The selected financial data below should be read in conjunction with
The Company, through its subsidiaries, underwrites a diverse portfolio of group employee benefit products, primarily long-term and short-term disability, life, excess workers’ compensation insurance for self-insured employers, large casualty programs including large deductible workers’ compensation, workers’ compensation and casualty treaty reinsurance, travel accident, dental and limited benefit health insurance. Revenues from this group of products are primarily comprised of earned premiums and investment income. The profitability of group employee benefit products is affected by, among other things, differences between actual and projected claims experience, the retention of existing customers, product mix and the Company’s ability to attract new customers, change premium rates and contract terms for existing customers and control administrative expenses. The Company transfers its exposure to a portion of its group employee benefit risks through reinsurance ceded arrangements with other insurance and reinsurance companies. Accordingly, the profitability of the Company’s group employee benefit products is affected by the amount, cost and terms of reinsurance it obtains. The profitability of those group employee benefit products for which reserves are discounted, in particular, the Company’s disability and excess workers’ compensation products, is also significantly affected by the difference between the yield achieved on invested assets and the discount rate used to calculate the related reserves.
For its other group employee benefit products, the Company is continuing to experience challenging market conditions from a competitive standpoint, particularly as to pricing. These conditions, in addition to the continuing effects of the recent recession on employment and wage levels have, in recent years, adversely impacted the Company’s ability to achieve higher levels of new business production and growth in premiums for these products. For these products, the Company is continuing to enhance its focus on the small case niche (insured groups of 10 to 500 individuals), including employers which are first-time providers of these employee benefits, which the Company believes to offer opportunities for superior profitability. The Company is also emphasizing its suite of voluntary group insurance products, which includes, among others, its group limited benefit health insurance product. The Company is generally marketing this product with a fixed indemnity benefit structure that is exempt from certain of the requirements of the federal health care reform legislation; however, it is uncertain whether this product can be effectively marketed once the minimum medical coverage requirements of the legislation become effective in 2014, since this product’s coverage will not satisfy these requirements. The Company markets its other group employee benefit products on an unbundled basis and as part of an integrated employee benefit program that combines employee benefit insurance coverages and absence management services. This integrated employee benefit program, which the Company believes helps to differentiate itself from competitors by offering clients improved productivity from reduced employee absence, has enhanced the Company’s ability to market its other group employee benefit products to large employers.
The Company also operates an asset accumulation business that focuses primarily on offering fixed annuities to individuals. Beginning in the second half of 2010, the Company has experienced particularly advantageous conditions in the fixed annuity marketplace resulting from various competitors having terminated their marketing of comparable fixed annuity products and, in some cases, having experienced ratings downgrades. From time to time, the Company acquires blocks of existing SPDA and FPA policies from other insurers through indemnity assumed reinsurance transactions and issues funding agreements. The Company believes that annuity reinsurance arrangements and funding agreements enhance the Company’s asset accumulation business by providing alternative sources of funds for this business. The Company’s liabilities for its annuity reinsurance arrangements and funding agreements are recorded in policyholder account balances. Deposits from the Company’s asset accumulation business are recorded as liabilities rather than as premiums. The profitability of asset accumulation products is primarily dependent on the spread achieved between the return on investments and the interest credited with respect to these products. The Company sets the crediting rates offered on its asset accumulation products in an effort to achieve its targeted interest rate spreads on these products, and is willing to accept lower levels of sales on these products when market conditions make these targeted spreads more difficult to achieve.
The management of the Company’s investment portfolio is an important component of its profitability. In recent years, the Company has repositioned its investment portfolio to reduce its holdings of those investments whose changes in value, positive or negative, are included in the Company’s net investment income, such as investment funds organized as limited partnerships and limited liability companies and trading account securities. See Part I, Item 1A - Risk Factors. As part of this effort, the Company increased its investments in more traditional sectors of the fixed income market such as mortgage-backed securities and municipal bonds. In addition, the Company has been maintaining a significant portion of its portfolio in short-term investments, which totaled $277.6 million and $334.2 million at December 31, 2011 and 2010, respectively. The Company has made progress in its recent efforts to deploy a significant portion of these short-term investments into longer-term fixed maturity securities which offer more attractive yields. However, since the market environment continues to be challenging from the standpoint of making new investments on attractive terms, no assurance can be given as to the timing of the completion of these efforts or their ultimate outcome or variability of its future net investment income.
The Company achieved improved levels of investment income in its repositioned investment portfolio in 2010 and 2011. However, in light of the continuing volatility in financial market conditions, significant fluctuations in the Company’s net investment income, and as a result, in its results of operations may occur. Accordingly, there can be no assurance as to the impact of the Company’s investment repositioning on the level or variability of its future net investment income. In addition, while the levels of the Company’s realized investment losses from declines in market value relative to the amortized cost of various securities that it determined to be other than temporary decreased significantly in 2011 as compared to 2010 and 2009, investment losses may recur in the future and it is not possible to predict the timing or magnitude of such losses.
On December 21, 2011, Delphi entered into a merger agreement which provides that at the effective time of the merger, TM Sub will be merged with and into Delphi, with Delphi continuing as the surviving corporation and becoming an indirect wholly owned subsidiary of Tokio Marine. Pursuant to the merger agreement, at the effective time of the merger (1) each share of our Class A Common Stock (other than (i) shares of our Class A Common Stock owned by Delphi, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (ii) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $43.875 in cash, without interest and less any applicable withholding taxes, and (2) each share of Class B Common Stock (other than (i) shares of our Class B Common Stock owned by Delphi, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (ii) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $52.875 in cash, without interest and less any applicable withholding taxes. In addition, the merger agreement provides that record holders of common stock immediately prior to the effective time of the merger will be entitled to receive a special dividend of $1.00 in cash per share that is contingent upon the completion of the merger and will be paid shortly after closing. The acquisition is subject to the approval of Delphi shareholders, including approval by the holders of a majority of the outstanding shares of our Class A Common Stock (other than shares of our Class A Common Stock owned, directly or indirectly, by holders of our Class B Common Stock, any holder of shares of our Class A Common Stock that were transferred to such holder by any holder of our Class B Common Stock after December 21, 2011, Tokio Marine, TM Sub or any officers or directors of Delphi, or any of their respective affiliates or “associates” (as defined in Section 12b-2 of the Securities Exchange Act of 1934, as amended)) and the approvals of various regulatory authorities in Japan and the U.S., as well as other customary closing conditions. We anticipate the completion of the merger in the second quarter of 2012, but we cannot be certain when or if the conditions to the closing of the merger will be satisfied or, to the extent permitted, waived.
The following discussion and analysis of the results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements and related notes included in this report. The preparation of financial statements in conformity with GAAP requires management, in some instances, to make judgments about the application of these principles. The amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period could differ materially from the amounts reported if different conditions existed or different judgments were utilized. A discussion of how management applies certain critical accounting policies and makes certain estimates is presented below in the “Critical Accounting Policies and Estimates” section and should be read in conjunction with the following discussion and analysis of results of operations
Summary of Results. Net income attributable to shareholders was $178.7 million, or $3.16 per diluted share, in 2011 as compared to $168.9 million, or $3.03 per diluted share, in 2010. Net income in 2011 and 2010 included net realized investment losses, net of the related income tax benefit, of $9.7 million, or $0.17 per diluted share, and $16.8 million, or $0.30 per diluted share, respectively. Net income in 2011 as compared to 2010 benefited from growth in income from the Company’s group employee benefit products and decreases in the levels of realized investment losses and interest expense. Net realized investment losses included losses resulting from other than temporary declines in the market values of various fixed maturity and other securities. For 2011 and 2010 these losses, net of the related income tax benefit, totaled $19.5 million, or $0.34 per diluted share, and $39.7 million, or $0.71 per diluted share, respectively. The decrease in interest expense was primarily due to the early retirement of the 2033 Senior Notes during 2010. The 2010 results included losses, net of the related income tax benefit, of $5.0 million associated with the early retirement of the 2033 Senior Notes.
Net Investment Income. Net investment income in 2011 was $351.1 million as compared to $351.2 million in 2010. This level of net investment income reflects a 15% increase in average invested assets to $6,834.4 million in 2011 from $5,966.1 million in 2010, a higher level of investment income from the Company’s fixed maturity security portfolio, offset by adverse performance on the part of the Company’s investments in investment funds organized as limited partnerships and limited liability companies. The tax equivalent weighted average annualized yield on invested assets was 5.6% and 6.3% for 2011 and 2010, respectively.
The Company may continue to recognize losses due to other than temporary declines in security fair values in the future, and such losses may be significant. See Part I, Item 1A - Risk Factors and “Overview”. The extent of such losses will depend on, among other things, future developments in the United States and global economies, financial and credit markets, credit spreads, interest rates, foreign currency exchange rates, expected future cash flows from structured securities, the outlook for the performance by the security issuers of their obligations and changes in security values. The Company continuously monitors its investments in securities whose fair values are below the Company’s amortized cost pursuant to its procedures for evaluation for other than temporary impairment in valuation. See Note B to the Consolidated Financial Statements and “Critical Accounting Policies and Estimates” for a description of these procedures, which take into account a number of factors. It is not possible to predict the extent of any future changes in value, positive or negative, or the results of the future application of these procedures, with respect to these securities. For
Interest Expense. Interest expense was $37.2 million in 2011 as compared to $43.1 million in 2010, a decrease of $5.9 million. This decrease resulted primarily from the early retirement of the 2033 Senior Notes during 2010, partially offset by an increase in interest expense associated with the 2020 Senior Notes, which were issued by the Company in the first quarter of 2010, as well as increased interest paid on the Company’s new bank credit facility.
Income Tax Expense. Income tax expense was $52.7 million in 2011 as compared to $49.6 million in 2010. The Company’s effective tax rate was 22.8% in 2011 compared to 22.7% in 2010.
Net Realized Investment Losses. Net realized investment losses were $25.9 million in 2010 as compared to $147.5 million in 2009. The Company monitors its investments on an ongoing basis. When the fair value of a security declines below its amortized cost, the decline is included as a component of accumulated other comprehensive income or loss, net of the related income tax benefit and adjustment to cost of business acquired, on the Company’s balance sheet. In the case of a fixed maturity security, if management judges the decline to be other than temporary, the portion of the decline representing credit losses is recognized as a realized investment loss in the Company’s income statement and the remaining portion of the decline continues to be included as a component of accumulated other comprehensive income or loss. For all other types of investments, the entire amount of the decline is recognized as a realized investment loss. Due to the continuing effects of the adverse market conditions for financial assets described above, the Company recognized $77.4 million and $180.2 million of losses in 2010 and 2009, respectively, due to the other than temporary declines in the fair values of certain fixed maturity and other investments, of which $61.1 million and $144.7 million was recognized as credit-related realized investment losses and $16.3 million and $35.5 million remained as a component of accumulated other comprehensive income. The Company’s investment strategy results in periodic sales of securities and, therefore, the
Benefits and Expenses. Policyholder benefits and expenses were $1,474.5 million in 2010 as compared to $1,436.8 million in 2009. This increase reflects the increase in premiums from the Company’s group employee benefit products discussed above, as well as additions to reserves for prior years’ claims and claim expenses of $3.3 million in 2010. There can be no assurance as to whether future periods will include further additions to reserves in respect of prior periods or the amount thereof, which will depend on the Company’s future loss development. If the Company were to experience significant adverse loss development in the future, the Company’s results of operations could be materially adversely affected. The combined ratio (loss ratio plus expense ratio) for group employee benefits products was 95.3% and 94.2% in 2010 and 2009, respectively. The increase in the combined ratio in 2010 reflects an increased incidence of long-term disability claims at RSLIC, a higher level of commissions at RSLIC resulting from changes in its product mix and increased expenses associated with new product development at SNCC. The weighted average annual crediting rate on the Company’s asset accumulation products, which reflects the effects of the first year bonus crediting rate on certain newly issued products, was 3.8% and 4.3% in 2010 and 2009, respectively.
In December 2010, the Company entered into a Credit Agreement with Bank of America, N.A. as administrative agent and a group of banking institutions (the “Credit Agreement”) providing for a revolving loan facility of $175 million which matures on December 22, 2013 and a term loan facility of $125 million which matures on December 22, 2015. Concurrently with the consummation of the Credit Agreement, the Company terminated its prior bank credit agreement, which was scheduled to expire in October 2011. On June 7, 2011, a new lender was added to the revolving loan facility and its amount was increased to $205 million. Interest on borrowings under the Credit Agreement is payable, at the Company’s election, either at a floating rate based on LIBOR plus a specified margin which varies based upon the specified ratings of the Company’s senior unsecured debt, as in effect from time to time, or a base rate equal to the highest of Bank of America’s prime rate, LIBOR plus a specified margin or the federal funds rate plus a specified margin. The Credit Agreement contains various financial and other affirmative and negative covenants, along with various representations and warranties. The covenants include, among others, a maximum Company consolidated debt to capital ratio, a minimum Company consolidated net worth, minimum statutory risk-based capital requirements for RSLIC and SNCC, and certain limitations on subsidiary indebtedness. As of December 31, 2011, the Company was in compliance in all material respects with the financial and various other affirmative and negative covenants in the Credit Agreement. At
December 31, 2011, the Company had $125.0 million of outstanding borrowings and $205.0 million of borrowings remaining available under the Credit Agreement.
The following table summarizes the Company’s significant contractual obligations at December 31, 2011 and the future periods in which such obligations are expected to be settled in cash. The 2020 Senior Notes and 2007 Junior Debentures are assumed to be repaid on their respective maturity dates. Additional details regarding these obligations are provided in the notes to the Consolidated Financial Statements, as referenced in the table:
(1) Other long-term liabilities consist of future policy benefits and unpaid claims and claim expenses relating to the Company’s insurance products, as well as policyholder account balances. Substantially all of the amounts reflected in this table with respect to such liabilities consist of estimates by the Company’s management based on various actuarial and other assumptions relating to the Company’s insurance products and, as to policyholder account balances, the periods for which the related annuity and other contracts will remain in force and the crediting rates to be applied thereto in the future. In accordance with GAAP, a substantial portion of such liabilities, as they relate to the Company’s insurance products, are carried on a discounted basis on its consolidated balance sheet; however, the amounts contained in this table are presented on an undiscounted basis. The actual payments relating to these liabilities will differ, both in amount and timing, from those indicated in this table and such differences are likely to be significant. See “Critical Accounting Policies and Estimates - Future Policy Benefits and Unpaid Claims and Claim Expenses”.
(3) Interest on the 2007 Junior Debentures is fixed at 7.376% until May 15, 2017.
The principal liquidity requirements of the Company’s insurance subsidiaries are their contractual obligations to policyholders and other financing sources and operating expenses. The primary sources of funding for these obligations, in addition to operating earnings, are the marketable investments included in the investment portfolios of these subsidiaries. The Company actively manages its investment portfolio in an effort to match its invested assets and related liabilities. The Company regularly analyzes the results of its asset/liability matching through cash flow analysis and duration matching under multiple interest rate scenarios. See “Asset/Liability Management and Market Risk.” Therefore, the Company believes that these sources of funding will be adequate for its insurance subsidiaries to satisfy, on both a short-term and long-term basis, these contractual obligations throughout their estimated or stated period. However, if such contractual obligations were to arise more rapidly or in greater amounts than anticipated in the Company’s asset/liability matching analysis, the Company could be required to sell securities earlier than anticipated, potentially resulting in the realization of capital losses, or to borrow funds from available credit sources, in order to fund the payment of such obligations. In any of such events, the Company’s results of operations, liquidity and financial condition could be materially adversely affected.
Cash Flows. Operating activities increased cash by $476.9 million, $362.8 million and $460.5 million in 2011, 2010 and 2009, respectively. Net investing activities used $748.5 million of cash during 2011 primarily for the purchase of securities. Financing activities provided $292.6 million of cash during 2011, principally from deposits to policyholder accounts, partially offset by the repayment of $65.0 million in aggregate principal amount of fixed rate funding
agreements at their maturity and acquisition of treasury stock. Net investing activities used $623.7 million of cash during 2010 primarily for the purchase of securities. Financing activities provided $268.3 million of cash during 2010, principally from deposits to policyholder accounts, proceeds from the issuance of 2020 Senior Notes and an increase in the Company’s bank credit facility borrowings, partially offset by the repayment in full of the $272.0 million of outstanding borrowings under the prior credit agreement at its termination in December 2010.
Investments. The Company’s overall investment strategy emphasizes safety and liquidity, while seeking the best available return, by focusing on, among other things, managing the Company’s interest-sensitive assets and liabilities and seeking to minimize the Company’s exposure to fluctuations in interest rates. The Company’s investment portfolio, which totaled $7,469.7 million at December 31, 2011, consists primarily of investments in fixed maturity securities, short-term investments, mortgage loans and equity securities. The Company’s investment portfolio also includes investments in investment funds organized as limited partnerships and limited liability companies and trading account securities which collectively totaled $290.9 million at December 31, 2011.
At December 31, 2011, approximately 23% of the Company’s total invested assets were comprised of corporate fixed maturity securities. Eighty-nine percent of the Company’s corporate fixed maturity portfolio, based on fair values, has been rated investment grade by nationally recognized statistical rating organizations. Investment grade corporate fixed maturity securities are distributed among the various rating categories as follows: AAA - 5%, AA - 11%, A - 34%, and BBB - 39%. Corporate fixed maturity securities subject the Company to credit risk and, to a lesser extent, interest rate risk. To manage its exposure to corporate credit risk, the Company attempts to diversify its investments across economic sectors, industry classes and issuers.
The Company, through its insurance subsidiaries, maintains a program in which investments are financed using advances from various Federal Home Loan Banks. The Company has utilized this program to manage the duration of its liabilities and to earn spread income, which is the difference between the financing cost and the earnings from the investments purchased with those funds. At December 31, 2011, the Company had an outstanding advance of $55 million. The advance was obtained at a fixed rate and has a term to maturity of 8.5 years. In addition, the Company has from time to time utilized reverse repurchase agreements, futures and option contracts and interest rate and credit default swaps in connection with its investment strategy. These transactions may require the Company to maintain securities or cash on deposit with the applicable counterparty as collateral. As the market value of the collateral or contracts changes, the Company may be required to deposit additional collateral or be entitled to have a portion of the collateral returned to it.
The types and amounts of investments made by the Company’s insurance subsidiaries are subject to the insurance laws and regulations of their respective states of domicile. Each of these states has comprehensive investment regulations. The Company also continually monitors its investment portfolio and attempts to ensure that the risks associated with concentrations of investments in either a particular sector of the market or a single entity are limited.
Asset/Liability Management and Market Risk. Because the Company’s primary assets and liabilities are financial in nature, the Company’s consolidated financial position and earnings are subject to risks resulting from changes in interest rates. The Company seeks to manage this risk by active portfolio management focusing on minimizing its exposure to fluctuations in interest rates by matching its invested assets and related liabilities and by periodically adjusting the crediting rates on its annuity products and the discount rate used to calculate reserves on the Company’s other products. In its asset/liability matching process, the Company determines and monitors on a quarterly basis the duration of its insurance liabilities in the aggregate and the duration of the investment portfolio supporting such liabilities in order to ensure that the difference between such durations, or the “duration gap,” remains below an internally specified maximum,
The Company regularly analyzes the results of its asset/liability matching through cash flow analysis and duration matching under multiple interest rate scenarios. These analyses assist the Company in estimating the potential gain or loss in fair value of its interest-rate sensitive financial instruments due to hypothetical changes in interest rates. Based on these analyses, if interest rates were to immediately increase by 10% from their year-end levels, the fair value of the Company’s interest-sensitive assets, net of corresponding changes in the fair value of cost of business acquired and insurance and investment-related liabilities, would decline by approximately $10.1 million at December 31, 2011 as compared to a decline of approximately $77.0 million at December 31, 2010. These analyses incorporate numerous assumptions and estimates and assume no changes in the composition of the Company’s investment portfolio in reaction to such interest rate changes. Consequently, the results indicated by these analyses will likely be materially different from the actual changes in the value of the Company’s assets that will be experienced under given interest rate scenarios.
The Company’s reserves for unpaid claims and claim expenses for its disability, accident and property and casualty products are determined on an individual basis for reported claims, for which case reserves are established, and estimates of incurred but not reported (“IBNR”) losses are developed on the basis of past experience. The unpaid claims and claim expense reserves carried for the Company’s casualty insurance products represent the difference between the selected ultimate loss amount and the loss amount paid to date. The unpaid claims and claim expense reserves carried for the Company’s disability and accident insurance products are established by the incurred loss development method (as described below) utilizing various mathematic tools in order to project future loss experience based on the Company’s historical loss experience. The difference between total unpaid claims and claim expense reserves and case unpaid claims and claim expense reserves represent the IBNR reserve.
The following table summarizes the composition of the Company’s total reserves for disability, accident and property and casualty claims and claim expenses, split between case and IBNR reserves, as of December 31, 2011 (dollars in millions):
For the reasons described above, if the Company’s actual loss experience is less favorable than the Company’s assumptions or estimates, the Company’s reserves could be inadequate. In such event, the Company’s results of operations, in addition to its liquidity and financial condition, could be materially adversely affected.
Deferred Acquisition Costs. Costs related to the acquisition of new insurance business, such as commissions, certain costs associated with policy issuance and underwriting, and certain sales support expenses, are deferred when incurred. The unamortized balance of these deferred acquisition costs is included in cost of business acquired on the consolidated balance sheet.
On January 1, 2011, the Company adopted, on a retrospective basis, guidance issued by the Financial Accounting Standards Board (“FASB”) limiting the extent to which an insurer may capitalize costs incurred in the acquisition of an insurance contract. The guidance provides that, in order to be capitalized, such costs must be incremental and directly related to the acquisition of a new or renewal insurance contract. Insurers may only capitalize costs related to successful efforts in attaining a contract and advertising costs may only be capitalized if certain direct response advertising criteria are met. As a result of its adoption of this guidance, the Company made an after-tax reduction to its retained earnings at January 1, 2009 in the amount of $52.1 million, net of an income tax benefit of $28.0 million, which represented the net reduction in deferred policy acquisition cost included in cost of business acquired on the consolidated balance sheet, and net income attributable to shareholders was reduced by $4.2 million or $0.08 per diluted share and $7.9 million or $0.15 per diluted share for the years ended December 31, 2010 and 2009, respectively.
Deferred acquisition costs related to annuity products, which totaled $87.1 million at December 31, 2011, are amortized over the anticipated lives of the annuity policies in relation to the expense margins. The amortization is a constant percentage of estimated future gross profits based on the ratio of the present value of amounts deferred as compared to the present value of estimated future gross profits. The key assumptions utilized in the Company’s estimates of future gross profits in 2011, 2010 and 2009 relate to the underlying annuity policies’ future crediting rates and persistency, the Company’s future yield on investments supporting the policies and level of expense necessary to maintain the policies over their entire lives. Adjustments are made, generally on an annual basis, to reflect the actual gross profits to date as compared to assumed experience and any changes in the remaining expected future gross profits. As a result of this process, known as “unlocking”, the Company records an adjustment to its deferred acquisition costs balance, which may be positive or negative, in order to reflect any changes in the amounts reflected in its key assumptions. A negative adjustment results in a corresponding benefit to the Company’s net income, while a positive adjustment results in a corresponding charge to net income. Changes in the Company’s deferred acquisition cost balance due to unlocking were $(2.9) million, $0.2 million and $(1.8) million for the 2011, 2010 and 2009 years. If significant changes in the levels of the Company’s key assumptions relating to its deferred acquisition costs balance were to occur in the future, such changes could result in a large unlocking event that would materially affect the Company’s results of operations and financial condition. If estimated gross profits for all future years on business in force at December 31, 2011 were to increase or decrease by 10%, the deferred policy acquisition costs balance at December 31, 2011 would increase, in the first case, by $4.6 million or decrease, in the second case, by $4.8 million.
The unamortized balance of deferred policy acquisition costs related to certain asset accumulation products is adjusted for the impact on estimated future gross profits as if net unrealized appreciation and depreciation on available for sale securities had been realized at the balance sheet date. The impact of this adjustment, net of the related income tax expense or benefit, is included in net unrealized appreciation and depreciation as a component of other comprehensive income or loss in shareholders’ equity.
51%, 52% and 52% of the total amounts of the deferred acquisition cost balances outstanding at the beginning of the respective periods. Prior periods have been restated to reflect the Company’s early adoption of FASB guidance for accounting for costs associated with acquiring or renewing insurance contracts.
Investments. Investments are primarily carried at fair value with unrealized appreciation and depreciation included as a component of other comprehensive income or loss in shareholders’ equity, net of the related income tax benefit or expense and the related adjustment to cost of business acquired. Substantially all of the securities in the Company’s fixed maturity and equity securities portfolio are actively traded in a liquid market or have other liquidity mechanisms. The Company measures the fair values of its investments based on the framework set forth in the GAAP fair value accounting guidance. This framework establishes a fair value hierarchy of three levels based upon the transparency and availability of information used in measuring the fair value of assets or liabilities as of the measurement date. See Notes A and C to the Consolidated Financial Statements included in this Form 10-K.
The Company regularly evaluates its investment portfolio utilizing its established methodology to determine whether declines in the fair values of its investments are other than temporary. Under this methodology, management evaluates, among other things, the financial position and prospects of the issuer, conditions in the issuer’s industry and geographic area, liquidity of the investment, changes in the amount or timing of expected future cash flows from the investment, recent changes in credit ratings of the issuer by nationally recognized rating agencies, and loan to collateral value ratios and current levels of subordination and vintages of its residential and commercial mortgage-backed securities to determine if and when a decline in the fair value of an investment below amortized cost is other than temporary. Management also considers the length of time and extent to which the fair value of the investment is lower than its amortized cost and evaluates whether the Company intends to, or will more likely than not be required to, sell the investment before the anticipated recovery in the investment’s fair value.
future cash flows from securities and changes in security values. The Company continuously monitors its investments in securities whose fair values are below the Company’s amortized cost pursuant to its procedures for evaluation for other than temporary impairment in valuation. While it is not possible to predict the extent of any future changes in value or the results of the future application of these procedures with respect to these securities, significant losses due to impairments of this type may occur in the future. There can be no assurance that the Company will realize investment gains in the future that would ameliorate the effect of any such losses.
In connection with, and because it desires to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements in the above “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K and in any other statement made by, or on behalf of, the Company, whether in future filings with the Securities and Exchange Commission or otherwise. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, prospects, outlooks or other developments. Some forward-looking statements may be identified by the use of terms such as “expects,” “believes,” “anticipates,” “intends,” “judgment,” “outlook,” “effort,” “attempt,” “achieve,” “project” or other similar expressions. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic, competitive and other uncertainties and contingencies, many of which are beyond the Company’s control and many of which, with respect to future business decisions, are subject to change. Examples of such uncertainties and contingencies include, among other important factors, those affecting the insurance industry generally, such as the economic and interest rate environment, federal and state legislative and regulatory developments, including but not limited to changes in financial services, employee benefit, health care and tax laws and regulations, changes in accounting rules and interpretations thereof, market pricing and competitive trends relating to insurance products and services, acts of terrorism or war, and the availability and cost of reinsurance, and those relating specifically to the Company and its business, such as the level of its insurance premiums and fee income, the claims experience, persistency and other factors affecting the profitability of its insurance products, the performance of its investment portfolio and changes in the Company’s investment strategy, acquisitions of companies or blocks of business, ratings by major rating organizations of the Company and its insurance subsidiaries, customer loss and business disruption, including but not limited to difficulties in maintaining relationships with employees, customers or suppliers, which may be greater than expected following the announcement of the merger with Tokio Marine, the retention of certain key employees at the Company, that the conditions to the completion of the merger with Tokio Marine may not be satisfied, or the regulatory approvals required for the merger may not be obtained on the terms expected or on the anticipated schedule and that the parties to the merger may not be able to meet expectations regarding the timing, completion and accounting and tax treatments of the merger. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Certain of these uncertainties and contingencies are described in more detail in Part I, Item 1A - Risk Factors. The Company disclaims any obligation to update forward-looking information.