no longer included in original option awards made on or after February 3, 2009. At December 31, 2009, Restorative Options may still be granted under all the plans in connection with the exercise of original options granted before February 3, 2009, subject to the limitations on certain equity awards as described below.
In addition to the stock option plans, the Company has a restricted stock plan, which has been approved by Unitrin’s shareholders. Under this plan, restricted stock and restricted stock units may be granted to all eligible employees. Recipients of restricted stock are entitled to full dividend and voting rights on the same basis as all other outstanding shares of Unitrin common stock and all awards are subject to forfeiture until certain restrictions have lapsed. As of December 31, 2009, 475,200 shares of restricted stock having a weighted-average grant-date fair value of $35.99 per share had been awarded, of which 113,808 shares were forfeited and 49,018 were tendered to satisfy tax withholding obligations. As of December 31, 2009, there were 687,626 common shares available for future grants under the restricted stock plan.
Prior to February 3, 2009, only awards of time-vested restricted stock had been granted under the restricted stock plan. On February 3, 2009, in addition to time-vested restricted stock granted to certain employees and officers, the Company awarded performance-based restricted stock to certain officers and employees under the restricted stock plan. The initial number of shares awarded to each participant represents the shares that would vest if the performance goals were achieved at the “target” performance level. The final payout of these awards will be determined based on Unitrin’s total shareholder return over a three-year performance period relative to a peer group comprised of companies in the S&P Supercomposite Insurance Index (“Peer Group”). The three-year performance period began on January 1, 2009 and will end on December 31, 2011. If, at the end of the performance period, the Company’s relative performance exceeds the “target” performance level, additional
shares of performance-based restricted stock will be issued to the award recipient. If, at the end of the performance period, the Company’s relative performance is below the “target” performance level, only a portion of the shares of performance-based restricted stock originally issued to the award recipient will vest. If, at the end of the performance period, the Company’s relative performance is below a “minimum” performance level, none of the shares of performance-based restricted stock originally issued to the award recipient will vest.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected terms of options are developed by considering the Company’s historical share option exercise experience, demographic profiles, historical share retention practices of employees and assumptions about their propensity for early exercise in the future. Further, the Company aggregates individual awards into relatively homogenous groups that exhibit similar exercise behavior to obtain a more refined estimate of the expected term of options. Expected volatility is estimated using weekly historical volatility. The Company believes that historical volatility is currently the best estimate of expected volatility. The dividend yield assumed was the annualized yield on Unitrin common stock on the date of grant for original grants made in 2008 and 2007. In light of the economic environment at the beginning of 2009, the Company changed its dividend yield assumption prospectively for original options granted in 2009. For original option grants made in 2009, the dividend yield assumed is the average, annualized dividend yield computed over the twenty consecutive quarters preceding the date of grant. Each quarterly dividend yield is calculated by dividing the amount of declared dividend per share during each quarter by the closing price of Unitrin common stock at the end of such quarter. The quarterly yields are then annualized and averaged to arrive at the dividend yield assumed. In light of the economic conditions at the beginning of 2009, the Company believes basing dividend yield over a longer historical period of time is likely to be more consistent with the actual yield during the expected life of the option rather than the current dividend yield. For Restorative Options, the annualized dividend yield on Unitrin common stock for the month prior to the grant of the Restorative Option was used for all restorative grants made in 2008 and 2007. No Restorative Options were granted in 2009. The risk free interest rate was the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option.
The assumptions used in the Black-Scholes pricing model for options granted during the years ended December 31, 2009, 2008 and 2007 were as follows:
Option and SAR activity for the year ended December 31, 2009 is presented below:
For equity compensation awards with a graded vesting schedule, the Company recognizes compensation expense on a straight-line basis over the requisite service period for each separately vesting portion of the awards as if each award were, in substance, multiple awards. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. Share-based compensation expense for all of the Company’s long-term equity-based compensation plans was $3.1 million, $7.4 million and $15.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. Total unamortized compensation expense related to nonvested awards of such plans at December 31, 2009 was $2.6 million, which is expected to be recognized over a weighted-average period of 1.4 years.
On March 24, 2009, Fireside Bank suspended all new lending activity and ceased opening new certificate of deposit accounts as part of a plan to exit the automobile finance business. The exit plan envisions an orderly wind-down of Fireside Bank’s operations over the next several years. Fireside Bank will continue to collect outstanding loan balances and make interest payments and redemptions on outstanding certificates of deposits in the ordinary course of business.
Employee termination costs are accrued and recognized as expense over the employee’s expecting remaining service period. Unrecognized employee termination costs were $7.8 million at December 31, 2009, of which $3.3 million and $4.5 million is expected to be recognized as expense in 2010 and 2011 and thereafter, respectively.
The Company’s awards of restricted common stock contain a right to receive non-forfeitable dividends and participate in the undistributed earnings with common shareholders. Accordingly, the Company is required to apply the two-class method of computing basic and diluted earnings per share. A reconciliation of the numerator and denominator used in the calculation of Basic Income Per Share from Continuing Operations and Diluted Income Per Share from Continuing Operations for the year ended December 31, 2009 is as follows:
Options outstanding to purchase 4.7 million shares of Unitrin common stock were excluded from the computation of Unitrin Share-based Compensation Equivalent Shares and Weighted-Average Common Shares and Equivalent Shares Outstanding Assuming Dilution for the year ended December 31, 2009 because the exercise price exceeded the average market price.
The components of Accumulated Other Comprehensive Income (Loss) at December 31, 2009 and 2008 were:
The components of Net Realized Gains on Sales of Investments for the years ended December 31, 2009, 2008 and 2007 were:
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007 were:
Insurance Expenses for the years ended December 31, 2009, 2008 and 2007 were:
The current and deferred income tax assets as presented in the Consolidated Balance Sheets at December 31, 2009 and 2008 were:
The components of Liabilities for Income Taxes as presented in the Consolidated Balance Sheets at December 31, 2009 and 2008 were:
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Tax Asset at December 31, 2009 and 2008 were:
Income taxes paid were $72.3 million and $98.8 million in 2009 and 2008, respectively.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2009 and 2008 is as follows:
Included in the balance of unrecognized tax benefits at December 31, 2009 and December 31, 2008 are tax positions of $7.2 million and $10.6 million, respectively, for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred income tax accounting, other than for interest and penalties, the disallowance of the shorter deductibility period would not affect the effective income tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
During 2007, a tax benefit of $5.3 million was recorded for state income taxes related to the tax year that ended on December 31, 2002, due to the expiration of a state’s statute of limitations.
Changes in Fair Value of Plan Assets and Changes in Benefit Obligations (the Projected Benefit Obligation in the case of the Pension Plans and the Accumulated Benefit Obligation in the case of the OPEB Plan) for the years ended December 31, 2009 and 2008 were:
The OPEB Plan was unfunded at December 31, 2009 and 2008. Weighted-average asset allocations for the Pension Plans at December 31, 2009 and 2008 by asset category were:
and any required employee contributions, is adequate to provide for the payment of the benefit obligations of the Pension Plans. The assets of the Pension Plans may be invested in both fixed income and equity investments. Fixed income investments may include cash and short-term instruments, U.S. Government securities, corporate bonds, mortgages and other fixed income investments. Equity investments may include various types of stock, such as large-cap, mid-cap and small-cap stocks, and may also include investments in investment companies and Unitrin common stock (subject to Section 407 and other requirements of ERISA). The Pension Plans have not invested in Unitrin common stock.
The trust investment committee for the Pension Plans periodically reviews the performance of the Pension Plans’ investments and asset allocation. Several external investment managers, one of which is Fayez Sarofim & Co. (“FS&C”), manage the equity investments of the trust for the Pension Plans. One of Unitrin’s directors, Mr. Fayez Sarofim, is Chairman of the Board, President and the majority shareholder of FS&C, a registered investment advisory firm (see Note 26, “Related Parties,” to the Consolidated Financial Statements). Each manager is allowed to exercise investment discretion, subject to limitations, if any, established by the trust investment committee for the Pension Plans. All other investment decisions are made by the Company, subject to general guidelines as set by the trust investment committee for the Pension Plans.
Total Pension Expense Recognized presented above includes service cost benefits earned and reported in discontinued operations of $0.7 million and $1.2 million for the years ended December 31, 2008 and 2007, respectively.
The actuarial assumptions used to develop the components of the OPEB Expense for the years ended December 31, 2009, 2008 and 2007 were:
The actuarial assumptions used to develop the components of the Pension Projected Benefit Obligation at December 31, 2009 and 2008 were:
The actuarial assumptions used to develop the components of the OPEB Accumulated Benefit Obligation at December 31, 2009 and 2008 were:
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $6.6 million, $7.0 million and $6.8 million in 2009, 2008 and
The Company is engaged, through its subsidiaries, in the property and casualty insurance, life and health insurance and automobile finance businesses. The Company conducts its operations through five operating segments: Kemper, Unitrin Specialty, Unitrin Direct, Life and Health Insurance and Fireside Bank.
The Company does not allocate insurance reserves from its 2002 acquisition of certain insurance companies from SCOR (see Note 8, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). It is also the Company’s management practice to allocate certain corporate expenses to its insurance operations. The Company considers the management of certain investments, including Northrop preferred and common stock, and Intermec common stock, to be a corporate responsibility. Accordingly, the Company does not allocate dividend income from these investments to its operating segments. The Company does not allocate Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings to its operating segments.
Segment Revenues for the years ended December 31, 2009, 2008 and 2007 were:
Segment Operating Profit for the years ended December 31, 2009, 2008 and 2007 was:
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. To limit its exposures to catastrophic events, the Company maintains various catastrophe reinsurance programs for its property and casualty insurance businesses. Coverage for each catastrophe reinsurance program effective January 1, 2009 is provided in various layers as presented below:
The catastrophe reinsurance program for the Life and Health Insurance and Unitrin Direct segments in 2009 also includes reinsurance coverage from FHCF for hurricane losses in Florida at retentions lower than those described above.
Coverage for each catastrophe reinsurance program effective January 1, 2008 is provided in various layers as presented below:
The annual reinsurance program covering the Kemper segment became effective on April 1, 2007 (the “2007 Kemper Program”). The first layer of the 2007 Kemper Program provided coverage of approximately 62% of reinsured catastrophe losses of $30 million above retention of $40 million. The second layer of the 2007 Kemper Program provided coverage of approximately 90% of reinsured catastrophe losses of $80 million above retention of $70 million. The third layer of the 2007 Kemper Program provided coverage of approximately 90% of reinsured catastrophe losses of $100 million above retention of $150 million.
The annual program covering the property insurance operations of the Company’s Life and Health Insurance segment provided, effective January 1, 2007, reinsurance coverage of 100% of reinsured catastrophe losses of $120 million above retention of $10 million. The catastrophe reinsurance programs for the Life and Health Insurance segment in 2007 also included reinsurance coverage from the FHCF for hurricane losses in Florida at retentions lower than those described above.
In addition, in the event that the Company’s incurred catastrophe losses and LAE covered by any of the various reinsurance programs in 2008 and 2007 exceeded the retention for a particular layer, each of the programs in 2008 and 2007 required one reinstatement of such coverage. In such an instance, the Company is required to pay a reinstatement premium to the reinsurers to reinstate the full amount of reinsurance available under such program.
The estimated losses presented above by the Life and Health Insurance segment are net of reinsurance recoveries of $2.9 million, $6.0 million and $37.2 million related to Hurricanes Dolly, Gustav and Ike, respectively. The Company’s estimates for Hurricanes Dolly, Gustav and Ike include estimates for both direct losses and LAE and indirect losses from residual market assessments, such as TWIA. In addition to the losses presented above, Insurance Expenses for the year ended December 31, 2008 includes an expense of $3.9 million related to the Kemper segment’s estimate of its share of assessments from TWIA. Insurance Expenses for the year ended December 31, 2009 includes a reduction of expense of $2.8 million due to a decrease in the Company’s estimate of its share of assessments from TWIA. The process of estimating and establishing reserves for catastrophe losses is inherently uncertain and the actual ultimate cost of a claim, net of actual reinsurance recoveries, may vary materially from the estimated amount reserved. The Company’s estimates of direct catastrophe losses are generally based on inspections by claims adjusters and historical loss development experience for areas that have not been inspected or for claims that have not yet been reported. The Company’s estimates of direct catastrophe losses are based on the coverages provided by its insurance policies. The Company’s homeowners and dwellings insurance policies do not provide coverage for losses caused by floods, but generally provide coverage for physical damage caused by wind or wind driven rain. Accordingly, the Company’s estimates of direct losses for homeowners and dwellings insurance do not include losses caused by flood. Depending on the policy, automobile insurance may provide coverage for losses caused by flood. Estimates of the number and severity of claims ultimately reported are influenced by many variables including, but not limited to, repair or reconstruction costs and determination of cause of loss, that are difficult to quantify and will influence the final amount of claim settlements. All these factors, coupled with the impact of the availability of labor and material on costs, require significant judgment in the reserve setting process. A change in any one or more of these factors is likely to result in an ultimate net claim cost different from the estimated reserve. The Company’s estimates of indirect losses from residual market assessments are based on a variety of factors including, but not limited to, actual or estimated assessments provided by or received from the assessing entity, insurance industry estimates of losses, and estimates of the Company’s market share in the assessable states. Actual assessments may differ materially from these estimated amounts.
In addition to the reinsurance programs described in Note 22, “Catastrophe Reinsurance,” to the Consolidated Financial Statements, Unitrin’s insurance subsidiaries utilize other reinsurance arrangements to limit their maximum loss, provide greater diversification of risk and to minimize exposures on larger risks. The ceding of insurance does not discharge the primary liability of the original insurer. Accordingly, insurance reserve liabilities are reported gross of any estimated recovery from reinsurers in the Consolidated Balance Sheets. Amounts recoverable from reinsurers are estimated in a manner consistent with the insurance reserve liability and are included in Other Receivables in the Consolidated Balance Sheets.
Trinity and Capitol are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by Capitol. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. Five employees of the Company serve as directors of Capitol’s five member board of directors. Nine employees of the Company also serve as directors of Capitol’s wholly owned subsidiary’s, ORCC’s, nine member board of directors. Trinity and ORCC are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by ORCC. Unitrin’s subsidiary, United Insurance, provides claims and administrative services to Capitol and ORCC. In addition, agents appointed by Unitrin’s subsidiary, Reliable, and employed by United Insurance, are also appointed by Capitol and ORCC to sell property insurance products. The Company also provides certain investment services to Capitol and ORCC.
Additional information pertaining to the Company’s investments in Fixed Maturities and Equity Securities classified as Level 3 at December 31, 2008 are presented below:
The Company’s investments in available for sale securities reported as Fixed Maturities and classified as Level 1 in the above tables primarily consist of U.S. Treasury Bonds and Notes. The Company’s investments in available for sale securities reported as Equity Securities and classified as Level 1 in the above tables primarily consist of investments in publicly-traded common stocks. The Company’s investments in available for sale securities reported as Fixed Maturities and classified as Level 2 in the above tables primarily consist of investments in corporate bonds and redeemable preferred stocks, state and municipal bonds, and bonds and mortgage-backed securities of U.S. government agencies. The Company’s investments in available for sale securities reported as Equity Securities and classified as Level 2 in the above tables primarily consist of investments in preferred stocks. The Company uses a leading, nationally recognized provider of market data and analytics to price the vast majority of the Company’s Level 2 measurements. The provider utilizes evaluated pricing models that vary by
Additional information pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2009 is presented below:
Included in Other Equity Interests is $35.2 million of private equity funds and mezzanine debt funds which the company has unfunded commitments of $65.3 million. These funds cannot be redeemed, instead distributions are received through the liquidation of the underlying investments of the fund. It is estimated that the assets of these funds will be liquidated and distributed to the Company between 2010 and 2023.
The Company believes that resolution of its pending legal proceedings will not have a material adverse effect on the Company’s financial position. However, given the unpredictability of the legal environment, there can be no assurance that one or more of these matters will not produce a loss which could have a material adverse effect on the Company’s financial results for any given period.
Eric J. Draut, Unitrin’s Executive Vice President and Chief Financial Officer and a member of Unitrin’s Board of Directors, is a director of Intermec (the Company’s Investee).
As described in Note 23, “Other Reinsurance,” to the Consolidated Financial Statements, the Company also has certain relationships with Capitol, a mutual insurance company which is owned by its policyholders.
We have audited the accompanying consolidated balance sheets of Unitrin, Inc. and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedules listed in Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.