The following management's discussion and analysis ("MD&A") should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements appearing elsewhere in this report. The consolidated financial statements include the results of all of FPIC’s wholly owned and majority owned subsidiaries. Except for the historical information contained here, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under Item 1A. Risk Factors.
Our discussion and analysis of financial condition, results of operations and liquidity and capital resources is based upon the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. We generally base our estimates on historical experience or other appropriate assumptions that we believe are reasonable and relevant under the circumstances and evaluate them on an on-going basis. The results of these estimation processes form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Each technique has inherent benefits and shortcomings (i.e., biases), particularly when applied to company-specific characteristics and trends. For example, certain methods (e.g., the Bornhuetter-Ferguson methods) are more relevant to immature accident years and other methods (e.g., the loss development methods) provide more meaningful information for years with a greater level of maturity. Because each method has its own set of attributes, we do not rely exclusively upon a single method. Rather, we evaluate each of the methods for the different perspectives that they provide. Each method is applied in a consistent manner from period to period and encompasses a review of selected claims data, including claim and incident counts, average indemnity payments, and loss adjustment costs.
We also utilize and evaluate calculations contained in an actuarial study performed by an independent actuarial firm as an objective confirmation of the adequacy of our carried reserves. Our best estimate may differ from the selected reserve estimate of our independent actuary as a result of differences in evaluating such things as the impact of historical experience, legal and regulatory changes, expectations about future claim results and trends and certain other factors as discussed below. While our assessment may differ, our carried reserves remain within a reasonable actuarial range of the independent actuary’s selected reserve estimate. The independent review of our reserves plays an important role in our overall assessment of the adequacy of our reserves. The reserve opinions of our independent actuary for the years ended December 31, 2005 and 2004 have been filed with state insurance regulators along with the statutory financial statements of our insurance companies.
During November 2003, our insurance subsidiaries entered into agreements to commute their ceded reinsurance to Gerling Global Reinsurance Corporation of America (“Gerling”). As a result of the commutation, our insurance companies assumed policy liabilities previously ceded under the contracts and received $23.2 million in exchange for the release of Gerling from its reinsurance obligations to them, which was added to net reserves. No gain or loss was recognized on the transaction.
Incurred losses and LAE related to the current year increased approximately 34%. As noted in our insurance segment discussion of results of operations below, our net premiums earned grew approximately 51% for the year ended December 31, 2005. The lower increase in incurred losses and LAE relative to the increase in net premiums earned reflects the impact of pricing and underwriting actions in our insurance business and favorable claims results, mainly a lower number of new reported claims and incidents and stable severity.
The following factors have contributed to the variation in our historical loss development:
Despite the historical volatility in our reserve estimates, our loss experience and outlook overall has improved significantly in the most recent years and claim results have essentially met or been better than our estimates. Accordingly, deficiencies in cumulative net reserves that have developed at the end of calendar years 1999 through 2001 have been substantially offset by improvements in reserves for years 2002 through 2004, resulting in a slight redundancy for all years prior to 2005 combined.
Data presented in the table above represents consolidated information of all our insurance subsidiaries commencing from their respective dates of acquisition. Data presented from 1996 to 1997 reflects only First Professionals’ liability for losses and LAE. The 1998 year reflects losses and LAE data for First Professionals and APAC. The data presented from 1999 to 2005 reflects all of our current insurance subsidiaries.
Our invested assets comprise our largest single asset class and consist primarily of investment securities in the form of fixed maturity investments in bonds and notes. Our fixed maturity investment securities, including short-term investments, are carried at their fair values and accounted for $664.3 million or 99% of our total investments and 51% of our total assets as of December 31, 2005 compared to $548.5 million or 99% of our total investments and 43% of our total assets as of December 31, 2004. Fair value is determined using the quoted market price of these securities provided by either independent pricing services, or when such prices are not available, by reference to broker or underwriter bid indications. Unrealized gains or losses in their fair values are recorded directly in shareholders’ equity, net of tax effects, as a component of accumulated other comprehensive (loss) income. Gross unrealized investment gains were $2.4 million and gross unrealized investment losses were $9.6 million as of December 31, 2005.
GAAP requires that the book value of investments be written down to fair value when declines in value are considered other-than-temporary. When such impairments occur, the decrease in value is reported in net income as a realized investment loss and a new cost basis is established. In the years ended December 31, 2005, 2004 and 2003, we recorded a pre-tax charge to earnings, for investments that were other-than-temporarily impaired of $0.7 million, $0.8 million, and $5.3 million, respectively. We evaluate our investment portfolio on a quarterly basis to identify securities that may be other-than-temporarily impaired. Our analysis takes into account relevant factors, both quantitative and qualitative in nature. Among the factors we consider are the following:
With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. If we do not expect a security’s decline in fair value to be fully recovered prior to the expected time of sale, we would record an other-than-temporary impairment in the period in which the decision to sell is made. Subsequent decisions on security sales could be made based on changes in liquidity needs (i.e., arising from a large insured loss), internal risk management considerations, the financial condition of the issuer or its industry, market conditions, and new investment opportunities. Day to day management of the majority of our investment portfolio is overseen by third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses until such losses are recovered, the dynamic nature of portfolio management may result in a subsequent decision to sell the security and realize the loss based upon new circumstances such as those related to the changes described above. We believe that subsequent decisions to sell such securities are consistent with the classification of our portfolio as available for sale.
In accordance with FAS 142 “Goodwill and Other Intangible Assets” we make an annual assessment by reporting unit as to whether the value of our goodwill is impaired. We completed such assessments in 2005, 2004 and 2003 and concluded that the value of our goodwill assets of $18.9 million was not impaired. We use both a market-based valuation analysis and a discounted cash flow analysis to estimate the fair value of each reporting unit. Our analysis includes the use of assertions regarding market perceptions of value as it relates to certain metrics and projected operating results, a review of economically similar entities, and assumptions of future cash flows, discount and market capitalization rates and growth rates. Changes to these assumptions could significantly lower our estimates of fair value and result in a determination that goodwill has suffered impairment in value.
Commission income for the insurance management segment is associated with the placement of insurance and reinsurance with external carriers on behalf of PRI, and in some cases, on behalf of our insurance subsidiaries, where commissions or brokerage fees related to a transaction are payable by the reinsurer. Commissions and brokerage fees are recognized as revenues as of the later of the billing or the effective date of the insurance or reinsurance placed.
Consolidated net income for the year ended December 31, 2005 was $35.0 million, or $3.26 per diluted share, an increase of 24% and 21%, respectively, when compared with net income of $28.2 million, or $2.70 per diluted share, for the year ended December 31, 2004. Included in consolidated net income for the years ended December 31, and 2004 were discontinued operations of $2.1 million and $1.4 million, respectively. Other changes in net income are due to the factors discussed in the paragraph above with regard to consolidated income from continuing operations.
Consolidated expenses for the year ended December 31, 2005 increased $69.0 million, or 39%, to $246.1 million from $177.1 million for the year ended December 31, 2004. The increase in consolidated expenses is mainly the result of increases in net losses and LAE incurred associated with growth in premiums and higher other underwriting expenses at our insurance segment. Our GAAP underwriting (combined) ratio was 90% for 2005 and 92% for 2004. The improvement in net losses and LAE incurred relative to net premiums earned reflects pricing and other improvements in our underwriting results. The growth in other underwriting expenses is primarily the result of corresponding growth in net premiums earned, a decrease in ceding commissions resulting from the elimination of cessions under the Hannover Re net account quota share reinsurance agreement and lower fronting fees, net of related expenses. In addition, other underwriting expenses for the year ended December 31, 2005 include a reduction of $1.7 million, which represents proceeds from the settlement of litigation. Interest expense on debt increased as a result of an increase in the three-month LIBOR rate, which is the base rate used to determine the interest on our long-term debt. Other expenses increased for the year ended December 31, 2005 due to charges for compensation and benefits costs associated with the resignation of certain former officers in accordance with the terms of their respective employment agreements and an impairment charge associated with one of our intangible assets.
Consolidated income from continuing operations for the year ended December 31, 2004 was $26.8 million, or $2.57 per diluted share, an increase of 75% and 63%, respectively, when compared with income from continuing operations of $15.3 million, or $1.58 per diluted share, for the year ended December 31, 2003. Income from continuing operations increased primarily due to significantly improved underwriting results and lower interest costs on our long-term debt in 2004 at our insurance segment. Growth in premiums written by PRI for 2004 contributed to growth in insurance management revenues and income from continuing operations.
Consolidated revenues for the year ended December 31, 2004 increased $35.2 million, or 19%, to $220.4 million from $185.2 million for the year ended December 31, 2003. The increase in consolidated revenues for the year 2004 is primarily due to higher net premiums earned as the result of rate increases and lower ceded reinsurance premiums in our insurance segment and higher insurance management fees in our insurance management segment associated with growth in written premiums at PRI. Net investment income also increased for the year 2004 primarily resulting from growth in our fixed income securities arising from growth in our insurance invested assets. Net realized investment gains also increased for the year 2004.
Consolidated expenses for the year ended December 31, 2004 increased $15.9 million, or 10%, to $177.1 million from $161.2 million for the year ended December 31, 2003. The increase in total expenses for the year 2004 is primarily due to higher other underwriting expenses at our insurance segment and insurance management expenses at our insurance management segment. Our GAAP underwriting (combined) ratio improved to 92% for 2004 from 98% for 2003. Other underwriting expenses increased for the year primarily due to lower ceding commissions associated with lower ceded premiums earned, resulting from the terminations of a large reinsurance agreement and fronting programs. Insurance management expenses were higher as a result of growth in premiums written by PRI and the related growth in insurance management revenues and operations. Offsetting these higher expenses were lower borrowing costs (interest plus the costs of related hedging instruments) on our debt. We also incurred charges of $2.5 million, in 2003, to unwind interest rate swap agreements, which did not recur during 2004. Income tax expense was higher for 2004 when compared to 2003 primarily due to higher taxable income. Income tax expense for 2004 also includes a small provision for income tax contingencies identified in a current Internal Revenue Service (“IRS”) examination.
During May 2005, First Professionals and APAC entered into agreements to commute their 25% quota share reinsurance ceded with APAL. Under the terms of the agreements, the two companies assumed policy liabilities previously ceded under the contracts of approximately $10.2 million and received a comparable amount of assets in the form of cash and investments, resulting in no material gain or loss on the transaction.
Due to increases in profitability and the growing equity and statutory surplus of our insurance businesses, we terminated future cessions under the Hannover Re net account quota share reinsurance agreement, effective June 30, 2004. With this termination, business was no longer ceded under the agreement beginning with business written and renewed in the third quarter of 2004. The business already ceded through June 30, 2004, will continue to be subject to the agreement as it runs off.
For the purpose of period over period comparison, net paid losses and LAE do not take into account $10.2 million received in connection with the APAL ceded reinsurance commutation during the second quarter of 2005, which would be a reduction to reported net paid losses and LAE.
For the purpose of period over period comparison, net paid losses and LAE do not take into account $23.2 million received in connection with the Gerling ceded reinsurance commutation during the fourth quarter of 2003, which would be a reduction to reported net paid losses and LAE.
Direct and assumed premiums written decreased 8% to $289.0 million for the year ended December 31, 2005 from $312.7 million for the year ended December 31, 2004. The decrease in direct and assumed premiums written for the year ended December 31, 2005 is primarily attributable to our planned exits from fronting programs and non-core states. We began exiting our fronting programs in 2002 to create capacity for our core MPL insurance business. All of these programs are now in run-off. The decrease was partially offset by the effects of pricing improvements and an increase in the number of policyholders.
Net premiums earned increased 51% to $226.0 million for the year ended December 31, 2005 from $149.7 million for the year ended December 31, 2004. The increase is primarily the result of the termination of cessions under the Hannover Re net account quota share reinsurance agreement, under which ceded earned premiums were $8.4 million and $75.7 million for the years ended December 31, 2005 and 2004, respectively. The decrease in ceded earned premiums earned under the agreement resulted in a corresponding increase in net premiums earned. Termination of the agreement is expected to result in relatively higher net premiums earned during the first half of 2006 as compared with net premiums earned on the corresponding business for the first half of 2005. Partially offsetting the increase in net premiums earned was the non-renewal, effective July 1, 2004, of the excess of loss reinsurance treaty under which First Professionals had previously assumed reinsurance from PRI.
Net paid losses and LAE on professional liability claims decreased 6% to $111.7 million for the year ended December 31, 2005 from $119.3 million for the year ended December 31, 2004. The number of professional liability claims closed with indemnity payment (“CWIP”) increased 12% to 391 for the year ended December 31, 2005 from 350 for the year ended December 31, 2004. The percentage of CWIP to all closed claims and incidents for the year ended December 31, 2005 was 16%, compared to 14% for the year ended December 31, 2004.
Income taxes increased 24% to $10.2 million for the year ended December 31, 2005 from $8.3 million for the year ended December 31, 2004. The increase in income tax expense reflects our higher income from continuing operations before income taxes. Our effective income tax rates were 29% and 34% for the years ended December 31, 2005 and 2004, respectively. The decrease in our effective income tax rate is primarily due to an increase in tax-exempt investment income and non-recurrence of a $0.75 million provision for income tax contingencies identified in an IRS examination that was included in income tax expense for the year ended December 31, 2004. During 2005, we reached a settlement with the IRS with regard to the examination of our income tax returns for the years ended December 31, 2000 and 2001. The settlement is currently pending approval by the Congressional Joint Committee on Taxation. We do not expect significant adjustments to develop as a result of the Congressional Joint Committee’s review. Our income tax returns for the years subsequent to December 31, 2001 have not been examined by the IRS and remain open under the statute of limitations.
Other expenses is comprised primarily of finance charges associated with funds withheld under the Hannover Re net account quota share reinsurance agreement, which were $6.6 million and $7.2 million for the years ended December 31, 2005 and 2004, respectively. Growth in these finance charges contributed to the increase in other expenses and is due to the growth in the amount of funds withheld for business ceded under this agreement through June 30, 2004. As discussed elsewhere, we exercised our option to terminate future cessions under the agreement as of June 30, 2004. Other expenses for the year ended December 31, 2005 also includes a charge for compensation and benefits costs associated with the resignation of certain former officers in accordance with the terms of their respective employment agreements and an impairment charge associated with one of our intangible assets, which was written down to $0.
Net premiums written increased 35% to $192.5 million for the year ended December 31, 2004 from $143.1 million for the year ended December 31, 2003. Approximately $33.9 million, or 69%, of the $49.4 million increase in net premiums written for 2004 was the result of the termination of the Hannover Re net account quota share reinsurance agreement, as of June 30, 2004. First Professionals had been ceding 50% of its direct MPL insurance premiums under this reinsurance agreement. In addition to the factors affecting direct premiums, lower reinsurance costs in 2004 as compared with 2003 under the excess of loss reinsurance program also contributed to higher net premiums written.
Net premiums earned increased 14% to $149.7 million for the year ended December 31, 2004 from $131.7 million for the year ended December 31, 2003. The termination of the Hannover Re net account quota share reinsurance agreement, accounted for approximately $11.6 million, or 64%, of the $18.0 million increase in net premiums earned for 2004. The remaining increase in net premiums earned is primarily due to the effects of pricing improvements at First Professionals, APAC and Intermed, which have all implemented significant rate increases in recent years. Partially offsetting these increases in net premiums earned was a reduction in assumed premiums earned due to the non-renewal of the excess of loss reinsurance treaty between First Professionals and PRI.
Net losses and LAE incurred increased 5% to $125.2 million for the year ended December 31, 2004 from $119.0 million for the year ended December 31, 2003. The increases in our net losses and LAE incurred relative to net premiums earned and corresponding decrease in our loss ratio reflects pricing and other improvements in our insurance business and the resulting improvement in our underwriting results. Our loss and LAE ratios (defined as the ratio of net losses and LAE incurred to net premiums earned) were 84% and 90% for the years ended December 31, 2004 and 2003, respectively.
The increase in net paid losses and LAE on professional liability claims and claims and incidents closed was generally to be expected and consistent with the growth in our insurance business, considering the inherent time lag until the related claims are settled and closed. The percentage of CWIP to all claims and incidents closed slightly increased in 2004 when compared with 2003, which is within a reasonable range of outcomes for the period relative to carried reserves. The percentage of CWIP to all claims and incidents closed has improved significantly when compared with the percentage of CWIP to all claims and incidents closed for the year ended December 31, 2000, which was 18%. This significant improvement is largely the result of a stricter claims philosophy and related management initiatives implemented beginning in 2001. In addition, we also believe that our application of disciplined underwriting and risk selection criteria have helped minimize claims.
Income taxes increased 246% to $8.3 million for the year ended December 31, 2004 from $2.4 million for the year ended December 31, 2003. The increase in income taxes for the year ended December 31, 2004 compared to the year ended December 31, 2003 is primarily due to higher taxable income. Income tax expense for 2004 also includes a $0.75 million provision for income tax contingencies identified in a current IRS examination. We also incurred additional state income taxes in from the amendment of certain prior year state income tax returns.
Other expenses is comprised primarily of finance charges associated with funds withheld under the Hannover Re net account quota share reinsurance agreement, which were $7.2 million and $4.5 million for the years ended December 31, 2004 and 2003, respectively. Growth in these finance charges contributed to the increase in other expenses and is due to the growth in the amount of funds withheld for business ceded under this agreement through June 30, 2004. As discussed elsewhere, we exercised our option to terminate future cessions under the agreement as of June 30, 2004.
Our insurance management segment is made up of the following subsidiaries: AFP, PRM, and FPIC Intermediaries, Inc., all of which are wholly owned, and PMA, of which we own 80%. AFP provides services as an attorney-in-fact for PRI, an insurance reciprocal domiciled in New York. PRM acts as attorney-in-fact for PaPRI, which was formed to take the place of the unrelated fronting carrier that previously had underwritten, and ceded as reinsurance to PRI, medical professional liability insurance program business in Pennsylvania. PaPRI commenced underwriting the Pennsylvania program business effective July 1, 2004.
Insurance management net income decreased 28% to $7.8 million for the year ended December 31, 2005 from $10.9 million for the year ended December 31, 2004. The decrease is primarily due to lower commission income earned for the placement of insurance premiums and an increase in claims administration and management expenses. Partially offsetting this decrease were higher management fees as a result of management fees earned by PRM for the administration of PaPRI. PRM began managing PaPRI, and therefore earning management fees, beginning with the third quarter of 2004.
Insurance management fees earned by the insurance management segment are entirely comprised of management fees from the Reciprocals. Under the management agreement between AFP and PRI, AFP receives a management fee equal to 13% of PRI’s direct premiums written, and under the management agreement between PRM and PaPRI, PRM receives a management fee equal to 21% of PaPRI’s direct premiums written. As such, changes in the direct premiums written by the Reciprocals result in corresponding changes in management fees earned by our insurance management segment. Insurance management fees increased 7% to $41.7 million for the year ended December 31, 2005 from $39.1 million for the year ended December 31, 2004. The increases are primarily due to an increase in premiums written by PaPRI, which commenced operations effective July 1, 2004.
Commission income decreased 68% to $2.0 million for the year ended December 31, 2005 from $6.2 million for the year ended December 31, 2004. The decline in commission income is primarily due to the decrease in insurance premiums placed by PMA with a third party carrier under a former PRI professional liability insurance program in Pennsylvania. Commission income also declined due to decreases in brokerage commissions earned by FPIC Intermediaries, Inc. due to reduced reinsurance needs at PRI and at our insurance subsidiaries. The need for reinsurance and the terms and conditions of the reinsurance agreements of our insurance subsidiaries and PRI are reviewed on an annual basis, which can result in fluctuations in the amount of commission income earned from period to period.
Insurance management expenses increased 7% to $31.2 million for the year ended December 31, 2005 from $29.2 million for the year ended December 31, 2004. The increase in insurance management expenses is due to an increase in operating expenses at AFP. The increase in operating expenses at AFP is primarily the result of the growth in business at PaPRI and PRI.
Insurance management net income increased 23% to $10.9 million for the year ended December 31, 2004 from $8.8 million for the year ended December 31, 2003. The increase is primarily due to higher management fees. The growth in management fees was the result of growth in premiums written at PRI, a significant portion of which was due to the acquisition of two new institutional clients, and higher insurance premiums placed by PMA under a PRI professional liability insurance program. The new institutional clients were acquired in the first and third quarters of 2004. Partially offsetting the positive effect of higher revenues on net income were higher claims administration and management expenses.
Commission income increased 13% to $6.2 million for the year ended December 31, 2004 from $5.5 million for the year ended December 31, 2003. The increase in commission income earned in 2004 is primarily the result of an increase in insurance premiums placed by PMA under a PRI professional liability insurance program.
Insurance management expenses increased 37% to $29.2 million for the year ended December 31, 2004 from $21.2 million for the year ended December 31, 2003. The increase in insurance management expenses is due to the increase in operating expenses at AFP and commission expenses at PMA. The increase in operating expenses at AFP is primarily the result of the growth of PRI’s business. The increase in commission expenses at PMA was associated with an increase in premiums written and placed under a PRI professional liability insurance program. Also contributing to the increase in insurance management expenses for the year ended December 31, 2004 were direct costs associated with compliance with the Sarbanes-Oxley Act of of approximately $1.0 million.
Under the terms of the management agreements with our insurance subsidiaries, we receive management fees equal to 115% of the costs incurred. The additional 15% provision in the First Professionals and APAC management fees is intended to cover overhead, corporate expenses and profit and is eliminated in the consolidated financial statements. In the case of the agreement with APAC, the total annual management fees are also limited to an amount not to exceed those that would have been paid under the terms of its former management agreement. The payment of losses and LAE and insurance operating expenses (including reinsurance costs) in the ordinary course of business are the principal needs for our insurance subsidiaries’ liquid funds. The principal sources of cash from their operations to meet on-going liquidity requirements are the premiums collected for the insurance sold, and income on the investment of those funds.
Net cash flows provided by financing activities were $2.1 million and $3.2 million for the years ended December 31, 2005 and 2004, respectively. Cash flows of $0.3 million were used for financing activities for the year ended December 31, 2003. Net cash flows provided by financing activities decreased in 2005 primarily due to the repurchase of common shares under our stock repurchase program, which totaled $1.5 million. Net cash flows were used in investing activities in 2004 due to the settlement and purchase of derivative hedging instruments in association with the refinancing of our previous revolving credit facility and term loan with long-term debt.
Both internal and external forces influence our financial condition, results of operations and cash flows. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. We believe that our cash balances, cash flow from operations, routine sales of investments and the liquidity provided by our long-term debt, as discussed below, are adequate to meet expected cash requirements.
As our business has grown, so has our need for capital to support our operations and maintain our ratings. In recent years, we have taken actions to obtain additional capital for general corporate purposes, including supporting growth by our insurance subsidiaries. During 2003, we completed the placement of $10.0 million in senior notes and created three trusts that issued 30-year trust preferred securities for which the proceeds from such issuances together with cash previously contributed to the trusts were used to purchase junior subordinated debentures from FPIC totaling $36.1 million. The debentures that we issued, which are reported as long-term debt in the consolidated statements of financial position, to the three trusts are subordinated to all senior indebtedness, including the senior notes, and are equal in standing with one another. In accordance with the guidance given in Financial Accounting Standards Board Interpretation No. 46, “Variable Interest Entities,” we have not consolidated these subsidiary trusts.
Due from reinsurers on unpaid losses decreased $29.6 million to $303.8 million as of December 31, 2005 from $333.4 million as of December 31, 2004. The decrease is primarily due to a decrease of $28.6 million in ceded loss and LAE reserves under the Hannover Re net account quota share agreement as a result of the termination of further cessions under the agreement as of June 30, 2004. Also contributing to the decrease was the commutation of the quota share agreement with APAL, whereby $10.2 million of loss and LAE reserves and corresponding funds were received from APAL. Partially offsetting the decrease was an increase in ceded loss and LAE reserves under one of our former fronting programs during the fourth quarter of 2005.
Ceded unearned premiums decreased $14.0 million to $14.1 million as of December 31, 2005 from $28.1 million as of December 31, 2004. Approximately $9.1 million of the reduction is due to a decrease in ceded unearned premiums under the Hannover Re net account quota share reinsurance agreement, which was terminated and placed into run-off. The remainder of the decrease is primarily due to the reduction of ceded premiums under former fronting programs.
The liability for losses and LAE decreased $28.4 million to $663.5 million as of December 31, 2005 from $635.1 million as of December 31, 2004. The decrease is primarily attributable to reductions in loss and LAE reserves on former fronting programs of approximately $13.0 million, all of which have been terminated and placed into run-off. Partially offsetting the decrease was growth in our core MPL insurance business. For additional information on our accounting policy for loss and LAE reserves, see the discussion under Critical Accounting Policies and Estimates and the discussion included in Item 8. Financial Statements and Supplementary Data, Note 6, Liability for Losses and LAE.
Reinsurance payable decreased $30.0 million to $104.6 million as of December 31, 2005 from $134.6 million as of December 31, 2004. The decrease is primarily the result of a $30.0 million reduction in the funds withheld balance under the Hannover Re net account quota share reinsurance agreement.
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also have items that represent contractual obligations, commitments and contingent liabilities that are not recorded or that are considered to possess off-balance sheet risks beyond their respective amounts otherwise reflected in our consolidated financial statements. These include: (1) derivative financial instruments, which are used to hedge interest rate risk, (2) guarantees by us and contractual obligations related to the trust preferred securities issued by separately created, unconsolidated trusts, (3) a contingent liability under an amendment made to AFP’s management agreement with PRI, effective January 1, 2002, (4) employee benefit plans, (5) two irrevocable letters of credit issued in favor of the lessor under operating leases and (6) a contractual liability related to the sale of our former TPA segment. We were not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2005, which would give rise to previously undisclosed market, credit or financing risk.
The costs and liabilities that we record for our defined benefit plans are significantly affected by changes in assumptions used to calculate those costs and liabilities. The assumptions include discount rates, benefits earned, interest cost, expected return on plan assets and other factors. Significant changes in these factors may result in volatility in pension costs and liabilities. Also, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation in future periods. While we believe that the assumptions used are appropriate, changes in assumptions or differences in actual experience may affect our future pension costs and obligations.
In May 2005, we sold the employee benefits administration assets of our TPA segment to WebTPA, Inc. for consideration of $0.6 million. In June 2005, we sold the remaining operations of our former TPA segment to a private investor for consideration of $3.5 million. In connection with these sales, we became subject to certain usual and customary obligations related to the indemnification of each buyer for commitments and contingencies that existed as of the respective sale dates. In addition, the sale agreement calls for us to be contractually liable for a specific line of business meeting certain revenue targets and to pay an amount to the private investor should WebTPA, Inc. exercise specified rights under the May 2005 purchase agreement. No amounts have been included in our consolidated financial statements related to these contractual liabilities as the contingencies are not believed to be probable.
The following table summarizes, in thousands, our significant contractual obligations and commitments as of December 31, 2005 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. Additional information regarding these obligations is provided in Item 8. Financial Statements and Supplementary Data, Note 12, Long-term debt, Note 15, Employee Benefit Plans, and Note 18, Commitments and Contingencies.
Employee benefit plan obligations are comprised of approved plan contributions and our obligation should our defined benefit plans terminate as of December 31, 2005.