Leased Properties. The Company leases space for its principal offices and for some of its insurance operations in an office building located in Atlanta, Georgia, from Delta Life Insurance Company under a lease which continues until either party provides written notice of cancellation at least twelve months in advance of the actual termination date. The lease, which incepted on November 1, 2007, provides for rent adjustments on every fifth anniversary of the term commencement date. On March 31, 2008, this lease was amended. As a result, the Company’s leased space was reduced by 15,903 square feet. Under the current terms of the lease, the Company occupies approximately 49,586 square feet of office space. Delta Life Insurance Company, the owner of the building, is controlled by J. Mack Robinson, Chairman Emeritus and the largest shareholder of the Company. The terms of the lease are believed by Company management to be comparable to terms which could be obtained by the Company from unrelated parties for comparable rental property.
Unpaid loss and loss adjustment expenses comprised 27% of the Company’s total liabilities at December 31, 2008. This obligation includes estimates for: 1) unpaid losses on claims reported prior to December 31, 2008, 2) development on those reported claims, 3) unpaid ultimate losses on claims incurred prior to December 31, 2008 but not yet reported and 4) unpaid loss adjustment expenses for reported and unreported claims incurred prior to December 31, 2008. Quantification of loss estimates for each of these components involves a significant degree of judgment and estimates may vary, materially, from period to period. Estimated unpaid losses on reported claims are developed based on historical experience with similar claims by the Company. Development on reported claims, estimates of unpaid ultimate losses on claims incurred prior to December 31, 2008 but not yet reported, and estimates of unpaid loss adjustment expenses, are developed based on the Company’s historical experience, using actuarial methods to assist in the analysis. The Company’s actuary develops ranges of estimated development on reported and unreported claims as well as loss adjustment expenses using various methods including the paid-loss development method, the reported-loss development method, the paid Bornhuetter-Ferguson method and the reported Bornhuetter-Ferguson method. Any single method used to estimate ultimate losses has inherent advantages and disadvantages due to the trends and changes affecting the business environment and the Company’s administrative policies. Further, a variety of external factors, such as legislative changes, medical cost inflation, and others may directly or indirectly impact the relative adequacy of liabilities for unpaid losses and loss adjustment expenses. The Company’s approach is to select an estimate of ultimate losses based on comparing results of a variety of reserving methods, as opposed to total reliance on any single method. Unpaid loss and loss adjustment
Future policy benefits comprised 30% of the Company’s total liabilities at December 31, 2008. These liabilities relate primarily to life insurance products and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Deferred acquisition costs comprised 7% of the Company’s total assets at December 31, 2008. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to expense in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any given previous calendar year.
Deferred income taxes comprised approximately 4% of the Company’s total assets at December 31, 2008. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for tax purposes. These deferred income taxes are measured by applying currently enacted tax laws and rates. Valuation allowances are recognized to reduce the deferred tax assets to the amount that is deemed more likely than not to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income and tax planning strategies.
On a consolidated basis, the Company had a net loss of $3.9 million, or $0.25 per diluted share, in 2008, compared to net income of $7.3 million, or $0.25 per diluted share, in 2007 and $8.9 million, or $0.33 per diluted share, in 2006. Loss from continuing operations was $0.5 million in 2008, compared with income from continuing operations of $11.6 million in 2007 and $7.2 million in 2006; while the loss from discontinued operations was $3.4 million in 2008, compared to loss from discontinued operations of $4.3 million in 2007 and income from discontinued operations of $1.8 million in 2006. The loss from continuing operations before income taxes was $1.0 million in 2008, compared to income from continuing operations before income taxes of $19.1 million in 2007 and $9.6 million in 2006. The loss from continuing operations in 2008 was primarily due to a $4.0 million realized loss related to the write-down in the value of certain bonds, preferred and common stocks due to an other than temporary impairment. The Company had net realized investment losses of $4.0 million in 2008, compared to net realized investment gains of $12.6 million in 2007 and $3.1 million in 2006. In 2007, the Company disposed of a significant holding in Wachovia Corporation which resulted in realized investment gains totaling $12.9 million. Such variations between years in realized investment gains and losses significantly influence the reported income (loss) from continuing operations before income taxes. Income from continuing operations before income taxes and realized investment gains and losses was $3.0 million in 2008 and was $6.5 million in both 2007 and 2006. The magnitude of realized investment gains and losses in any year are a function of the timing of trades of investments relative to the markets themselves as well as the recognition of any impairments on investments.
Gross written premiums at American Southern increased $0.8 million, or 1.8%, during 2008 as compared to 2007. The increase in gross written premiums was primarily attributable to a significant increase in commercial automobile business generated by a newly appointed agency. Partially offsetting this increase in gross written premiums were decreases in both the general liability and property lines of business due to the weak construction industry, particularly in the state of Florida.
Ceded premiums decreased $0.1 million, or 2.0%, during 2008 as compared to 2007. The decrease in ceded premiums was primarily due to the decline in the related earned premiums. As American Southern’s premiums are determined and ceded as a percentage of earned premiums, a decrease in ceded premiums occurs when earned premiums decrease.
In establishing reserves, American Southern initially reserves for losses at the upper end of the reasonable range if no other value within the range is determined to be more probable. Selection of such an initial loss pick is an attempt by management to give recognition that initial claims information received generally is not conclusive with respect to legal liability, is generally not comprehensive with respect to magnitude of loss and generally, based on historical experience, will develop more adversely as time and information evolves. However, as a result, American Southern generally experiences reserve redundancies when analyzing the development of prior year losses in a current period. At December 31, 2008, the range of estimates developed in connection with the loss reserves for American Southern indicated that reserves could be as much as 22.1% lower or as much as 5.4% higher. Development from prior years’ reserves has historically reduced the current
year loss ratio; however, such reduction in the current year loss ratio is generally offset by the reserves established in the current year for current period losses. American Southern’s reserve redundancies for the years ended December 31, 2008, 2007 and 2006 were $8.0 million, $8.6 million and $6.7 million, respectively. To the extent reserve redundancies vary between years, there is an incremental impact on the results of operations from American Southern and the Company. The indicated redundancy in 2008 was $0.6 million less than that in 2007. After considering the impact on contingent commissions and other related accruals, the $0.6 million decline in the redundancy resulted in a decline in income from operations before tax of approximately $0.4 million in 2008 as compared to 2007. Conversely, the indicated redundancy in 2007 was $1.9 million greater than that in 2006; and after considering the impact of contingent commissions and other related accruals, the $1.9 million increase in the indicated redundancy resulted in an increase in income from operations before tax of approximately $1.1 million in 2007 as compared to 2006. Management believes that such differences will continue in future periods but is unable to determine if or when incremental redundancies will increase or decrease, until the underlying losses are ultimately settled.
Premium revenue at Bankers Fidelity decreased $2.7 million, or 4.5%, during 2007 as compared to 2006. The most significant decrease in premiums was in the Medicare supplement line of business, where premiums decreased $3.1 million, or 7.0%, due to the continued decline in new business levels and non-renewal of certain policies that resulted from increased competition, as discussed previously. In 2007, the company’s key five states collectively accounted for approximately 55% of total earned premiums. The Medicare supplement line of business in these states decreased approximately $2.4 million as compared to 2006. Premiums from the life insurance line of business decreased $0.3 million, or 3.1%, during 2007 due to a continued decline in sales related activities. The other health products premiums increased to $3.8 million in 2007 from $3.0 million in 2006, or 26.5%, primarily as a result of increased business activities with group “associations.” In 2007, Bankers Fidelity began targeting group “associations” for additional sources of new business.
Benefits and losses decreased slightly during 2008 as compared to 2007 and $1.7 million, or 4.1%, during 2007 as compared to 2006. As a percentage of earned premiums, benefits and losses were 72.7% in 2008 compared to 71.6% in 2007 and 71.3% in 2006. The increasing loss ratio between years was primarily due to the continued aging of the life business. In the years ended December 31, 2008, 2007 and 2006, favorable loss development, primarily from adjustments to the prior years’ IBNR reserves, was $0.7 million, $2.9 million and $3.2 million, respectively. Bankers Fidelity’s Medicare supplement premium revenue peaked in 2005 and has continued to decline through 2008. With the introduction of Medicare Advantage and other competitive products, discussed previously, Medicare supplement revenues declined 1.0% in the year ended December 31, 2008 as compared to 2007. For the years ended December 31, 2007 and 2006, Medicare supplement premiums declined 7.0% and 12.6%, respectively, from the comparable prior years. Such premium revenue declines disrupted historical patterns on which determinations of IBNR reserve adequacy had been based. A primary consideration in reserve adequacy during this period was the significant potential for adverse selection. Even though premium revenues declined, because of offsetting rate increases, the decline in policy count was greater than indicated. Accordingly, until historical experience could be further developed in a declining business environment, indicated excess reserves as a result of favorable development were recognized at the low end of the reasonable range of indicated redundancy. Premium declines on a monthly basis have since moderated and management does not believe that redundancies of such magnitude will continue in future years as evidenced in the 2008 development.
Underwriting expenses decreased $1.0 million, or 5.3%, during 2008 as compared to 2007, and decreased $0.4 million, or 2.2%, during 2007 as compared to 2006. The decrease in underwriting expenses during 2008 was primarily due to decreases in advertising and agency related expenses. The decrease in underwriting expenses during 2007 was directly related to the decline in premium revenues. As a percentage of earned premiums, these expenses were 31.4% in 2008 compared to 32.4% in 2007 and 31.7% in 2006. The increase in the expense ratio during 2007 was primarily due to increased costs on marketing initiatives related to product diversification initiatives.
The indicated underwriting loss of $2.3 million in 2008 and 2007 and $1.8 million in 2006 is prior to considering investment income which is a significant component in evaluating profitability; particularly in the life insurance business. Increased marketing efforts have resulted in underwriting expenses declining at a slower rate than the related premiums and thus increasing the indicated underwriting loss.
The Company had net realized investment losses of $4.0 million in 2008 and net realized investment gains of $12.6 million in 2007 and $3.1 million in 2006. The net realized investment losses in 2008 were due to impairment charges related to the write-down in the value of certain bonds, preferred and common stocks. The significant net realized investment gains in 2007 were primarily the result of the disposition of the investment in equity securities of Wachovia Corporation which resulted in a realized investment gain of $12.9 million. The net realized investment gains in 2006 were primarily due to the sale of a portion of the Company’s automotive sector investments (bonds of General Motors, GMAC and Ford), a portion of the Company’s investment in equity securities of Wachovia Corporation, and the sale of a real estate partnership interest, all of which resulted in realized investment gains totaling $3.1 million. During the years ended December 31, 2008 and 2007, the Company recorded investment impairments due to other than temporary declines in values, which reduced reported realized investment gains, related to the following investments:
While the impairments did not impact the carrying value of the investments, they resulted in realized losses of $4.0 million in 2008 and $0.2 million in 2007. Management continually evaluates the Company’s investment portfolio and, as needed, makes adjustments for impairments and/or will divest investments. See Note 3 of Notes to Consolidated Financial Statements.
Interest expense of $4.2 million decreased $0.4 million, or 9.7%, during 2007 as compared to 2006. The decrease in interest expense during 2007 was due to active management of the revolving nature of amounts outstanding under the Credit Agreement. During each quarter, using excess funds, the Company repaid a substantial portion of its bank borrowings. At each quarter end, the Company would then reborrow funds under the Credit Agreement such that borrowed amounts were consistent at each quarter end. Such periodic bank borrowings and repayments resulted in a reduction in interest expense by reducing the average debt level outstanding during 2007 as compared to 2006.
The primary differences between the effective tax rate and the federal statutory income tax rate result from the dividends-received deduction (“DRD”), the small life insurance company deduction (“SLD”) and the change in asset valuation allowance. The current year DRD is adjusted as underlying factors change, including known actual 2008 distributions earned on invested assets. The actual current DRD can vary from the estimates based on, but not limited to, amounts of distributions from these investments as well as appropriate levels of taxable income. The SLD varies in amount and is determined at a rate of 60 percent of the tentative life insurance company taxable income (“LICTI”). The amount of the SLD for any taxable year is reduced (but not below zero) by 15 percent of the tentative LICTI for such taxable year as it exceeds $3.0 million and is ultimately phased out at $15.0 million. The change in the asset valuation allowance primarily results from a periodic assessment of the realization of certain loss carry forward benefits.
In addition to these internal funding sources, the Company maintains its revolving credit facility under the Credit Agreement pursuant to which the Company was able to, subject to the terms and conditions thereof, initially borrow or reborrow up to $15.0 million (the “Commitment Amount”). In accordance with the terms of the Credit Agreement, the Commitment Amount is incrementally reduced every six months and was equal to $13.0 million at December 31, 2008. The interest rate on amounts outstanding under the Credit Agreement is, at the option of the Company, equivalent to either (a) the base rate (which equals the higher of the Prime Rate or 0.5% above the Federal Funds Rate, each as defined) or (b) the LIBOR determined on an interest period of 1-month, 2-months, 3-months or 6-months, plus an Applicable Margin (as defined). The Applicable Margin varies based upon the Company’s leverage ratio (funded debt to total capitalization, each as defined) and ranges from 1.75% to 2.50%. Interest on amounts outstanding is payable quarterly. The Credit Agreement requires the Company to comply with certain covenants, including, among others, ratios that relate funded debt to both total capitalization and earnings before interest, taxes, depreciation and amortization, as well as the maintenance of minimum levels of tangible net worth. The Company must also comply with limitations on capital expenditures, certain payments, additional debt obligations, equity repurchases and certain redemptions, as well as minimum risk-based capital levels. Upon the occurrence of an event of default, Wachovia may terminate the Credit Agreement and declare all amounts outstanding due and payable in full. During the first half of 2008, the Company repaid the outstanding balance of $12.8 million to Wachovia and since then has not reborrowed any amounts under this Credit Agreement.
During 2006, the Company entered into a zero cost rate collar with Wachovia to hedge future interest payments on a portion of the Junior Subordinated Debentures. The notional amount of the collar was $18.0 million with an effective date of March 6, 2006. The collar has a LIBOR floor rate of 4.77% and a LIBOR cap rate of 5.85% and adjusts quarterly on the 4th of each March, June, September and December through termination on March 4, 2013. The Company began making payments to Wachovia under the zero cost rate collar on June 4, 2008. While the Company is exposed to counterparty risk should Wachovia fail to perform, the recent decrease in interest rates, coupled with the current macroeconomic outlook would indicate
At December 31, 2007, the Company had 134,000 shares of Series B Preferred Stock outstanding, having a stated value of $100 per share. All of the shares of Series B Preferred Stock were held by Mr Robinson, the Company’s Chairman Emeritus, and his affiliates (the “Holders”). Annual dividends on the Series B Preferred Stock were $9.00 per share and were cumulative. Dividends accrued whether or not declared by the Company’s board of directors. As of December 31, 2007, the Company had accrued but unpaid dividends on the Series B Preferred Stock of $14.5 million. On October 28, 2008, the Company redeemed all of the issued and outstanding shares of Series B Preferred Stock at the stated value of $100 per share, for an aggregate payment of $13.4 million. In connection therewith, the Company also paid $1.7 million in dividends to the Holders of the Series B Preferred Stock in satisfaction of a portion of the accrued but unpaid dividends on the Series B Preferred Stock through the date of redemption. The Holders of the Series B Preferred Stock agreed to discharge the Company from any obligation to pay the remaining $13.8 million of accrued but unpaid dividends on the Series B Preferred Stock and to release the Company from any further obligations thereunder. As a result, the reversal of the $13.8 million of accrued but unpaid dividends on the Series B Preferred Stock was recorded as a capital contribution during the fourth quarter of 2008.
At December 31, 2008, the Company had 70,000 shares of Series D Preferred Stock (“Series D Preferred Stock”) outstanding. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s Chairman Emeritus. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,754,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. During 2008 and 2007, the Company issued common stock in lieu of Series D Preferred Stock dividend payments of $0.5 million and $0.6 million, respectively. As of December 31, 2008, the Company had accrued but unpaid dividends on the Series D Preferred Stock of $.02 million.
Net cash used in operating activities totaled $2.7 million in 2008 compared to net cash provided by operating activities of $5.6 million and $6.8 million in 2007 and 2006, respectively. Cash and short-term investments increased to $37.3 million at December 31, 2008 from $36.9 million at December 31, 2007. The increase in cash and short-term investments during 2008 was primarily due to the cash received from the sale of the Company’s regional property and casualty operations, Association Casualty and Georgia Casualty, to Columbia Mutual Insurance Company discussed previously. Partially offsetting the increase in cash and short-term investments during 2008 were tax sharing payments of $3.1 million to the Company’s regional property and casualty operations in connection with such sale, federal income tax payments of $2.2 million, as well as an increased level of investment purchasing activity exceeding normal sales and maturities. The Company also redeemed all the outstanding shares of its Series B Preferred Stock for $13.4 million and paid a $1.7 million dividend in connection therewith. In addition, the Company repaid $12.8 million of bank debt to Wachovia. Cash and short-term investments at December 31, 2008 of $37.3 million are believed to be sufficient to meet the Company’s near-term needs.
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60” (“SFAS 163”).
The scope of SFAS 163 is limited to financial guarantee insurance (and reinsurance) contracts issued by enterprises that are included within the scope of SFAS 60 and that are not accounted for as derivative instruments. SFAS 163 excludes from its scope insurance contracts that are similar to financial guarantee insurance such as mortgage guaranty insurance and credit insurance on trade receivables. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for certain disclosures about the insurance enterprise’s risk-management activities. Except for certain disclosures, earlier application is not permitted. The Company does not have financial guarantee insurance products, and, accordingly does not expect the issuance of SFAS 163 to have an effect on the Company’s financial condition or results of operations.
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principles to be used in preparing financial statements for non-governmental entities in conformity with GAAP. Adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”), an amendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS 161 amends and expands disclosures about an entity’s derivative and hedging activities with the intent of providing users of financial statements with an enhanced understanding of a) how and why an entity uses derivative instruments, b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures. The Company expects to adopt SFAS 161 on January 1, 2009, and does not expect the adoption to have a material impact on the Company’s financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). This statement replaces SFAS No. 141, “Business Combinations” and establishes the principles and requirements for how the acquirer in a business combination: (a) measures and recognizes the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquired entity, (b) measures and recognizes positive goodwill acquired or a gain from bargain purchase (negative goodwill), and (c) determines the disclosure information that is decision-useful to users of financial statements in evaluating the nature and financial effects of the business combination. SFAS 141(R) further requires all transaction costs for an acquisition to be expensed as incurred rather than capitalized, and changes the measurement date to the date an acquisition closes. In December 2007, the FASB also issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). This statement amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (“ARB 51”). Noncontrolling interest refers to the minority interest portion of the equity of a subsidiary that is not attributable directly or indirectly to a parent. SFAS 160 establishes accounting and reporting standards that require for-profit entities that prepare consolidated financial statements to (a) present noncontrolling interests as a component of equity, separate from the parent’s equity, (b) separately present the amount of consolidated net income attributable to noncontrolling interests in the income statement, (c) consistently account for changes in a parent’s ownership interests in a subsidiary in which the parent entity has a controlling financial interest as equity transactions, (d) require an entity to measure at fair value its remaining interest in a subsidiary that is deconsolidated, and (e) require an entity to provide sufficient disclosures that identify and clearly distinguish between interests of the parent and interests of noncontrolling owners. Both SFAS 141(R) and SFAS 160 are effective for fiscal years beginning on or after December 15, 2008 with earlier adoption prohibited. The Company does not believe that the adoption of either of the standards will have a material impact on the Company’s financial condition and results of operations; although if future acquisitions are made, the prospective accounting will differ from that in the past.
The Company’s Level 3 instruments include certain fixed maturity securities and a zero cost rate collar. Fair value is based on criteria that use assumptions or other data that are not readily observable from objective sources. As of December 31, 2008, the Company’s fixed maturity securities valued using Level 3 criteria totaled $1.9 million and the zero cost rate collar was a liability of $2.1 million. See Note 16 of Notes to Consolidated Financial Statements.
In the normal course of business, the Company has structured borrowings that, in accordance with accounting principles generally accepted in the United States of America, are recorded on the Company’s balance sheet at an amount that differs from the ultimate contractual obligation. See Note 7 of Notes to Consolidated Financial Statements.
Represents balances due for goods and/or services which have been contractually committed as of December 31, 2008. To the extent contracts provide for early termination with notice but without penalty, only the amounts contractually due during the notice period have been included.
Losses and claims include case reserves for reported claims and reserves for claims IBNR. While payments due on claim reserves are considered contractual obligations because they relate to insurance policies issued by the Company, the ultimate amount to be paid to settle both case reserves and IBNR reserves is an estimate, subject to significant uncertainty. The actual amount to be paid is not determined until the Company reaches a settlement with any applicable claimant. Final claim settlements may vary significantly from the present estimates, particularly since many claims will not be settled until well into the future. In estimating the timing of future payments by year, the Company has assumed that its historical payment patterns will continue. However, the actual timing of future payments will likely vary materially from these estimates due to, among other things, changes in claim reporting and payment patterns and large unanticipated settlements. Amounts reflected do not include reinsurance amounts which may also be recoverable based on the level of ultimate sustained loss.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Atlantic American Corporation and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
At December 31, 2008, the Parent owned three insurance subsidiaries, Bankers Fidelity Life Insurance Company (“Bankers Fidelity”), American Southern Insurance Company and its wholly-owned subsidiary, American Safety Insurance Company (together known as “American Southern”), in addition to one non-insurance subsidiary, Self-Insurance Administrators, Inc. (“SIA, Inc.”). On December 26, 2007, the Company entered into a stock purchase agreement providing for the sale of all the outstanding shares of stock of Association Casualty Insurance Company and Association Risk Management General Agency, Inc., together known as “Association Casualty” and Georgia Casualty & Surety Company (“Georgia Casualty”) to Columbia Mutual Insurance Company (“Columbia”). The Company completed this sale on March 31, 2008. Accordingly, the assets, liabilities, and results of operations of Association Casualty and Georgia Casualty have been reflected by the Company as discontinued operations. See Note 2.
regulator. During 2008 and 2007, impairment charges of $260 and $620, respectively, were recognized. No impairment of the Company’s recorded goodwill was identified during 2006.
In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60” (“SFAS 163”). The scope of SFAS 163 is limited to financial guarantee insurance (and reinsurance) contracts issued by enterprises that are included within the scope of SFAS 60 and that are not accounted for as derivative instruments. SFAS 163 excludes from its scope insurance contracts that are similar to financial guarantee insurance such as mortgage guaranty insurance and credit insurance on trade receivables. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for certain disclosures about the insurance enterprise’s risk-management activities. Except for certain disclosures, earlier application is not permitted. The Company does not have financial guarantee insurance products, and, accordingly does not expect the issuance of SFAS 163 to have an effect on the Company’s financial condition or results of operations.
(d) require an entity to measure at fair value its remaining interest in a subsidiary that is deconsolidated, and (e) require an entity to provide sufficient disclosures that identify and clearly distinguish between interests of the parent and interests of noncontrolling owners. Both SFAS 141(R) and SFAS 160 are effective for fiscal years beginning on or after December 15, 2008 with earlier adoption prohibited. The Company does not believe that the adoption of either of the standards will have a material impact on the Company’s financial condition or results of operations; although if future acquisitions are made, the prospective accounting will differ from that in the past.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115” (“SFAS 159”). This statement permits entities to choose, at specified election dates, to measure eligible items at fair value (i.e. the fair value option). Items eligible for the fair value option include certain recognized financial assets and liabilities, rights and obligations under certain insurance contracts that are not financial instruments, host financial instruments resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument, and certain commitments. Business entities are required to report unrealized gains and losses on items for which the fair value option has been elected in net income. The fair value option: (a) may be applied instrument by instrument, with certain exceptions; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS 159 was effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, although early adoption was permitted under certain conditions. The Company adopted SFAS 159 on January 1, 2008 and did not elect the fair value option for any eligible items. Adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.
The fair values for fixed maturity and equity securities are largely determined by either independent methods prescribed by the National Association of Insurance Commissioners (“NAIC”), which do not differ materially from nationally quoted market prices, when available, or independent broker quotations.
On December 26, 2007, the Company entered into a stock purchase agreement providing for the sale of all the outstanding shares of stock of Association Casualty and Georgia Casualty to Columbia. On March 31, 2008, the Company completed the sale of shares to Columbia in exchange for approximately $43,000 in cash. Accordingly, the consolidated financial statements reflect the assets, liabilities, and operating results of Georgia Casualty and Association Casualty as discontinued operations. In connection with the closing, the Company and Columbia had agreed to thereafter finalize a valuation matter with respect to certain loss reserves related to the discontinued operations. Effective March 17, 2009, the Company and Columbia entered into a final agreement with respect to all valuation matters, and the Company agreed to make a payment to Columbia of $1,750; $500 of such liability had been recorded as of the closing and the additional $1,250 was recorded as additional loss from discontinued operations effective December 31, 2008.
Market changes in interest rates and credit spreads result in changes in the fair values of investments and are accumulated and reported as unrealized gains and losses. The carrying value of the Company’s investments in fixed maturity securities, non-redeemable preferred stocks and common stocks decreased during 2008 as a result of numerous macroeconomic factors which impacted significantly all of the United States markets. The majority of the unrealized losses at December 31, 2008 resulted from holdings in financial entities which have been impacted by the markets and the related liquidity in the markets. The following table sets forth the carrying value, amortized cost, and net unrealized gains or losses of the Company’s investments aggregated by industry type as of December 31, 2008.
Media includes related party investments in Gray Television, Inc. and Triple Crown Media, Inc. which had an aggregate carrying value of $268 and an amortized cost basis of $3,198 at December 31, 2008. See Note 14.
As part of the Company’s quarterly investment review, the Company has reviewed its investment portfolio and concluded that there were no additional investments with other than temporary impairments as of December 31, 2008 or 2007. The evaluation for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. As a result of issuers’ continued satisfaction of the investment obligations in accordance with their contractual terms, if applicable, and management’s expectation that they will continue to do so, also if applicable, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that the unrealized losses on investments at December 31, 2008 and 2007 were temporary.
Prior years’ development was primarily the result of better than expected development on prior years IBNR reserves for Medicare supplement as well as certain lines of business within American Southern.
The primary differences between the effective tax rate and the federal statutory income tax rate result from the dividends-received deduction (“DRD”), the small life insurance company deduction (“SLD”) and the change in asset valuation allowance. The current year DRD is adjusted as underlying factors change, including known actual 2008 distributions earned on invested assets. The actual current DRD can vary from the estimates based on, but not limited to, amounts of distributions from these investments as well as appropriate levels of taxable income. The SLD varies in amount and is determined at a rate of 60 percent of the tentative life insurance company taxable income (“LICTI”). The amount of the SLD for any taxable year is reduced (but not below zero) by 15 percent of the tentative LICTI for such taxable year as it exceeds $3,000 and is ultimately phased out at $15,000. The change in the asset valuation allowance primarily results from a periodic assessment of the realization of certain loss carry forward benefits.
Deferred tax liabilities and assets at December 31, 2008 and 2007 were comprised of the following:
The components of the income tax benefit from discontinued operations were:
At December 31, 2008, the Company had a reducing revolving credit facility (the “Credit Agreement”) with Wachovia Bank, National Association (“Wachovia”) pursuant to which the Company was able to, subject to the terms and conditions thereof, initially borrow or reborrow up to $15,000 (the “Commitment Amount”). In accordance with the terms of the Credit Agreement, the Commitment Amount is incrementally reduced every six months and was equal to $13,000 at December 31, 2008. The interest rate on amounts outstanding under the Credit Agreement is, at the option of the Company, equivalent to either (a) the base rate (which equals the higher of the Prime Rate or 0.5% above the Federal Funds Rate, each as defined) or (b) the London Interbank Offered Rate (“LIBOR”) determined on an interest period of 1-month, 2-months, 3-months or 6-months, plus an Applicable Margin (as defined). The Applicable Margin varies based upon the Company’s leverage ratio (funded debt to total capitalization, each as defined) and ranges from 1.75% to 2.50%. Interest on amounts outstanding is payable quarterly. The Credit Agreement requires the Company to comply with certain covenants, including, among others, ratios that relate funded debt to both total capitalization and earnings before interest, taxes, depreciation and amortization, as well as the maintenance of minimum levels of tangible net worth. The Company must also comply with limitations on capital expenditures, certain payments, additional debt obligations, equity repurchases and certain redemptions, as well as minimum risk-based capital levels. Upon the occurrence of an event of default, Wachovia may terminate the Credit Agreement and declare all amounts outstanding due and payable in full. During the first half of 2008, the Company repaid the outstanding balance of $12,750 to Wachovia and since then has not reborrowed any amounts under this Credit Agreement.
Effective October 28, 2008, the Credit Agreement was amended to allow the Company to redeem all the outstanding shares of the Company’s Series B Preferred Stock, par value $1.00 per share (“Series B Preferred Stock”) for $13,400, and to allow the Company to pay a dividend in connection therewith of $1,675. This redemption, and the related dividend payment, was completed on October 28, 2008. See Note 11.
The Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all senior debt of the Parent and are effectively subordinated to all existing and future liabilities of its subsidiaries.
The Company’s rental expense, including common area charges, for operating leases was $1,253, $1,268, and $1,276 in 2008, 2007, and 2006, respectively. The Company’s future minimum base lease obligations under non-cancelable operating leases are as follows:
In accordance with the Company’s 1992 Incentive Plan, the Board of Directors was authorized to grant up to 1,800,000 stock options or share awards. The Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company’s common stock and other stock unit awards; (e) deferred shares of common stock; or (f) all or any combination of the foregoing to officers and key employees. Stock options granted under this plan expire five or ten years from the date of grant, as specified in an award agreement. Vesting occurs at 50% upon issuance of an option, and the remaining portion vests in 25% increments in each of the following two years. In accordance with the Company’s 1996 Director Stock Option Plan, a maximum of 200,000 stock options were authorized to be granted, which fully vest six months after the grant date. In accordance with the Company’s 2002 Incentive Plan (the “2002 Plan”), the Board of Directors was authorized to grant up to 2,000,000 stock options or share awards. Subject to adjustment as provided in the 2002 Plan, the Board of Directors is authorized to grant: (a) incentive stock options; (b) non-qualified stock options; (c) stock appreciation rights; (d) restricted shares; (e) deferred shares; and (f) performance shares and/or performance units. Further, the Board may authorize the granting to non-employee directors of stock options and/or restricted shares. A total of 28,688, 12,397 and 21,923 restricted shares were issued to the Company’s Board of Directors under the 2002 Plan in 2008, 2007 and 2006, respectively. As of December 31, 2008, an aggregate of twenty-two employees, officers and directors held options under the three plans.
The fair value of options granted is determined on the date of grant using the Black-Scholes option pricing model, which requires the input of subjective assumptions, including the expected volatility of the stock price. No options were granted in 2008, 2007 or 2006.
The Company has both a funded and unfunded noncontributory defined benefit pension plan covering the employees of American Southern. The plans provide defined benefits based on years of service and average salary. The Company’s general funding policy has been to contribute annually the maximum amount that can be deducted for income tax purposes. Effective May 31, 2008, the Company decided to freeze all benefits
The weighted-average assumptions used to determine the benefit obligation at December 31, 2008 and 2007 were as follows:
Net periodic pension cost for the Company’s qualified and non-qualified defined benefit plans for the years ended December 31, 2008, 2007 and 2006 included the following components:
The weighted-average assumptions used to determine the net periodic benefit cost for the years ended December 31, 2008, 2007 and 2006 were as follows:
At December 31, 2007, the Company had 134,000 shares of Series B Preferred Stock outstanding, having a stated value of $100 per share. All of the shares of Series B Preferred Stock were held by Mr Robinson, the Company’s Chairman Emeritus and his affiliates (the “Holders”). Annual dividends on the Series B Preferred Stock were $9.00 per share and were cumulative. Dividends accrued whether or not declared by the Board of Directors. As of December 31, 2007, the Company had accrued but unpaid dividends on the Series B Preferred Stock of $14,472. On October 28, 2008, the Company redeemed all of the issued and outstanding shares of Series B Preferred Stock at the stated value of $100 per share, for an aggregate payment of $13,400. In connection therewith, the Company also paid $1,675 in dividends to the Holders of the Series B Preferred Stock in satisfaction of a portion of the accrued but unpaid dividends on the Series B Preferred Stock through
The assumed conversion of the Series B and Series D Preferred Stock was excluded from the earnings per common share calculation for 2008 and 2007 since their impact was antidilutive. In 2008, all outstanding stock options were excluded from the earnings per common share calculation since their impact was antidilutive.
Under the insurance code of the state of jurisdiction under which each insurance subsidiary operates, dividend payments to the Parent by its insurance subsidiaries are subject to certain limitations without the prior approval of the applicable state’s Insurance Commissioner. The Parent received dividends of $5,496, $5,576 and $7,786 in 2008, 2007, and 2006, respectively, from its subsidiaries. In 2008, dividend payments by insurance subsidiaries in excess of $8,175 would require prior approval.
The Company leases approximately 49,586 square feet of office and covered garage space from an entity which is an affiliate of the Company and its Chairman Emeritus. On March 31, 2008, this lease was amended. As a result, the Company’s leased space was reduced from 65,489 square feet to 49,586 square feet. During the years ended December 31, 2008, 2007, and 2006, the Company paid $909, $1,066 and $1,069, respectively, under this lease.
Certain financing for the Company has been provided by affiliates of the Company’s Chairman Emeritus, in the form of investments in the Series B and the Series D Preferred Stock (See Note 11).
The Company’s Level 3 fixed maturity securities are comprised solely of issuances of pooled debt obligations of multiple, smaller financial services companies. They are not actively traded and valuation techniques used to measure fair value are based on future estimated cash flows discounted at an appropriate rate of interest. Other qualitative and quantitative information received from the original underwriter of the pooled offering is also considered, as applicable. As the derivative is an interest rate collar, changes in valuation are more closely correlated with changes in interest rates and accordingly values are estimated using projected cash flows at current interest rates discounted at an appropriate rate of interest. Fair value quotations are also obtained from the single counterparty to the transaction.
In accordance with the provisions of SFAS 142, “Goodwill and Other Intangible Assets,” goodwill with a carrying amount of $3,008 was written down to its implied fair value of $2,388 at December 31, 2007 resulting in an impairment charge of $620, which was included in earnings for the year ended December 31, 2007. Goodwill was further written down to its implied fair value of $2,128 at December 31, 2008 resulting in an impairment charge of $260, which was included in earnings for the year ended December 31, 2008.
The following describes the methods and assumptions used by the Company in estimating fair values:
The carrying amount is determined in accordance with methods prescribed by the NAIC, which do not differ materially from publicly quoted market prices. Certain fixed maturity securities that do not have publicly quoted values are carried at estimated fair value as determined by management.
Includes a $3.6 million impairment charge primarily related to the write-down in the value of certain bonds, preferred and common stocks in the fourth quarter of 2008. See Note 3.
Includes a $3.3 million pre-tax adjustment to adjust the carrying value of the discontinued operations to their estimated fair value.