The segregated portfolio cell reinsurance segment’s combined ratio increased from 88.3% in 2008 to 91.3% in 2009. The increased combined ratio primarily reflects the impact of the current economic environment on the Company’s workers’ compensation loss and LAE ratio.
Net premiums earned. Net premiums earned represent the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2009, one-half of the premiums would be earned in 2009 and the other half would be earned in 2010. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices as a percentage to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date. The majority of the Company’s group benefits insurance policies are billed on a monthly basis with premiums being earned in the month in which coverage is provided. As a result, there is minimal unearned premium related to the group benefits insurance policies as of the balance sheet date.
Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and LAE) in cash, cash equivalents, fixed income securities, convertible bonds and equity securities. Investment income includes interest earned on invested assets, including the impacts of premium amortization and discount accretion. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an
amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in fair value of convertible bonds.
Other expenses. Other expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately. Other expenses also include interest expense related primarily to the Company’s junior subordinated debt and loan payable.
Net premiums written to statutory surplus ratio. The net premiums written to statutory surplus ratio represents the ratio of net premiums written to statutory surplus. This ratio measures the Company’s insurance subsidiaries’ exposure to pricing errors in its current book of business. The higher the ratio, the greater the impact on surplus should pricing prove inadequate.
The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance segment as of December 31, 2009 and 2008 are summarized below (in thousands):
In estimating ULAE reserves, the Company reviews past loss adjustment expenses in relation to paid claims and estimated future costs based on expected claims activity and duration. The sum of the Company’s net loss and ALAE reserve and ULAE reserves represents its total net reserve for unpaid losses and LAE.
As of December 31, 2009, the Company’s best estimate of its ultimate liability for losses and LAE, net of amounts recoverable from reinsurers and before purchase accounting adjustments, for its workers’ compensation insurance segment was $57.4 million.
experience and tail factors to estimate values for the variables that are explicitly used in the unpaid loss and LAE analysis. For the most recent accident year, we rely on selecting an expected loss ratio to estimate the reserves for unpaid losses and LAE. In addition to the examples above that represent reasonably likely changes in our tail factor, another example of potential variability in our loss and LAE estimation process involves selecting an expected loss ratio for the most recent accident year. For example, if our expected loss ratio for the 2009 accident year were to increase by 5 percentage points, our reserves for unpaid losses and LAE as of December 31, 2009 would increase by $3.7 million, which would result in an after-tax reduction in our earnings of $2.4 million. Management believes that changes in the most recent year accident year loss ratio are reasonably likely due to variability in underwriting and rate changes. It is important to note that actual claims costs will vary from our estimate of ultimate claim costs, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated.
The Company’s reserves for unpaid losses and LAE in its group benefits insurance segment, by line business, as of December 31, 2009 and 2008, were as follows (in thousands):
With respect to the run-off specialty reinsurance segment, numerous internal and external factors will affect the ultimate settlements of future claims including, but not necessarily limited to, changes in the cost of environmental remediation, impacts of relevant federal or state legislation, changes in technology and the resulting impact on costs, and reliance on ceding companies to handle claims and remit proper loss information in a timely manner. Reserving for assumed reinsurance requires evaluating loss information received from the ceding company. On a quarterly basis, the Company receives a statement from the ceding company which includes premium and loss settlement activity for the period with corresponding reserves as established by the ceding company. Claims reported to the ceding company by insureds are entered into its claim system and ceded to the Company on a quarterly basis. The claim information received from the ceding company is compiled into loss development triangles. Generally accepted actuarial methodologies, supplemented by judgment where appropriate, are used to develop the appropriate IBNR reserves for the Company. Each quarter the Company compares its actual reported losses for the quarter, and cumulative reported losses since the most recently completed reserve study, to expected reported losses for the respective period, which may result in the Company increasing its losses and LAE, and its corresponding loss
The Company analyzes its ultimate losses and LAE for the run-off specialty reinsurance segment after consideration of the loss experience on each treaty for each underwriting year on a quarterly basis. The methodologies that the Company employs include, but may not be limited to, paid loss development methods and incurred loss development methods similar to those described in the workers’ compensation insurance and segregated portfolio cell reinsurance segments above.
In applying these methods, the Company evaluates loss development trends by underwriting year to determine various assumptions that are required as inputs in the actuarial methodologies it employs. These typically involve the analysis of historical loss development trends by underwriting year. In addition to the use of historical loss development data, the Company utilizes external or internal benchmark sources of information for which it has limited loss development data to calculate credible trends. External benchmarks are not precise with respect to the run-off specialty reinsurance segment’s environmental claims and historical data is subject to changes in claim payment patterns at the ceding company, which adds additional uncertainty related to the estimation of the reserves for unpaid losses and LAE. The evaluation of the reserve for unpaid losses and LAE related to the run-off specialty reinsurance segment requires that loss development be estimated over an extended period of time.
Increases or decreases in the run-off specialty reinsurance segment’s reserves for unpaid losses and LAE, as a result of changes in loss development based on actual loss results, would result in an equivalent increase or decrease in net income. There is no tax effect related to the run-off specialty reinsurance segment’s operating results as a result of the significant losses incurred in the segment for the year ended December 31, 2008.
Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than-temporary,” such investment is written-down to its fair value. The amount written-down is recorded in earnings as a realized loss on investments. Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the years ended December 31, 2009 and 2008, the Company recorded other-than-temporary impairments of $4.5 million and $9.5 million, respectively, including other-than-temporary impairments of $749,000 and $1.2 million, respectively in the segregated portfolio cell reinsurance segment. The Company did not record any impairments in 2007. As of December 31, 2009, the Company held fixed income securities, excluding the segregated portfolio cell reinsurance segment, with gross unrealized losses of $841,000, of which $612,000 were in an unrealized loss position for more than twelve months. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:
Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). When the Company determines a credit loss has been incurred, but the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss), and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income (loss). A fixed income security is reviewed for potential credit loss if any of the following situations occur:
For the year ended December 31, 2009, the Company recorded other-than-temporary impairments of $189,000 related to two fixed income securities. One security was impaired as a result of management’s intent to sell the security. This security was sold in the second quarter of 2009. The other security was impaired as a result of management determining that a credit loss had been incurred.
For the 2009 annual impairment test, the fair value of the workers’ compensation insurance segment was estimated using a discounted cash flow analysis, a form of the income approach, using management’s internal four-year forecast for the workers’ compensation insurance segment and a terminal value estimated using a long-term growth rate of 5.0%, which is reflective of the segment’s historical growth rate, and a discount rate of 13.0%, which is reflective of the risks inherent in the segment. Cash flows were adjusted as necessary to maintain adequate capital requirements.
Both the discounted cash flow analysis and the estimate of the Company’s value in a potential transaction resulted in the workers’ compensation insurance segment’s estimated fair value exceeding its carrying value as of September 30, 2009; therefore, goodwill was considered not impaired, and the second step of impairment testing was not necessary.
In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in a fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.
As of December 31, 2009, the Company has not recognized a deferred tax asset related to its run-off specialty reinsurance segment of $7.3 million, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re as of December 31, 2009. The outside basis difference primarily arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes. Management presently believes that the Company will not be able to recognize these tax benefits in the foreseeable future and, therefore has not recognized these tax benefits as of December 31, 2009.
As of December 31, 2009, the Company recognized a deferred tax asset of $2.0 million related to other-than-temporary investment impairments. Under United States federal income tax rules and regulations, capital losses can only be utilized to offset income generated from capital gains. Capital losses can be carried back to offset capital gains reported in the three prior tax periods and can be carried forward for five tax periods. Management has determined, based on a review of its investment portfolio and giving consideration to capital gains reported in prior tax periods, that the Company’s deferred tax asset related to other-than-temporary investment impairments and net unrealized losses on investments is recoverable; therefore, a valuation allowance has not been recorded as of December 31, 2009. Due to the significant volatility in the investment markets, management’s conclusion on the recoverability of the deferred tax asset could change in future periods. Further declines in the estimated fair value of the Company’s investments may result in the need for a valuation allowance, which could have an adverse impact of the Company’s financial condition and/or results of operations.
Amounts recoverable from Company’s reinsurers are estimated in a manner consistent with the reserves for unpaid losses and LAE associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and LAE are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and LAE affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers and where necessary obtains collateral. As of December 31, 2009, the Company had reinsurance recoverables of $28.5 million.
In June 2009, the FASB established the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative accounting principles in the preparation of financial statements in conformity with GAAP. The Codification explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. The Codification was effective for financial statements issued for periods ending after September 15, 2009. The Company adopted the Codification effective September 30, 2009 and revised its disclosures to reflect Codification as the source of authoritative accounting principles.
In May 2009, the FASB issued new accounting and disclosure guidance related to subsequent events. The new guidance defines subsequent events as either “recognized” or “nonrecognized” and is consistent with existing guidance related to the reporting of subsequent events. Recognized subsequent events are those events that provide additional evidence about conditions that existed at the balance sheet date and must be recognized in an entity’s financial statements. Nonrecognized events are those events that provide evidence about conditions that did not exist at the balance sheet date but arose before the financial statements are issued or are available to be issued. Nonrecognized events may require disclosure in an entity’s financial statements to prevent the financial statements from being misleading. Publicly traded entities must evaluate subsequent events through the financial statement issuance date. The new guidance was effective for interim or annual financial periods ending after June 15, 2009. The Company adopted the new accounting and disclosure requirements effective June 30, 2009, which are included in Note 22.
The major components of consolidated revenue were as follows for the years ended December 31, 2009 and 2008 (in thousands):
The components of consolidated net income (loss), by segment, for the years ended December 31, 2009 and 2008 were as follows (in thousands):
The improvement in the Company’s net income from 2008 to 2009 primarily reflects the improvement in the run-off specialty reinsurance segment and the aforementioned improvement in the Company’s investment portfolio. The run-off specialty reinsurance segment’s 2008 financial results were adversely impacted by unfavorable loss reserve development related to prior accident years.
The increase in net income primarily reflects a decrease in net realized investment losses and an increase in the value of the segment’s limited partnership investments. The decrease in net realized investment losses primarily reflects a reduction in other-than-temporary impairments from 2008 to 2009. The improved investment results were partially offset by an increase in the combined ratio from 2008 to 2009. The increase in the loss and LAE ratio from 2008 to 2009 primarily reflects an increase in the 2009 accident year loss ratio reflecting management’s view of the expected impact of the current economic environment on the Company’s workers’ compensation book of business. The increase in the expense ratio primarily reflects an increase in corporate expense allocations and the impact of premium rate decreases and audits of prior year policies that resulted in return premium to customers in 2009.
The increase in direct premiums written from 2008 to 2009 primarily reflects new business sales of $28.0 million and direct premiums written of $6.1 million related to the acquisition of ESIC, partially offset by a reduction in the renewal retention rate from 87.6% in 2008 to 84.1% in 2009 and renewal rate decreases of 3.9%. Traditional and alternative market direct premiums written were $81.4 million and $28.7 million, respectively, for the year ended December 31, 2009, compared to $72.8 million and $29.1 million, respectively, for the same period in 2008.
The decrease in net investment income primarily reflects a decline in the average yield on the fixed income portfolio and a decline in short-term interest rates from 2008 to 2009. The average yield on the fixed income portfolio was 3.61% as of December 31, 2009, compared to 4.18% as of December 31, 2008.
The increase in the calendar period loss and LAE ratio primarily reflects an increase in the accident period loss ratio, partially offset by an increase in favorable loss reserve development related to prior accident periods. The accident period loss ratio was 65.6% and 60.2% for the years ended December 31, 2009 and 2008, respectively. The increase in the accident period loss ratio primarily reflects management’s estimate of the impact of the current economic environment on the Company’s workers’ compensation book of business, including the impact of rising unemployment on management’s return to work controls. Favorable loss reserve development totaled $3.7 million for the year ended December 31, 2009, compared to favorable loss reserve development of $2.7 million for the same period in 2008. The favorable development primarily reflects continued improvements in loss mitigation and underwriting, including greater availability and use of employers’ return to work programs. Furthermore, the Company was able to settle a large amount of Pennsylvania claims via compromise and release, which is a lump sum cash payment in exchange for a full and final claim settlement. Management attributes the large amount of compromise and release claim closures to the difficult economic conditions and the claimants’ choosing a lump sum cash settlement over the continuation of a workers’ compensation annuity payment.
The increase in acquisition and other underwriting expenses primarily reflects the impact of the Indiana state tax liability related to ESIC’s operating results for the year ended December 31, 2009.
The following table represents the operations of the segregated portfolio cell reinsurance segment for the years ended December 31, 2009 and 2008 (in thousands):
(1) The workers’ compensation insurance, run-off specialty reinsurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.
The segregated portfolio cell reinsurance ratios were as follows for the years ended December 31, 2009 and 2008:
The increase in the calendar period loss and LAE ratio primarily reflects an increase in the accident period loss ratio, partially offset by an increase in favorable loss reserve development related to prior accident periods. The accident period loss ratio was 71.7% and 64.9% for the years ended December 31, 2009 and 2008, respectively. The increase in the accident period loss ratio primarily reflects management’s estimate of the impact of the current economic environment on the Company’s workers’ compensation book of business, including the impact of rising unemployment on management’s return to work controls. Favorable loss reserve development totaled $2.8 million for the year ended December 31, 2009, compared to favorable loss reserve development of $2.0 million for the same period in 2008. The favorable loss reserve development relates primarily to a decrease in the prior accident period loss development factors used to estimate losses and LAE. The decrease in prior accident period loss development factors primarily reflects prior year claim settlements during 2009 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of December 31, 2009. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims. Management believes that the realization of the benefits of its return-to-work controls enabled it to record losses and LAE that were lower than the amount reserved for claim settlements.
The decrease in net realized investment losses from 2008 to 2009 primarily reflects a reduction in other-than-temporary impairments. Other- than-temporary impairments totaled $120,000 in 2009, compared to $3.9 million in 2008. In addition, the convertible bond portfolio experienced an increase in fair value of $2.3 million in 2009, compared to a decrease in fair value of $2.1 million in 2008
The calendar period loss ratios, by line of business, for the years ended December 31, 2009 and 2008 were as follows:
The decrease in the short-term disability loss ratio for the year ended December 31, 2009, compared to the same period in 2008, primarily reflects a decrease in the accident period loss ratio from 65.6% in 2008 to 62.1% in 2009. Favorable development on prior accident year reserves further reduced the loss ratio by 2.4 percentage points, or $146,000, for the year ended December 31, 2009, compared to 1.8 percentage points, or $120,000, for the same period in 2008. The decrease in the accident period loss ratio primarily reflects lower claim frequency and severity.
The increase in the term life loss ratio primarily reflects a reduction in premium waiver claim terminations from 2008 to 2009, partially offset by a reduction in reported death claims.
The effective tax rate was 32.5% and 48.4% for the years ended December 31, 2009 and 2008, respectively. The difference between the statutory tax rate of 35% and the effective tax rate primarily reflects tax exempt income on municipal bond securities. The decrease in the effective tax rate primarily reflects the impact of tax-exempt income, which increased the income tax benefit in 2008.
The following table represents the operations of the run-off specialty reinsurance segment for the years ended December 31, 2009 and 2008 (in thousands):
The results of operations for the year ended December 31, 2009 reflect the run-off of the segment and the impact of other-than-temporary investment impairments of $1.8 million.
Reinsurance premiums assumed, by line of business, were as follows for the years ended December 31, 2009 and 2008 (in thousands):
The decrease in reinsurance premiums assumed reflects the termination of the quota-share reinsurance treaties.
The average yield on the fixed income portfolio was 3.16% as of December 31, 2009, compared to 3.97% as of December 31, 2008.
The increase in net realized investment losses primarily reflects the aforementioned other-than-temporary investment impairments. The impairments were related to equity securities that had been in an unrealized loss position for more than twelve months.
The major components of consolidated revenue were as follows for the years ended December 31, 2008 and 2007 (in thousands):
The components of consolidated net (loss) income, by segment, for the years ended December 31, 2008 and 2007 were as follows (in thousands):
The decrease in net income primarily reflects the impact of other-than-temporary investment impairments, a decline in the fair value of limited partnership investments, and an increase in the combined ratio. Other-than-temporary impairments totaled $3.6 million for the year ended December 31, 2008. The increase in the combined ratio primarily reflects a decrease in favorable loss reserve development from 2007 to 2008 and an increase in expenses related to the Company’s Southeast expansion, state licensing initiatives and the integration expenses associated with the acquisition of ESHC.
The expense ratios are consistent with the contractual ceding commissions for the years ended December 31, 2008 and 2007.
The net realized investment losses for the year ended December 31, 2008 primarily reflect the aforementioned other-than-temporary impairments. There were no impairments recorded in 2007. In addition, the change in the fair value of convertible bond securities increased the net realized investment losses by $2.1 million in 2008, compared to a decrease in net realized investment gains of $422,000 in 2007.
The increase in the dental calendar period loss ratio primarily reflects a 1.4% decrease in premiums per certificate per month (“PCPM”) and a 5.9% increase in claims expense PCPM from 2007 to 2008. The decrease in the premiums PCPM primarily reflects the impact of premium discounts on new business written in 2007 and early 2008. The accident period loss ratio increased from 70.8% in 2007 to 75.6% in 2008. The increase in the accident period loss ratio primarily reflects the impact of the aforementioned premium rate discounts. In addition to the increase in the accident period loss ratio, there was a slight decrease in favorable loss reserve development from 2007 to 2008.
The decrease in the short-term disability calendar period loss ratio primarily reflects a reduction in claim frequency and severity from 2007 to 2008. The accident period loss ratio decreased from 71.5% in 2007 to 65.6% in 2008. The decrease in the accident period loss ratio was partially offset by a decline in favorable loss reserve development from $148,000, or 2.2 percentage points, in 2007, to $120,000, or 1.8 percentage points, in 2008.
The following table represents the operations of the run-off specialty reinsurance segment for the years ended December 31, 2008 and 2007 (in thousands):
The increase in the calendar period loss and LAE ratio primarily reflects the aforementioned unfavorable loss reserve development. The accident period loss ratios were 59.3% and 56.5% for the years ended December 31, 2008 and 2007, respectively. The 2008 unfavorable loss reserve development of $19.3 million primarily reflects additional information acquired by the Company during the annual claims audit in January 2009. The claims audit revealed several factors which contributed to the increased case reserves reported to the Company and, therefore, resulted in management increasing the loss development factors utilized in estimating the IBNR reserves. Those factors include 1) an improvement in the ceding company’s ability to estimate loss costs earlier in the claims process, including the receipt of damage estimates from contractors and consultants, 2) jurisdictions becoming more aggressive in requiring quicker, more extensive clean-up and an increase in construction costs related to the clean-up, and 3) courts limiting the ability of insurance companies to enforce policy coverage limitations as the courts are more interested in an expeditious clean up due to environmental concerns.
The increase in the expense ratio is related to a decrease in net earned premium due to the termination of the reinsurance treaties. As part of its previously in-force quota share reinsurance agreement with the primary insurer, the Company paid the primary insurer a ceding commission of 30.0% based on assumed premiums.
The increase in the net loss in the corporate/other segment primarily reflects a decline in net investment income. The decrease in net investment income reflects the decline in short-term interest rates as well as the decrease in cash related to the stock buyback program and the repayment of the junior subordinated debentures.
December 31, 2009 compared to December 31, 2008. Total assets were $391.5 million as of December 31, 2009, compared to $377.3 million as of December 31, 2008. Cash and investments increased $17.0 million, primarily reflecting an increase in the estimated fair value of the Company’s investment portfolio, partially offset by the sale and maturity of investments during 2009. Premiums receivable increased $2.8 million, primarily reflecting the increase in direct premiums written. Net deferred income taxes decreased $4.9 million, primarily reflecting the increase in the fair value of the Company’s investment portfolio, and federal income taxes recoverable increased $2.2 million, primarily reflecting estimated federal income tax payments and the recognition of a recoverable related to the carryback of capital losses incurred in 2008 to prior tax years.
Total liabilities were $237.6 million as of December 31, 2009, compared to $239.2 million as of December 31, 2008. Reserves for unpaid losses and LAE decreased $7.6 million primarily reflecting the run-off of the specialty reinsurance segment. Unearned premiums increased $3.7 million, primarily reflecting higher direct premiums written. The segregated portfolio cell dividend payable increased $3.5 million, reflecting positive operating results in the segregated portfolio cell reinsurance segment and an increase in the estimated fair value of the segment’s investment portfolio.
For the years ended December 31, 2009, 2008 and 2007, the Company’s cash inflows from premiums and investment activity were sufficient to support the Company’s cash outflows related to claims and operating expenses. Management expects future cash flows from operations in its workers’ compensation insurance, segregated portfolio cell reinsurance and group benefits insurance segments to be sufficient to cover claims and operating expenses. However, in the event cash flows from operations are not sufficient, the Company may have to liquidate investments to cover such costs. As of December 31, 2009, the Company’s investment portfolio included securities with gross unrealized gains totaling $10.2 million; therefore, based on current gross unrealized gains in the investment portfolio as of December 31, 2009, management does not believe it would have to sell securities at a loss in the event cash flows from operations proved insufficient to cover the Company’s operating needs.
The Company has a $2.6 million line of credit available to provide additional liquidity if needed. In addition to the line of credit, the Company has obtained letters of credit totaling $45.8 million for the purpose of securing obligations to reinsurers, if necessary. As of December 31, 2009, there was approximately $5.9 million still available under the Company’s letter of credit facilities.
Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to the Company.
The primary sources of cash flows for the Company are net premiums written, investment income, and proceeds from the sale or maturity of investments. The major components of cash flow are as follows for the years ended December 31, 2009, 2008, and 2007 (in thousands):
The decrease in cash flows from financing activities for the year ended December 31, 2008 reflects an increase in share repurchases under the Company’s stock repurchase program, and increase in the quarterly shareholder dividend from $0.05/share in 2007 to $0.07/share in 2008, and the repayment of the junior subordinated debentures.
(2) The payments related to the loss reserves are shown before purchase accounting adjustments of $537,000.
The loss reserves payments due by period in the table above are based upon the loss and LAE reserves estimates as of December 31, 2009 and actuarial estimates of expected payout patterns by line of business. As a result, our calculation of loss reserve payments due by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our reserving process, see “Item 1 - Business, Loss and LAE Reserves.” Actual payments of loss and LAE by period will vary, perhaps materially, from the above table to the extent that current estimates of loss reserves vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns.
As of December 31, 2009, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
In our opinion, the consolidated financial statement listed in the index appearing under Item 15 a)(1) present fairly, in all material respects, the financial position of Eastern Insurance Holdings, Inc. and its subsidiaries (the “Company”) at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15 a)(2) present fairly, in all material respects the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective 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 (COSO). 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 “Management’s Report on Internal Controls Over Financial Reporting” appearing under Item 9A - Controls and Procedures. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
On September 29, 2008, EIHI acquired all of the outstanding stock of Employers Security Holding Company (“ESHC”) and its wholly-owned subsidiaries, Employers Security Insurance Company (“ESIC”) and Affinity Management Services (“AMS”) (See Note 3). ESIC is an Indiana-domiciled, mono-line workers’ compensation insurance company licensed to write business in Indiana, Illinois and Missouri.
EHC was merged into EIHI with EIHI being the surviving entity;
The Company currently operates in five segments: workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, specialty reinsurance and corporate/other. The specialty reinsurance segment was placed into run-off effective July 1, 2008. See Note 16 for a description of each segment.
The Company’s investments in fixed income securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax. Fixed income securities include publicly traded and private placement bonds. The estimated fair value of publicly traded bonds are based on prices obtained from an independent pricing service. Prices obtained from the independent pricing service are determined based on quoted market prices or, in the absence of quoted market prices, dealer quotes or matrix pricing, all of which are based on observable market-based inputs when available. Adverse credit market conditions have caused some markets to become relatively illiquid, thus reducing the availability of certain data used by the independent pricing services and dealers. When prices provided by the independent pricing service vary significantly from week to week, management reviews and validates such prices with other recognized market information sources or independent broker/dealers. Other criteria used by management to determine whether a market has become inactive include price quotations not based on current information, price quotations varying among brokers, significant increases in the bid-ask spread of a security and a significant decline or absence of a market for new issuances. The estimated fair value of private placement bonds is determined using valuation models, taking into consideration the securities’ coupon rate, maturity date, and other pertinent features.
Other long-term investments consist primarily of investments in limited partnerships. Investments in limited partnerships are reported in the consolidated financial statements using the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnerships’ net asset value. Changes in the value of the Company’s proportionate share of its limited partnership investments are included in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income (loss). The Company reports changes in the value of its limited partnership investments on a month lag as a result of the timing of statements being received from the limited partnership.
Reinsurance premiums assumed by the Company’s run-off specialty reinsurance operations are estimated based on information provided by the ceding companies. The information used in establishing these estimates is reviewed and subsequent adjustments are recorded in the period in which they are reported. These premiums are earned over the terms of the related reinsurance contracts.
A liability is established for the estimated unpaid losses and LAE of the Company’s group benefits insurance segment as follows:
The liability for reported but unpaid long-term disability claims is calculated using the 1987 Commissioners Group Disability Table. The long-term disability reserves are discounted based on the expected rate of return of ELH’s fixed income portfolio in the year that the claim was incurred. The discount rate for claims incurred in 2009, 2008 and 2007 was 4.00%, 3.85% and 5.25%, respectively. The liability for IBNR claims is estimated on a policy-by-policy basis, taking into consideration average monthly premium, policy elimination periods, and an expected loss ratio.
The liability for life premium waiver reserves represents the present value of future life insurance benefits under those term life insurance policies for which premium has been waived due to the insured’s disability. The liability for life premium waiver reserves is calculated using the 2005 Group Term Life Waiver Reserve Table for claims reported on or after October 1, 2007 and the 1970 Intercompany Group Life Disability Table for claims reported prior to October 1, 2007.
Management believes that its reserves for unpaid losses and LAE is adequate as of December 31, 2009. However, estimating the ultimate liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded as of December 31, 2009, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.
Amortization of policy acquisition costs, before the impact of purchase accounting, totaled $6,202, $6,872, and $6,033 for the years ended December 31, 2009, 2008 and 2007, respectively.
The Company’s federal income tax returns for tax years subsequent to December 31, 2004 are subject to examination by the Internal Revenue Service.
The Company is subject to state guaranty fund assessments in the states in which it is licensed, which provide for the payment of covered claims or to meet other insurance obligations from insurance company insolvencies. The Company’s assessments consist primarily of charges from the Workers’ Compensation Security Fund of Pennsylvania (“Security Fund”). The Security Fund serves as a guaranty fund to provide claim payments for those workers entitled to workers’ compensation benefits when the insurance company originally providing the benefits was placed into liquidation by a court. Security Fund assessments are established on an actuarial basis to provide an amount sufficient to pay the outstanding and anticipated claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department to administer the fund and to maintain a minimum balance in the fund of $500 million. If the Security Fund determines that the balance in the Security Fund is less than $500 million based on the actuarial study, then an assessment up to one percent of direct written premium is made to all companies licensed to write workers’ compensation in Pennsylvania. Eastern Alliance, Allied Eastern and
Goodwill represents the excess of cost over the fair value of net assets of businesses acquired. Goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but are instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles-Goodwill and Other.
In April 2009, the FASB issued new accounting guidance related to the recognition and presentation of other-than-temporary investment impairments. The new guidance requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the other-than-temporary impairment related to a credit loss is recorded as a net realized investment loss in the statements of operations, and the amount of the other-than-temporary impairment related to other factors is recorded as an other comprehensive loss. The new guidance was effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the new guidance effective April 1, 2009, which resulted in the Company recording a cumulative effect adjustment that increased retained earnings and decreased accumulated other comprehensive income (loss), net, as of April 1, 2009, by $685 and $445, respectively, resulting in an increase to shareholders’ equity of $240. The increase in shareholders’ equity reflects the reversal of a prior period deferred tax valuation allowance, of which $240 was applied to the retained earnings cumulative effect adjustment.
Amortization expense totaled $1,732, $1,373 and $1,738 for the years ended December 31, 2009, 2008 and 2007, respectively.
Basic earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the years ended December 31, 2009, 2008 and 2007, there were 797,141, 1,170,297 and 843,058 stock options and restricted stock awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the years ended December 31, 2009, 2008 and 2007, dilutive potential common shares outstanding included 67,057, 0, and 339,980 restricted stock awards and stock warrants, respectively.
Consolidated net (loss) income, basic shares outstanding, diluted shares outstanding, basic earnings per share, diluted earnings per share and cash dividends per share for the years ended December 31, 2009, 2008 and 2007 were as follows (in thousands, except share and per share data):
Total stock-based compensation expense recognized in the consolidated statement of operations and comprehensive income for the years ended December 31, 2009 and 2008 is shown in the following table (in thousands):
There were no stock options granted in 2009. The fair values of stock options granted during the years ended December 31, 2008 and 2007 were determined on the dates of grant using a lattice-based binomial option valuation model with the following assumptions:
The following table summarizes stock option activity for the year ended December 31, 2009:
Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. The Company’s domestic insurance subsidiaries did not have any permitted practices as of or for the year ended December 31, 2009.
The principal differences between GAAP and SAP relate to the carrying value of fixed income securities, deferred acquisition costs, deferred income taxes, dividends payable, benefit plan liabilities, the non-admissibility of certain assets for SAP purposes, and the reporting of reserves for unpaid losses and loss adjustment expenses and the related reinsurance recoverables on a gross versus net basis.
The statutory surplus and statutory net income (loss) of Eastern Alliance, Allied Eastern, Eastern Advantage, ESIC and ELH as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008, and 2007 was as follows (in thousands):
The ability of Eastern Alliance, Allied Eastern, Eastern Advantage, ESIC and ELH to pay dividends to EIHI is limited by the laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that EIHI’s insurance subsidiaries may pay without the prior approval from the Pennsylvania Insurance Department and Indiana Insurance Department is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the most recently filed annual statement.
Level 1-Represents financial assets whose fair value is determined based upon observable unadjusted quoted market prices for identical financial assets in active markets that the Company has the ability to access. An example of a Level 1 input utilized to measure fair value includes the closing price of one share of common stock on an active exchange market. The Company considers U.S. Treasuries and equity securities as Level 1 assets.
are observable for the asset such as interest rates or yield curves; or other inputs derived principally from or corroborated from other observable market information. An example of a Level 2 input utilized to measure fair value, specifically for the Company’s fixed income portfolio, is “matrix pricing.” “Matrix pricing” relies on observable inputs from active markets other than quoted market prices including, but not limited to, benchmark securities and yields, latest reported trades, quotes from brokers or dealers, issuer spreads, bids, offers, and other relevant reference data to determine fair value. “Matrix pricing” is used to measure the fair value of fixed income securities where obtaining individual quoted market prices is impractical. The Company considers U.S. Government agencies, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, corporate bonds, and convertible bonds as Level 2 assets.
The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of December 31, 2009 and 2008, excluding the segregated portfolio cell segment (in thousands):
The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. Approximately 99.0% of the Company’s fixed income and equity security prices are obtained from the independent pricing service. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices. The Company obtains an understanding of the methods, models and inputs, used by the independent pricing service, and has controls in place to validate that amounts provided represent current exit values. The Company’s controls include, but are not limited to, initial and ongoing evaluation of the methodologies used by the independent pricing service as well as comparing the fair value estimates to the Company’s knowledge of the current market. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and corporate bonds.
The Company’s fixed income securities and convertible bonds consist primarily of publicly traded securities for which there are observable inputs and/or broker quotes. Most fixed income security prices provided by the independent pricing service are based on observable inputs and, therefore, are classified as Level 2 securities. The Company does not hold any fixed income securities, for which pricing was based on significant unobservable inputs; therefore, the Company has not classified any of its fixed income securities as Level 3 securities.
The Company’s equity securities consist primarily of mutual fund instruments for which there is an active market and quoted market prices; therefore, the Company has classified its equity securities as Level 1 securities.
Structured finance opportunity fund-The fund seeks superior risk-adjusted absolute returns by acquiring and actively managing a diversified portfolio of debt securities, including bonds, loans, and other asset-backed instruments.
As of December 31, 2009, the only restrictions on the Company’s ability to redeem its interest in its limited partnership investments relate to the timing of redemption (i.e., monthly, quarterly). There are no restrictions related to the amount the Company can redeem, in the event it chooses to redeem all or a portion of its interest in its limited partnership investments. The Company has no unfunded commitments related to these investments as of December 31, 2009.
The activity in the Company’s limited partnership investments for the years ended December 31, 2009, 2008 and 2007 was as follows (in thousands):
current credit market conditions, the municipal bond arbitrage fund experienced a permanent decline in value during 2008 and will be dissolved. The estimated fair value of the Company’s interest in the limited partnership as of December 31, 2008 reflects management’s best estimate of the proceeds the Company is expected to receive upon dissolution of the fund. As a result of these events, the Company recorded an impairment write-down of $1,397 for the year ended December 31, 2008. There were no impairments in 2007 or 2006.
The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of December 31, 2009 and 2008 (in thousands):
Other structured securities include other asset-backed securities collateralized by home equity loans, credit card receivables and manufactured homes.
The amortized cost and estimated fair value of fixed income securities and convertible bonds as of December 31, 2009, by contractual maturity, are shown below (in thousands). Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of December 31, 2009 and 2008 are as follows (in thousands):
Proceeds from the sale of fixed income securities totaled $95,518, $41,058, and $50,309 for the years ended December 31, 2009, 2008 and 2007, respectively. Proceeds from the sale of equity securities totaled $7,823, $4,699, and $11,956 for the years ended December 31, 2009, 2008, and 2007, respectively. Proceeds from the sale of other long-term investments totaled $461, $820, and $1,876 for the years ended December 31, 2009, 2008, and 2007, respectively.
The gross realized gains and gross realized losses recognized by the Company as a result of the sale of investments were as follows for the years ended December 31, 2009, 2008, and 2007 (in thousands):
For the years ended December 31, 2009, 2008 and 2007, the change in the estimated fair value of convertible bonds included in net realized investment (losses) gains in the consolidated statement of operations and comprehensive income totaled $3,195, $(2,674) and $(457), respectively.
The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE, excluding term life premium waiver reserves, for the years ended December 31, 2009, 2008, and 2007 (in thousands):
For the years ended December 31, 2009, 2008 and 2007, the Company (decreased) increased its reserves for unpaid losses and LAE, including the accretion of prior period discount on its workers’ compensation insurance and segregated portfolio cell reinsurance reserves for unpaid losses and LAE, by the following amounts (in thousands):
For the year ended December 31, 2009, the Company recognized net favorable development on prior accident year workers’ compensation loss reserves of $3.7 million, representing 6.8% of the Company’s estimated workers’ compensation net loss reserves as of December 31, 2008 and 5.1% of the Company’s workers’ compensation net premiums earned for the year ended December 31, 2009. The favorable development arose mostly from accident years 2006 and 2007, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting. The improvements in loss mitigation and underwriting include greater availability and use of employers’ return to work programs. Furthermore, the Company was able to settle a large amount of Pennsylvania claims via compromise and release, which is a lump sum cash payment in exchange for a full and final claim settlement. Management attributes the large amount of compromise and release claim closures to the difficult economic conditions and the claimants’ choosing a lump sum cash settlement over the continuation of a workers’ compensation annuity payment.
For the year ended December 31, 2008, the Company recognized net favorable development on prior accident year workers’ compensation loss reserves of $2.7 million, representing 6.3% of the Company’s estimated workers’ compensation net loss reserves as of December 31, 2007 and 4.1% of the Company’s workers’ compensation net premiums earned for the year ended December 31, 2008. The favorable development arose mostly from accident year 2007, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting the continued improvements in loss mitigation and underwriting. The improvements in loss mitigation and underwriting include greater availability and use of employers’ return to work programs and an improved economy in the Company’s underwriting territories during the first nine months of 2008.
For the year ended December 31, 2007, the Company recognized net favorable development on prior accident year workers’ compensation loss reserves of $8.4 million, representing 20.1% of the Company’s estimated workers’ compensation net loss reserves as of December 31, 2006 and 14.9% of the Company’s workers’ compensation net premiums earned for the year ended December 31, 2007. The favorable development arose mostly from accident years 2004, 2005 and 2006, and resulted from actual loss development being less than the Company had expected based on its historical loss development experience. The loss development factors used by the Company to determine its workers’ compensation loss reserves as of December 31, 2006, were based on its loss development history at that time. During 2007, the Company’s favorable loss development relative to its historical experience was driven by favorable effects from its loss mitigation efforts, which include greater availability and use of employers’ return to work programs, an improved economy relative to the historical experience of the Company, and significant claim settlements during 2007 at amounts less than reserves previously established.
The Company estimates and records reserves for its segregated portfolio cell reinsurance segment in the same manner as for its workers’ compensation insurance segment. Furthermore, the Company’s underwriting, claim administration and risk management services are consistent between its workers’ compensation insurance and segregated portfolio cell reinsurance segments. This is because the segregated portfolio cell and workers’ compensation segments derive their books of business from the same general business demographics and geography.
For the year ended December 31, 2008, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance loss reserves of $2.0 million, representing 9.4% of the Company’s estimated segregated portfolio cell reinsurance net loss reserves as of December 31, 2007 and 8.4% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2008. The favorable development arose mostly from accident years 2006 and 2007, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting. The improvements in loss mitigation and underwriting include greater availability and use of employers’ return to work programs and an improved economy in the Company’s underwriting territories during the first nine months of 2008.
For the year ended December 31, 2007, the Company recognized net favorable development on prior accident year group benefits insurance reserves of $961,000. The favorable development primarily reflects a decrease in prior accident year dental and short-term disability reserves of $709,000 as a result of better than expected claim experience. The Company’s long-term disability reserves decreased $286,000, primarily related to prior year claim terminations. The Company also decreased its term life reserves by $175,000 as a result of lower than expected reported death claims.
For the year ended December 31, 2009, there was no development recorded on prior accident year specialty reinsurance loss reserves. While there was no reserve development recorded in 2009, there is significant uncertainty related to the estimation of the specialty reinsurance loss and LAE reserves. The Company is dependent on the ceding company to provide accurate loss information on a quarterly basis from which management estimates the specialty reinsurance loss and LAE reserves. In the event the loss information received by the Company reflected higher losses than anticipated, as occurred in 2008 and 2007, the Company may incur additional losses related to this segment.
For the year ended December 31, 2007, the Company recognized net unfavorable development on prior accident year specialty reinsurance loss reserves of $4.8 million, representing 24.6% of the Company’s estimated specialty reinsurance net loss reserves as of December 31, 2006. The unfavorable development arose mostly from accident years 2001, 2002, 2003, 2004 and 2005, and resulted from an increase in reported losses from the ceding company primarily related to the EIA liability product.
The following table provides a summary of the Company’s losses and loss adjustment expenses incurred on a direct, assumed, ceded and net basis for the years ended December 31, 2009, 2008, and 2007 (in thousands):
The components of the net deferred tax asset as of December 31, 2009 and 2008 are as follows (in thousands):
As of December 31, 2009, the net deferred tax asset of $1,349 has not been reduced by a valuation allowance because management believes that, while it is not assured, it is more likely than not that the Company will generate sufficient future taxable income to utilize these net future tax deductions. The amount of the net deferred tax asset considered realizable, however, could be materially reduced in the near term if estimates of future taxable income in the years in which the differences are expected to reverse are decreased.
Suspense shares, allocated shares, shares committed to be released, average price per share and stock compensation expense as of and for the years ended December 31, 2009 and 2008 were as follows (in thousands, except share data):
ELH sponsors a non-contributory defined benefit pension plan (the “pension plan”) and a defined benefit postretirement plan (the “postretirement plan”), both of which are frozen as to the earning of additional benefits.
The net periodic benefit cost incurred by the Company for the years ended December 31, 2009, 2008 and 2007 totaled $68, $(59), and $(533) for the pension plan and $(5), $(3), and $(12) for the postretirement plan.
Benefits paid totaled $39, $234, and $424 for the pension plan and $1, $21, and $134 for the postretirement plan for the years ended December 31, 2009, 2008, and 2007, respectively. The estimated future benefits to be paid over the next ten years are as follows (in thousands):
The Company’s current operates in five business segments. The specialty reinsurance segment was placed into run-off effective July 1, 2008.
The Company offers traditional workers’ compensation insurance coverage to employers, primarily in the Mid-Atlantic, Southeast and Midwest regions of the continental United States. The Company’s workers’ compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies and large deductible policies.
The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, investment and segregated portfolio management services. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation, run-off specialty reinsurance, and corporate/other segments totaling approximately $4,054,$4,188 and $3,900 for the years ended December 31, 2009, 2008 and 2007, respectively.
Prior to July 1, 2008, the Company assumed business through its participation in reinsurance treaties with an unaffiliated insurance company related to an underground storage tank insurance program, referred to as “EnviroGuard,” and a non-hazardous waste transportation product, referred to as “EIA liability” (“EIA”). The EnviroGuard program provided coverage to underground tank owners for third party off-site bodily injury and property damage claims as well as clean-up coverage and first party on-site claims. The EIA program provided commercial automobile liability coverage for non-hazardous waste haulers. Prior to terminating its participation in the reinsurance treaties effective July 1, 2008, the Company had reduced its participation in the EnviroGuard and EIA programs from a 25% quota share participation to a 15% quota share participation effective January 1, 2008. Net premiums earned, by program and before purchase accounting adjustments, for the years ended December 31, 2009, 2008 and 2007 were as follows (in thousands):
The Company’s corporate headquarters are located at 25 Race Avenue in Lancaster, Pennsylvania. The Company leases its home office building under a 15-year, non-cancelable lease through February 2017. The annual base rent is subject to an annual increase based upon the consumer price index at the end of each preceding calendar year. In addition to the base rent, the Company is responsible for its proportionate share of expenses related to the building including, but not limited to, utilities, maintenance, real estate taxes, and insurance. The Company has a 5% interest in the limited partnership that owns the building.
The Company maintains regional offices in North Carolina and Indiana and leases office space under multi-year operating leases through January 2013 and March 2017, respectively.