AssuranceAmerica Corporation leases office space for its corporate headquarters located at RiverEdge One, 5500 Interstate North Parkway, Atlanta, Georgia 30328. Effective October 1, 2009 the Company signed an amendment to extend its lease until 2019 under more favorable lease terms. AssuranceAmerica Managing General Agency, LLC., leases a claims office in the state of Florida. During 2011, the Company sold its TrustWay retail operations and the leases associated with the sale are no longer commitments for the Company. However, the Company is still obligated for the lease commitment on three discontinued retail offices in Alabama under short term commercial leases. The Company believes that its existing facilities in the various states are adequate for the Company’s current requirements and operations. Rent expense for long-term leases with predetermined minimum rental escalations is recognized on a straight-line basis, and the difference between the recognized rental expense and amounts payable under the leases, or deferred rent, is included in other liabilities.
The $2.7 million pre-tax loss from discontinued operations for the year ended December 31, 2011 includes a loss on disposal of $1.3 million from the sale of TrustWay retail agency operations. The pre-tax loss from discontinued operations also includes $1.4 million of discontinued operating losses for the year ended December 31, 2011 compared to a $3.2 million pre-tax loss for the same period last year. The prior year pre-tax loss reflects a discontinued operating loss of $1.7 million and a goodwill impairment of $1.5 million related to the TrustWay agency operations. See Note 9 of the Consolidated Financial Statements for further information.
Gross premiums written (“GPW”) for the year ended December 31, 2011 were $89.5 million, a decline of 11% compared to the same period in 2010. The decline in premium was driven by a reduction in new business policies as well as a product mix shift from 12 month policies to 6 month policies. The reduction in new business is due to the challenging economic environment as well as actions taken by the Company to improve profitability in underperforming market segments. These actions include rate increases, implementation of tighter underwriting guidelines and restrictions on new business in high fraud areas in the state of Florida. Additionally, the Company stopped writing new business policies in the states of Texas, Mississippi and Louisiana in November, 2011. Average policy premium for six month policies increased for new and renewal policies written during the last six months of the year by 15.4% and 5.4%, respectively, compared to the same period in 2010, reflecting the impact of the rate increases taken earlier in the year.
The Company ceded approximately 65% or $58.1 million of its direct premiums written to its reinsurers in 2011 compared to 67% or $67.8 million in 2010. The reduction is the result of lower direct premium volume produced and lower ceded premium for the state of Florida, which was ceded for only nine months during 2011.
Premiums written refers to the total amount of premiums billed to the policyholder less the amount of premiums returned, generally as a result of cancellations, during a given period. Premiums written become premiums earned as the policy ages. Barring premium rate changes, if an insurance company writes the same gross premiums written (“GPW”) each year, premiums written and premiums earned will be equal and the unearned premium reserve will remain constant. During periods of growth in GPW, the unearned premium reserve will increase, causing premiums earned to be less than premiums written. Conversely, during periods of decline in GPW, the unearned premium reserve will decrease, causing premiums earned to be greater than premiums written. The Company’s net premiums earned, after deducting reinsurance, remained flat at $33.4 million for the year ended December 31, 2011.
The MGA operations also receive finance and other fees associated with premium installment plans. Managing general agent fees of $10.5 million for the year ended December 31, 2011 were $0.5 million lower than the prior year, resulting from the reduction of in-force policies.
On December 30, 2010, AAIC issued a dividend in-kind to its parent Company of all the 5,000 of the AssuranceAmerica Capital Trust’s floating rate capital securities, with a liquidation amount of $1,000 per capital security (the “Capital Securities”) in the amount of $1,001,089 and the Company extinguished the floating rate junior subordinated debentures of the Company (the “Debentures”) of $4,988,513, which resulted in a gain of $3,509,845 after the unamortized issuance cost.
Effective January 1, 2011, the Company entered into a new quota share agreement with Swiss Reinsurance America Corporation for business written in 2011 for all states other than Florida. The Company ceded premium and losses equal to 75% of the bodily injury liability coverage and 82.5% of physical damage and other automobile liability coverages. The agreement includes a loss corridor of 75.0%-79.0%, whereby the Company retains the amount by which losses and loss adjustment expenses incurred exceed 75% of collected net premiums earned, subject to a maximum additional retention equal to 4% of collected net premiums earned. The Company retains the amount by which losses and loss adjustment expense incurred, after the application of the loss corridor, exceeds 120% of collected net premiums earned.
The $4.1 million of adverse development is attributed to higher than expected cost for bodily injury claims as well as additional cost exposure for Florida no-fault coverage (PIP). The Company has implemented both rate and underwriting actions to improve loss results for the bodily injury coverage. The adverse development on PIP coverage in Florida is related to recent Florida district court decisions, ruling that an insurer may not limit payment for PIP medical services to the permissive fee schedule of the Florida PIP statute unless there is specific language in the policy contract indicating use of the fee schedule. This is not expected to be a recurring issue as the Company added language to its policy contract effective January 1, 2011. As of December 31, 2011 the Company reserved for the estimated amount of remaining exposure.
The net income tax expense for the year ended December 31, 2011 from continuing and discontinued operations was $2.4 million compared to $0.9 million for the prior year. The increase in the tax expense during the year relates to a valuation allowance of $4.9 million on the Company’s deferred tax assets. The valuation allowance was established based on the “more likely than not” threshold for the Company’s net deferred income tax asset as of December 31, 2011. The Company’s ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryforward period provided for in the tax law. The Company considered the following possible sources of taxable income when assessing the possible realization of deferred tax assets: future reversals of existing taxable temporary differences; future taxable income exclusive of reversing temporary differences and carryforwards; taxable income in prior carryback years; and tax planning strategies.
As of December 31, 2011, the Company had investments and cash of $16.6 million, compared to $21.5 million at December 31, 2010. The Company’s investment strategy is to be investing in bonds with short durations in order to meet its insurance obligations. As of December 31, 2011, the Company had $8.1 million in cash and short-term investments, which included $0.3 million of cash restricted to provide security for certain reinsurance reserve obligations. The Company’s long term investments of $7.9 million are spread among direct obligations of the U.S. Treasury as well as those securities unconditionally guaranteed as to the payment of principal and interest by the United States government or any agency thereof and in corporate bonds. The Company changed its investment strategy during the year and sold all of its remaining equity securities in order to mitigate its exposure to a volatile equity market environment and reinvested the funds received in bonds. The other long term investments of $0.6 million represent low income housing tax credits, which will be used to offset the Company’s future tax liabilities.
The Company’s investment activities are made in accordance with the Company’s investment policy. The objectives of the investment policy are to obtain favorable after-tax returns on investments through a diversified portfolio of fixed income securities. The Company’s investment criteria and practices reflect the short-term duration of its contractual obligations with policyholders. Tax considerations include federal and state income tax as well as premium tax abatement and credit opportunities offered to insurance companies in the states where AAIC writes policies.
Assets of discontinued operations decreased $8.1 million to $0.2 million as of December 31, 2011 from the balance of $8.3 million as of December 31, 2010. This decrease is mainly related to the sale of the TrustWay agency assets disposed of during 2011. See Note 9 of the Consolidated Financial Statements for further information.
Unearned premium decreased $6.1 million to $28.1 million as of December 31, 2011 from $34.2 million as of December 31, 2010, and represents premiums written but not earned. This decrease is directly attributable to the decline in AAIC’s premium writings during 2011.
Unpaid losses and loss adjustment expenses increased $8.8 million to $42.1 million as of December 31, 2011 from $33.3 million at December 31, 2010. This amount represents management’s estimates of future amounts needed to pay claims and related expenses. The increase is primarily related to reserve strengthening and adjustments to the actuarial estimate for prior accident years related to the bodily injury and personal injury protection coverages.
Reinsurance payable as of December 31, 2011 decreased $8.9 million to $20.5 million, compared to $29.4 million on December 31, 2010. The amount represents premiums owed to the Company’s reinsurers. AAIC maintains nine reinsurance treaties with its reinsurers and is currently ceding approximately 65% of premiums written. The decrease is mainly due to the decrease in premiums written during the year.
Notes payable due to a related party increased by $1,557,911. The increase represents two notes payable issued in the amount of $2.5 million and $1.5 million to Mr. Millner, the Chairman of the Company, in consideration of providing the secured notes to AssuranceAmerica Corporation, (for assignment by the Company as a capital contribution to its subsidiary AssuranceAmerica Insurance Company). As additional consideration, the Company also issued a Warrant Agreement giving the Chairman the right to purchase 11,629,000 shares of the common stock of the Company for $0.01 per share. At December 31, 2011, the recorded balance of the notes is $1,557,911, net of $2,442,089 discount related to the issuance of the warrants. The discount will be amortized over the life of the notes as a yield adjustment. See Note 11 of the Consolidated Financial Statements for further information.
Net cash used by operating activities for the year ended December 31, 2011 was $7.0 million. The decrease in operating cash was primarily due to a change in payment terms for reinsurance commissions (paid on collected premium versus paid on written premium) impacting cash flow in 2011 by $3.4 million, the return of $1.6 million held as restricted on behalf of the reinsurer and payment of provisional commissions of $1.8 million.
Investing activities provided cash for the year ended December 31, 2011 of $7.9 million. The increase primarily consists of $4.5 million related to the sale of the TrustWay insurance agencies, $2.8 million net proceeds from the sale of bonds and equity securities, and $1.5 million transfer of cash from restricted funds held for reinsurers, offset by $0.9 million of purchases of property and equipment related to the wholesale division.
On June 30, 2010, the Company entered into a First Amendment Agreement (“First Amendment”) to the Loan Agreement between the Company and Wells Fargo Bank, N.A. (as successor in interest by merger to Wachovia Bank, N.A.) (“Lender”). The First Amendment amends the Loan Agreement, dated July 17, 2009, between the Company and the Lender (“Loan Agreement”).
To support Company growth, the Company maintains a highly liquid investment portfolio and closely manages capital requirements. AAIC is required by the state of South Carolina to maintain minimum statutory capital and surplus of $3.0 million. As of December 31, 2011, AAIC’s statutory capital and surplus was $11.4 million.
The Company does have off balance sheet leasing arrangements. For further information, please refer to Note 16 in the Consolidated Financial Statements.
The Company considers its historical loss experience and the factors set forth above at a state, product and line of business level to estimate its loss and LAE reserves. The Company reviews its loss and LAE reserves by line of business on a monthly basis as new information becomes known and it is able to observe actual loss development. Our statistical average reserves are reviewed throughout the year. If emerging issues relating to a product or state necessitate a change in our scheduled reviews of a particular coverage of the business, we identify and measure variances and make adjustments if necessary. For example, we track medical and auto repair costs and may adjust statistical averages if trends were emerging.
At December 31, 2011 and 2010, we had $14.5 million and $9.9 million of net loss and LAE reserves, respectively, which included $5.1 million and $5.2 million of case reserves and $9.4 million and $4.7 million of IBNR reserves, respectively. The Company’s case reserves were flat year-over-year and IBNR reserves increased $4.7 million. This increase in IBNR reserves is related to reserve strengthening and adjustments to the actuarial estimate for prior accident years related to the bodily injury and personal injury protection coverages.
On a quarterly basis, the Company’s external actuary performs an in-depth independent review of our actuarial data and determines whether or not the established reserves for both IBNR and LAE are within an acceptable range. At the end of each year, our independent actuary opines on and certifies our reserves. For all years presented, our independent actuary has determined that our reserves are within acceptable ranges, and therefore management has not adjusted the liability for unpaid losses and LAE from the amount determined by its external actuaries.
Index to Financial Statements During each quarterly review by the external actuarial staff, factor selections are updated using the additional information obtained with the passage of time. The ultimate loss estimates and held IBNR reserves for the line of business and accident periods effected are adjusted through this updating process. Additionally, the external actuaries and internal staff evaluate the overall reasonableness of the loss and LAE ratios by accident year and by line of business.
The following table provides the estimated changes in the liability and related payments made for the year ended December 31, 2011 and 2010:
Effective May 15, 2011, the Company entered into a new catastrophe agreement with Shelter Mutual Insurance Company (“SMIC”). SMIC shall be liable for private passenger automobile physical damage coverage with respect to each loss occurrence, for the ultimate net loss over and above an initial ultimate net loss of $400,000 each event, such as a storm or flood, subject to a limit of liability to SMIC of $1,600,000 each event, and further subject to a limit of liability to SMIC of $3,200,000 with respects all events commencing during the term of this contract.
Effective April 1, 2011, the Company entered into a twelve month quota share agreement with Greenlight Reinsurance Ltd. for business written in Florida. The Company ceded 50% of premium and losses for bodily injury liability, physical damage and other automobile liability coverages. The Company will receive a 19% ceding commission on ceded premiums earned if the loss and loss adjustment expense ratio as a percentage of earned premium is 75.5% or greater. If the loss ratio is less than 75.5%, but not less than 71.5% then the ceding commission shall be 19.0%, plus one half of the difference in percentage points between 75.5% and the actual loss ratio. If the loss ratio is 71.5% or less, then the ceding commission rate will be 21.0%. The Company receives a provisional commission rate of 20% in advance, which is subject to adjustment once the final loss ratio is known.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company periodically reviews the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The Company has nine reinsurers, of which eight are A- rated or better based on the most recent A.M. Best ratings available. While one of the reinsurers does not have a rating, the contract is in run-off. Further, the reinsurers cover up to $2,000,000 in aggregate claims for extra contractual obligations each policy year.
The impact of reinsurance on the income statement as of December 31 is as follows:
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. The Company reports as assets (a) the estimated reinsurance recoverable on unpaid losses, including an estimate for losses incurred but not reported, and (b) amounts paid to reinsurers applicable to the policies-in-force. During 2011, the Company ceded approximately 65% of its premium and 67% of losses during the year ended December 31, 2011 as compared to approximately 67% of its premium and 71% of losses ceded to reinsurers for the prior year. The ceded premium and losses reflect the new contract terms entered into during 2011 as previously mentioned. The ceded premium under these reinsurance agreements for the year ended December 31, 2011 and 2010 was $58.1 million and $67.8 million, respectively. The related ceding commission earned was $11.9 million in 2011 and $15.4 million in 2010. The lower ceded premium and commission were mainly due to lower production and the reduced ceded premium related to the state of Florida, which is ceded at 50% effective April 1, 2011.
Reinsurance assets include balances due from other contracted reinsurers under the terms of reinsurance agreements. Amounts applicable to ceded unearned premiums, ceded loss payments, and ceded claims liabilities are reported as assets in the accompanying balance sheets. Under the reinsurance agreements, the Company has four reinsurers that are required to collateralize the reinsurance recoverables. As of December 31, 2011, all reinsurers have provided a letter of credit or a secured trust account to provide security sufficient to satisfy the reinsurer’s obligations under the reinsurance agreements. The Company believes the fair value of its reinsurance recoverables approximates their carrying amounts.
We assess the carrying amount of identifiable intangible assets and long-lived assets if events or changes in circumstances indicate that such carrying amount may not be recoverable. We assess the carrying amount of our goodwill at least annually. Factors we consider important, which could trigger an impairment review, include the following:
While we believe that our assumptions are appropriate, such amounts estimated could differ materially from what will actually occur in the future. In assessing goodwill, these estimates are prepared at the generating segment level. Goodwill is allocated to the TrustWay segments for the purpose of impairment testing.