The Company offers property and casualty insurance products in the excess and surplus lines marketplace. The Company manages its operations by differentiating them into three product classifications: Penn-America, which markets to small commercial businesses through a select network of wholesale general agents with specific binding authority; United National, which markets insurance products for targeted insured segments, including specialty products, such as property, general liability, and professional lines through program administrators with specific binding authority; and Diamond State, which markets property, general liability, and professional lines products, which are developed by the Company’s underwriting department by individuals with expertise in those lines of business, through wholesale brokers and also markets through program administrators having specific binding authority. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia.
The Company’s wholly-owned business trust subsidiaries, United National Group Capital Trust I (“UNG Trust I”), United National Group Capital Statutory Trust II (“UNG Trust II”), and Penn-America Statutory Trust II (“Penn Trust II”), are not consolidated pursuant to Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FIN 46R”). The Company’s business trust subsidiaries have issued $45.0 million in floating rate capital securities (“Trust Preferred Securities”) and $1.4 million of floating rate common securities. The sole assets of the Company’s business trust subsidiaries are $46.4 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments and distributions as the Trust Preferred Securities and the floating rate common securities.
other than for impairments deemed to be other than temporary. The change in the difference between amortized cost and fair value of the options imbedded within the convertible bond and convertible preferred stock portfolios is included in income as a component of net realized investment gains and losses.
At December 31, 2007, the Company held $25.1 million of convertible bonds and $3.1 million of convertible preferred stock. The change in the difference between the amortized cost and the market value of the convertible portfolio is included in income as a component of net realized investments gains (losses). The Company realized a $2.6 million loss, a $1.6 million gain, and a $1.2 million loss for the years ended December 31, 2007, 2006, and 2005, respectively, due to market value changes related to convertibles.
The Company’s investments in other invested assets are comprised primarily of limited liability partnership interests. Partnership interests of 3% ownership or greater are accounted for using the equity method. The change in the difference between amortized cost and fair value of partnership interests of 3% ownership or greater, net of the effect of deferred income taxes, is reflected in income. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair values of the Company’s investments in bonds and stocks are determined on the basis of quoted market prices. Partnership interests of less than 3% ownership are carried at their fair value. The change in the difference between amortized cost and the fair value of partnership interests of less than 3% ownership, net of the effect of deferred income taxes, is reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income other than for impairments deemed to be other than temporary. On January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS 159”) which gives entities the option to measure eligible assets, financial liabilities and firm commitments at fair value (i.e., the fair value option), on an instrument-by-instrument basis. See “New Accounting Pronouncements” below for a discussion of the adoption of SFAS 159. Several of the limited partnerships invest mainly in securities that are publicly traded. Securities that are held by these partnerships are valued by obtaining values from Bloomberg, other external pricing sources, and managers that make markets for these securities. The Company obtains the value of the partnerships at the end of each reporting period; however, the Company is not provided with a detailed listing of the investments held by these partnerships. The Company receives annual audited financial statements from each of the partnerships it owns. For the partnerships that do not invest mainly in publicly traded securities, the fair value of such securities is determined by the general partner of each limited partnership based on comparisons to transactions involving similar investments. The Company’s investments in other invested assets, including investments in several limited partnerships, were valued at $64.5 million and $60.9 million as of December 31, 2007 and 2006, respectively.
As of December 31, 2007 and 2006, respectively, the Company’s other invested assets portfolio of $64.5 million and $60.9 million was comprised of securities for which there is no readily available independent market price. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the prior month-end pricing period.
For bonds, the factors considered in reaching the conclusion that a decline below cost is other than temporary include, among others, whether (1) the issuer is in financial distress, (2) the investment is secured, (3) a significant credit rating action occurred, (4) scheduled interest payments were delayed or missed and (5) changes in laws or regulations have affected an issuer or industry.
For an analysis of other than temporary losses that were recorded for the years ended December 31, 2007, 2006, and 2005, please see Note 4 below.
In accordance with SFAS 133, the Company formally documents the cash flow hedging relationship between the hedging instrument and the hedged item, the risk management objective and strategy for undertaking the hedge, and how the effectiveness of hedging the exposure to variability in interest rates will be assessed. At inception, the Company determined its cash flow hedge to be highly effective in achieving offsetting cash flows attributable to the hedge risk during the term of the hedge, as it meets the criteria for assuming “no ineffectiveness”, pursuant to SFAS 133.
The Company evaluates the collectibility of agents’ balances based on a combination of factors. In circumstances in which the Company is aware of a specific agent’s inability to meet its financial obligations to the Company, a specific allowance for bad debts against amounts due is recorded to reduce the net receivable to the amount reasonably believed by the Company’s management to be collectible. For all remaining balances, allowances are recognized for bad debts based on the length of time the receivables are past due. The allowance for bad debts was $3.9 million and $4.0 million as of December 31, 2007 and 2006, respectively. For 2007 and 2006, there were net bad debts written off of $0.6 million and $0.07 million, respectively.
Other intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. The carrying amount of intangible assets that are not deemed to have an indefinite useful life is regularly reviewed for indicators of impairments in value in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Impairment is recognized only if the carrying amount of the intangible asset is considered not to be recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset. No impairments of intangible assets that are not deemed to have indefinite life were recognized in the year ended December 31, 2007.
Amortization expense related to the Penn-America Group, Inc. merger for the years ended December 31, 2007, 2006, and 2005 was $1.0 million, $1.0 million, and $1.1 million, respectively. Amortization expense related to the Penn Independent Corporation acquisition for the years ended December 31, 2007, 2006, and 2005 was $0.0 million, $0.5 million, and $0.8 million, respectively.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with reinsurers. Amounts receivable from reinsurers are estimated in a manner consistent with the reinsured policy. The Company analyzes its reinsurance contracts to ensure they meet the risk transfer requirements of SFAS No. 113, “Accounting for Reinsurance of Short Duration and Long Duration Contracts” (“SFAS 113”) and regularly reviews the collectibility of reinsurance receivables. Any changes in the allowances resulting from this review are included in income during the period in which the determination is made.
SFAS 113 requires that the reinsurer must assume significant insurance risk under the reinsured portions of the underlying insurance contracts and that there must be a reasonably possible chance that the reinsurer may realize a significant loss from the transaction. The Company has evaluated its reinsurance contracts and concluded that each contract qualifies for reinsurance accounting treatment pursuant to SFAS 113.
The costs of acquiring new and renewal insurance and reinsurance contracts include commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of new and renewal insurance and reinsurance contracts. The excess of the Company’s costs of acquiring new and renewal insurance and reinsurance contracts over the related ceding commissions earned from reinsurers is capitalized as deferred acquisition costs and amortized over the period in which the related premiums are earned. In accordance with SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” the method followed in computing such amounts limits them to their estimated realizable value that gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. The amortization of deferred acquisition costs for the years ended December 31, 2007, 2006, and 2005 was $142.2 million, $145.7 million, and $107.4 million, respectively.
Pursuant to FIN 46R, the Company does not consolidate its business trust subsidiaries, which in the aggregate issued $45.0 million of Trust Preferred Securities and $1.4 million of floating rate common securities. The sole assets of the Company’s business trust subsidiaries are $46.4 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments and distributions as the Trust Preferred Securities and the floating rate common securities. Therefore, the Company’s junior subordinated debentures are presented as a liability in the balance sheet at December 31, 2007 and 2006.
The Company accounts for stock options and other equity based compensation using the modified prospective application of the fair value-based method permitted by SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), which revised SFAS 123 “Accounting for Share-Based Compensation.” The Company adopted SFAS 123R effective January 1, 2006. See Note 12 for details.
Basic earnings per share has been calculated by dividing net income available to common shareholders by the weighted-average common shares outstanding. Diluted earnings per share has been calculated by dividing net income available to common shareholders by the sum of the weighted-average common shares outstanding and the weighted-average common share equivalents outstanding, which include options and warrants and other equity awards.
The provisions of SFAS 157 are to be applied prospectively, except changes in fair value measurements that result from the initial application of SFAS 157 which are to be recorded as an adjustment to beginning retained earnings in the year of adoption.
The provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS 157 on January 1, 2008. The adoption of this statement is not expected to have a material impact on beginning retained earnings or on the Company’s consolidated financial position or results of operations.
The Company adopted SFAS 159 on January 1, 2008 and elected to apply the fair value option within its limited partnership investment portfolio. Since these securities are already reported at fair value, the Company does not expect the adoption of SFAS 159 to have a material impact on its financial condition although it could have a material effect on the results of operations in periods subsequent to adoption.
On September 30, 2006, the Company sold to Brown & Brown, Inc., an unrelated third party, substantially all of the assets of its Agency Operations. The gain on the sale was $9.4 million, net of applicable taxes of $4.5 million. As part of the sale agreement, 10% of the cash payment was originally held in escrow for a period of up to two years to cover indemnification obligations under the asset purchase agreement. Half of that amount was released in October 2007. As of December 31, 2007, 5% of the cash payment is still being held in escrow. As a result of this sale, the Company has terminated its Agency Operations segment and has classified the results of this segment, including the gain on the sale, as discontinued operations for 2007, 2006, and 2005. There were no Agency Operations prior to the Company’s acquisition of Penn Independent Corporation in 2005.
The amortized cost and estimated fair value of investments classified as available for sale were as follows as of December 31, 2007 and 2006:
Accumulated comprehensive income as of December 31, 2007 and 2006 was as follows:
As of December 31, 2007, the Company had approximately $5.8 million worth of investment exposure to subprime investments. Of that amount, approximately $3.7 million of those investments have been rated AAA by S&P. The remaining subprime exposure is rated AA or A. There were no write-downs on these investments during 2007.
There was one non-income producing bond with an estimated fair value of $0.5 million as of December 31, 2006 and 2005. In 2007, the estimated fair value of this bond was written down to $0.0 million.
Certain cash balances, cash equivalents, and bonds available for sale were deposited with various governmental authorities in accordance with statutory requirements or were held in trust pursuant to intercompany reinsurance agreements. The estimated fair values of bonds available for sale and on deposit or held in trust were as follows as of December 31, 2007 and December 31, 2006:
At December 31, 2007 and 2006, the Company carried reinsurance receivables of $719.7 million and $982.5 million, respectively. These amounts are net of a purchase accounting adjustment and an allowance for uncollectible reinsurance receivables. The purchase accounting adjustment is related to discounting the loss reserves to their present value and applying a risk margin to the discounted reserves. This adjustment was $17.5 million and $18.5 million at December 31, 2007 and 2006, respectively. The allowance for uncollectible reinsurance receivables was $10.5 million and $20.7 million at December 31, 2007 and 2006, respectively. The decrease in the allowance was primarily due to a commutation of the Company’s reinsurance agreement with an unrelated third party reinsurer during the first quarter of 2007 that reduced the uncollectible reinsurance reserve by $6.5 million. A benefit of $0.7 million was realized as a result of the commutation. In addition, the Company released $3.7 million of the reserve for uncollectible reinsurance during 2007, primarily due to a reduction in ceded
loss reserves, including losses incurred but not reported (“IBNR”), as a result of better than expected loss emergence.
During the years ended December 31, 2007, 2006, and 2005, the Company recorded the following ceded amounts:
The Company reduced both gross and ceded unpaid loss and loss adjustment expenses related to prior periods by $142.3 million in 2005 due to better than expected loss emergence.
The Company’s current property writings create exposure to catastrophic events. To protect against these exposures, the Company purchases property catastrophe coverage. In June 2007, the Company entered into a new property catastrophe reinsurance agreement that provides single event coverage for losses of $100.0 million in excess of $10.0 million. This coverage provides for one full reinstatement of coverage at 100% additional premium as to time and pro-rata as to amount of limit reinstated and replaces the contracts that expired on May 31, 2007. The Company did not cede any incurred losses under the property catastrophe contracts during 2007. Effective January 1, 2008, the Company renewed its casualty clash treaty which affords protection for exposures arising from two or more casualty insureds being involved in the same loss occurrence. The structure for losses occurring in 2008 remains $10.0 million in excess of $3.0 million.
The Company evaluated retention levels during 2006 to ensure that the ultimate reinsurance structures are aligned with corporate risk tolerance levels and capital levels. As a result of this analysis, during the first quarter of 2007, the Company increased its property retention for individual property losses from $0.5 million to $1.0 million for property losses occurring on or after January 1, 2007. As a result of the Company’s increased appetite for larger property risks, the Company has increased its protection for individual property losses by purchasing an additional
As a result of the allied health business unit’s expansion of policy limits up to $10.0 million per risk, the Company has increased its professional liability protection by purchasing an additional $5.0 million layer of reinsurance protection effective March 1, 2007. As a result, the Company’s professional liability treaty covers losses of $9.5 million in excess of $0.5 million per occurrence, or claim or wrongful or negligent act. Effective January 1, 2008, the Company renewed the aforementioned expiring reinsurance structure.
As of December 31, 2007, the Company had aggregate unsecured reinsurance receivables that exceeded 3% of shareholders’ equity from the following groups of reinsurers. Unsecured reinsurance receivables include amounts receivable for paid and unpaid losses and loss adjustment expenses and prepaid reinsurance premiums, less amounts secured by collateral.
The weighted average expected tax provision has been calculated using income (loss) before income taxes in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The Company’s income before income taxes in 2007 of $118.1 million represents $54.3 million from its foreign operations and $63.8 million from its United States operations. The Company’s income before income taxes in 2006 of $106.5 million represents $43.2 million from its foreign operations and $63.2 million from its United States operations. The Company’s
The Company recognized tax expense (benefit) on discontinued operations of $0.02 million, $4.8 million and $(0.3) million for the years ended December 31, 2007, 2006, and 2005, respectively.
The IRS initiated examination of the U.S. income tax return of Penn-America Group, Inc. and its subsidiaries for the period January 1, 2005 through January 24, 2005 in the third quarter of 2007. No audit adjustments have yet been reported to the Company.
now applies a more-likely-than-not recognition threshold for all tax uncertainties. FIN 48 only allows the recognition of those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities. As a result of the implementation, the Company recognized no material adjustment to reserves for uncertain tax positions.
The Company’s unrecognized tax benefits were $3.6 million as of December 31, 2007 and 2006.
Included in 2005 is $5.8 million of negative development for the Penn-America Group that is related to prior years. This amount is not included in the “Prior years” line due to the fact that the Company did not own the Penn-America Group during the prior year periods to which the losses and loss adjustment expenses are related.
Prior to 2001, the Company underwrote multi-peril business insuring general contractors, developers, and sub-contractors primarily involved in residential construction that has resulted in significant exposure to construction defect (“CD”) claims. Management believes its reserves for CD claims ($49.3 million and $47.3 million as of December 31, 2007 and 2006, net of reinsurance, respectively) are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to the inherent uncertainty concerning this type of business, the ultimate exposure for these claims may vary significantly from the amounts currently recorded.
The following table shows the Company’s gross reserves for A&E losses:
Establishing reserves for A&E and other mass tort claims involves more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. In response to these developments, management increased gross and net A&E reserves during the third quarter of 2007 to reflect its best estimate of A&E exposures. One of the Company’s insurance companies has been named in a lawsuit seeking coverage from it and other unrelated insurance companies that involves such issues with regard to approximately 5,000 asbestos-related bodily injury claims and others that continue to be filed. Management is continuing to gather information to enable it to both evaluate the numerous factual and legal issues that are presented by this lawsuit and to estimate the timing of any payments that may be required. Until that information is obtained and analyzed, it is difficult to predict the ultimate financial exposure that this matter presents.
As of December 31, 2007, 2006, and 2005, the survival ratio on a gross basis for the Company’s open A&E claims was 13.3 years, 7.4 years, and 7.1 years, respectively. As of December 31, 2007, 2006, and 2005, the survival ratio on a net basis for the Company’s open A&E claims was 23.6 years, 10.6 years, and 9.6 years, respectively. The survival ratio, which is the ratio of gross or net reserves to the 3-year average of annual paid claims, is a non-GAAP financial measure that indicates how long the current amount of gross or net reserves are expected to last based on the current rate of paid claims.
Debt consisted of the following as of December 31, 2007 and 2006:
subordinated debentures of Penn-America Group, Inc. (“PAGI”), which were the sole assets of Penn Trust I, were also redeemed.
At December 31, 2007 and 2006, Wind River Reinsurance was a limited partner in the Fox Paine Capital Fund, II, which is managed by Fox Paine & Company. This investment was originally made by United National Insurance Company in June 2000 and pre-dates the September 5, 2003 acquisition by Fox Paine & Company of Wind River Investment Corporation, the holding company for the Company’s Predecessor Insurance Operations. The Company’s investment in this limited partnership was valued at $5.6 million and $5.9 million at December 31, 2007 and 2006, respectively. At December 31, 2007, the Company had an unfunded capital commitment of $4.1 million to the partnership.
In November 2007, management fees of $1.5 million in the aggregate were paid to Fox Paine & Company pursuant to the Management Agreement. The management fees cover the period from September 5, 2007 through September 4, 2008 and will be recognized ratably over that period. In November 2006, management fees of $1.5 million in the aggregate were paid to Fox Paine & Company. The management fees covered the period from September 5, 2006 through September 4, 2007 and were recognized ratably over that period. In November 2005, management fees of $1.5 million in the aggregate were paid to Fox Paine & Company and The AMC Group, L.P. (“The AMC Group”), both of which were affiliates. The management fees covered the period from September 5, 2005 through September 4, 2006 and were recognized ratably over that period. The Company relies on Fox Paine & Company to provide management services and other services related to the operations of the Company.
On April 20, 2006, the Company announced that it had entered into Amendment No. 1 (the “Amendment”) of the Amended and Restated Shareholders Agreement. The Amendment reduced the requirement that the Board of Directors be comprised of no fewer than eleven directors to no fewer than seven directors. Furthermore, the Amendment (i) reduced the number of directors that Fox Paine & Company can nominate for election from six directors to five directors; and (ii) terminated the right of the Ball family trusts to nominate one director for election.
In 2007, 2006, and 2005, the Company paid $1.3 million, $0.2 million, and $0.08 million, respectively, to Cozen O’Connor for legal services rendered. There is an additional accrual of $0.4 million as of December 31, 2007 for legal services rendered. Stephen A. Cozen, the chairman of Cozen O’Connor, is a member of the Company’s Board of Directors.
Total rental expense under operating leases for the years ended December 31, 2007, 2006, and 2005 were $3.6 million, $3.5 million, and $4.0 million, respectively. At December 31, 2007, future minimum payments under non-cancelable operating leases were as follows:
There is a greater potential for disputes with reinsurers who are in a runoff of their reinsurance operations. Some of the Company’s reinsurers’ reinsurance operations are in runoff, and therefore, the Company closely monitors those relationships. The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will continue to be subject to litigation and arbitration proceedings in the ordinary course of business.
The Company allows employees to surrender the Company’s Class A common shares as payment for the tax liability incurred upon the vesting of restricted stock that was issued under the Company’s Share Incentive Plan. During 2007, the Company purchased an aggregate of 7,386 of surrendered Class A common shares from its employees for $0.2 million. All Class A common shares purchased from employees by the Company are held as treasury stock and recorded at cost.
Includes 316 shares surrendered by employees as payment of taxes withheld on the vesting of restricted stock.
On February 11, 2008, the Company announced that its Board of Directors authorized the Company to repurchase up to an additional $50.0 million of its Class A common shares. The timing and amount of the repurchase transactions under this program will depend on market conditions and other factors.
Prior to the adoption of SFAS 123R, cash retained as a result of tax deductions relating to share-based compensation was presented in operating cash flows, along with other tax cash flows. SFAS 123R requires tax benefits relating to excess stock-based compensation deductions to be prospectively presented in the statement of cash flows as financing cash inflows. Tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes were $0.4 million, $0.4 million and $0.5 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company maintains the United America Indemnity, Ltd. Share Incentive Plan (as so amended, the “Plan”). The purpose of the Plan is to give the Company a competitive advantage in attracting and retaining officers, employees, consultants and non-employee directors by offering stock options, restricted shares and other stock-based awards. As amended in May 2005, the Company may issue up to 5.0 million Class A common shares for issuance pursuant to awards granted under the Plan. Award activity for stock options granted under the Plan is summarized as follows:
In 2007, the Company recorded $0.8 million of compensation expense for the 993,948 outstanding options granted under the Plan. In 2006, the Company recorded $2.0 million of compensation expense for the 1,390,642 outstanding options granted under the Plan. In 2005, the Company recorded $3.3 million of compensation expense for the 1,545,055 options granted under the Plan. The Company received $1.9 million, $4.6 million and $2.1 million of proceeds from the exercise of options during 2007, 2006 and 2005, respectively.
The following tables summarize the range of exercise prices of options outstanding at December 31, 2007, 2006 and 2005:
The Company recognized compensation expense for restricted stock of $1.4 million, $2.5 million and $0.6 million for 2007, 2006 and 2005, respectively. The total unrecognized compensation expense for the non-vested restricted stock was $3.8 million at December 31, 2007, which will be recognized over a weighted average life of 2.5 years. The fair value of the 54,886 Class A common shares, subject to certain restrictions granted to key employees of the Company under the Plan (“Restricted Shares”) that vested during the year ended December 31, 2007 was $22.80 per share. In addition to stock option awards, the Plan also provides for the issuance of Restricted Shares to employees and non-employee Directors. The following table summarizes the restricted stock awards since inception.
The following table summarizes the non-vested Restricted Shares activity for the year ended December 31, 2007:
During 2007, the Board of Directors authorized a grant of Restricted Shares to officers of the Company if the Company achieves a minimum 10% return on equity based on 2007’s operating results. 45,514 Restricted Shares were awarded during the first quarter of 2008, based on the December 31, 2007 market value of the Company’s common shares, and will vest 34% on January 1, 2009 and 33% on each January 1 of years 2010 and 2011. The Board of Directors also authorized an incentive award of Restricted Shares to these individuals if the Company earns no less than 85% of planned 2007 net income excluding after-tax net realized investment gains (losses), after-tax gain and one-time charges from discontinued operations, and after-tax extraordinary items that do not reflect overall operating trends. The results of calendar year 2007 will be examined in 2010 by an independent actuary. If net income excluding after-tax net realized investment gains (losses), after-tax gain and one-time charges from discontinued operations, and after-tax extraordinary items that do not reflect overall operating trends, adjusted to reflect the results of the actuarial study, is greater than or equal to net income excluding after-tax net realized investment gains (losses), after-tax gain and one-time charges from discontinued operations, and after-tax extraordinary items that do not reflect overall operating trends as originally reported, Restricted Shares may be awarded in 2011 based on the December 31, 2007 market value of the Company’s common shares. The awards are being expensed over the intrinsic service period, which includes the performance period and the employee service period. The employee must be continually employed through the vesting date to be eligible to receive the award. The Company recognized $0.4 million of expense in 2007 related to these awards.
Program (the “Awards Program”). The purpose of the Awards Program is to encourage increased efficiency and profitability and reward employees’ contributions to corporate success. All employees of the Company and its subsidiaries are eligible to participate in the Awards Program, and Awards Program participants are selected by the Compensation Committee of the Board of Directors (the “Committee”). Incentive awards under the Awards Program are determined and paid in cash and/or restricted stock based upon objective performance-based criteria as determined by the Committee. The criteria relate to certain performance goals, such as net income, combined ratio, return on equity, and individual performance expectations as established by the Committee, except that certain specific performance targets will be approved by the Section 162(m) Committee of the Board of Directors with respect to the executives covered by Section 162(m) of the Internal Revenue Code (“Section 162(m)”). It is the Company’s intent that any compensation paid pursuant to the Awards Program comply with Section 162(m).
In connection with the business combinations of the Company with Penn-America Group and Penn Independent Group, along with their respective subsidiaries, certain executives of Penn-America Group and Penn Independent Group entered into employment agreements which provided for the establishment of an integration bonus payable in Class A common shares of the Company in 2006 and 2007, if specified integrated company performance goals for 2005 and 2006, respectively, were achieved (the “Integration Plan”).
Second, the Compensation Committee approved an award of an Annual Integration Bonus relating to the 2006 fiscal year to the Integration Plan participants who were employed by Penn-America Group, Inc. as of February 15, 2006 (the “Current Plan Participants”). Such awards would have otherwise been determined and paid in full following the 2006 fiscal year. The decision by the Compensation Committee to modify the determination and award of the 2006 Annual Integration Bonus was based on: (i) the Compensation Committee’s recognition of the earlier-than-anticipated consolidation of the Company’s Insurance Operations, (ii) the Compensation Committee’s determination that the Penn-America Group, Inc. performance targets contained in the Integration Plan for the 2006 Bonus Determination Year were no longer appropriate performance targets on which to base plan awards given the earlier - than-anticipated consolidation, and the fact that the 2006 targets were exceeded in 2005, and (iii) the Compensation Committee’s desire to achieve parity among the Current Plan Participants and other executives of the Company entitled to receive awards of stock based on time versus performance-based vesting. Therefore, the Compensation Committee eliminated the performance criteria relating to the 2006 Bonus Determination Year, and instead granted restricted stock to the Current Plan Participants, which will vest at the rate 20% on each of February 15, 2007 and February 15, 2008 and 60% on February 15, 2009, subject to certain employment-related requirements. Although the Current Plan Participants were granted restricted stock earlier than they otherwise would have, the restricted stock vests over time as set forth above. Under the original terms of the Integration Plan, the granted stock would have vested immediately.
Through December 31, 2006, for employees of Penn Independent Corporation, Penn-America Group Inc. and their respective subsidiaries, the Company matched 50% of the first 6% contributed by an eligible employee. Vesting in the Company’s contribution was immediate for eligible employees. Total expenses for this plan for the years ended December 31, 2006 and 2005 were $0.4 million and $0.5 million, respectively.
were approximately 35.0 million common shares outstanding at December 31, 2007 compared to approximately 37.2 million outstanding shares at December 31, 2006.
As a result of the sale of substantially all of the assets of the Company’s Agency Operations in September 2006, the Company no longer has an Agency Operations segment, and the results of its Agency Operations are now classified as discontinued operations.
An unaudited summary of the Company’s 2007 and 2006 quarterly performance is as follows: