Our net losses and loss adjustment expense ratio for 2004 includes a 1.7 percentage point increase attributable to a $4.4 million reduction in earned premium due to purchase accounting, and $1.7 million of catastrophic losses related to hurricanes in the third quarter of 2004. Our net losses and loss adjustment expense ratio for the period September 6, 2003 to December 31, 2003 includes a 9.0 percentage point increase attributable to a $7.2 million reduction in earned premium due to purchase accounting.
Our combined ratio for 2004 includes a 2.0 percentage point increase attributable to a $4.4 million reduction in earned premium and a $1.0 million decrease in acquisition costs and underwriting expenses due to purchase accounting, and $1.7 million of catastrophic losses related to hurricanes in the third quarter of 2004. Our combined ratio for the period September 6, 2003 to December 31, 2003 includes a 2.6 percentage point increase attributable to a $7.2 million reduction in earned premium and a $6.6 million decrease in acquisition costs and other underwriting expenses due to purchase accounting, and $0.9 million of deferred compensation option expense.
On January 24, 2005 we completed our previously announced merger with Penn-America Group, Inc. (NYSE: PNG), as well as the previously announced acquisition of Penn Independent Corporation. In connection with the transactions, our shareholders’ approved our change in name from United National Group, Ltd. to United America Indemnity, Ltd.
As a result of the transactions, we are one of the leading specialty property and casualty insurers in the industry as well as a significant originator of and placement agent for specialty property and casualty insurance coverage. Under our ownership structure, each company will retain its existing corporate identity and the businesses of United America Indemnity, Penn-America Group and Penn Independent Group will continue to be operated by essentially the existing management teams.
Under the terms of the merger agreement, Penn-America Group, Inc.’s shareholders received $15.375 of value for each share of Penn-America Group, Inc. common stock as follows: 1) 0.7756 of a Class A common share of United America Indemnity, based on $13.875 divided by the volume weighted average sales price of United America Indemnity’s Class A common shares for the 20 consecutive trading days ending January 21, 2005, which was $17.89, and 2) $1.50 in cash.
At a Penn-America Group, Inc. special meeting held on January 24, 2005, Penn-America Group, Inc.’s shareholders of record as of December 15, 2004 voted to approve, among other things, the merger transaction; and at the United America Indemnity extraordinary general meeting held on January 24, 2005, United America Indemnity shareholders of record as of December 15, 2004 voted to approve, among other things, the issuance of United America Indemnity Class A common shares to Penn-America Group, Inc.’s shareholders in the merger and to change the name of United National Group, Ltd. to United America Indemnity, Ltd.
The Company acquired all of the outstanding common stock of Wind River Investment Corporation and its subsidiaries (“Wind River” or the “Predecessor”) on September 5, 2003 (the “Acquisition”). As a result of the Acquisition, the capital structure and basis of accounting of the Company differ from those of Wind River prior to the Acquisition. Therefore, the financial data with respect to periods prior to the Acquisition (“Predecessor” period) may not be comparable to data for periods subsequent to the Acquisition (“Successor” period).
We operate our business principally through two business segments: E&S and specialty admitted. Our E&S segment focuses on writing insurance for hard-to-place risks and risks that standard admitted insurers specifically choose not to write. Our specialty admitted segment focuses on writing insurance for risks that are unique and hard to place in the standard market for insureds that are required, for marketing and regulatory reasons, to purchase insurance from an admitted insurance company. We de-emphasized our reinsurance segment in 2002 and have not written any business in that segment in 2002, 2003, or 2004.
We offer four general classes of insurance products across both our E&S and specialty admitted business segments. These four classes of products are specific specialty insurance products, umbrella and excess insurance products, property and general liability insurance products and non-medical professional liability insurance products.
Our expenses include losses and loss adjustment expenses, acquisition costs and other underwriting expenses, other operating expenses and interest and other investment expenses. Losses and loss adjustment expenses are estimated by management and reflect our best estimate of ultimate losses and costs arising during the reporting period and revisions of prior period estimates. We record losses and loss adjustment expenses based on an actuarial analysis of the estimated losses we expect to be reported on insurance policies written. The ultimate losses and loss adjustment expenses will depend on the actual costs to resolve claims. Acquisition expenses consist principally of commissions that are typically a percentage of the premiums on insurance policies written, net of ceding commissions earned from reinsurers. Other underwriting expenses consist primarily of personnel expenses and general operating expenses. Other operating expenses are comprised primarily of management fees paid to affiliates. Interest expense consists of interest paid on funds held on behalf of others, senior notes payable to related parties and junior subordinated debentures.
In managing the business and evaluating performance, the management focuses on measures such as loss ratio, expense ratio, combined ratio and net operating income, which we define as net income excluding after-tax realized investment gains (losses) and extraordinary items that do not reflect overall operating trends. Our management focuses on net operating income as a useful measure of the net income attributable to the ongoing operations of the business. Net operating income is not a substitute for the net income determined in accordance with GAAP, and investors should not place undue reliance on this measure.
During 2004, we realized additional rate increases at levels less than those levels realized in 2003. These increases have resulted primarily from a number of industry wide factors, including a reduction in underwriting capacity, ratings downgrades, the exit or insolvency of several insurers and the industry wide recording of reserve charges resulting from reserve deficiencies.
The following table contains an analysis of our securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2004:
Subject to the risks and uncertainties in evaluating the impairment of a security’s value, the impairment evaluation conducted by us as of December 31, 2004, concluded the unrealized losses discussed above are not other than temporary impairments.
The following sets forth the liability for gross unpaid losses and loss adjustment expenses by segment as of December 31, 2004 and, 2003.
The following sets forth the liability for net unpaid losses and loss adjustment expenses by product class as of December 31, 2004 and 2003.
The total liability for net unpaid losses and loss adjustment expenses includes both reported and IBNR reserves. A point estimate is developed around which an actuarial range is built. As of December 31, 2004, the upper limit of the range for our carried reserves is 7.9% above the recorded net liability for unpaid losses and loss adjustment expenses and the lower limit is 6.4% below the recorded amount.
There were 353 claimants with A&E claims outstanding as of December 31, 2004. As of December 31, 2003, there were 369 claimants with A&E outstanding claims, compared to 346 claimants as of December 31, 2002. In 2004, 320 claimants opened claims and claims were closed for 336 claimants. In 2003, 387 claimants opened claims and claims were closed for 364 claimants. In 2002, 282 claimants opened claims and claims were closed for 436 claimants. Indemnity payments per claim have varied over time due primarily to variations in insureds, policy terms and types of claims. Payments for A&E claims were $0.9 million for the year ended December 31, 2004. Payments for A&E claims were $0.5 million and $0.5 million for the years ended December 31, 2003 and 2002, respectively. Management cannot predict whether indemnity payments per claim will increase, decrease or remain the same.
During 2004, we decreased the liability for unpaid losses and loss adjustment expenses for prior years’ losses, net of reinsurance, by $0.8 million. There were no changes in the key assumptions underlying the 2004 actuarial study as compared to the 2003 actuarial study.
As of January 24, 2005, Penn-America Group had total reinsurance receivables of $43.9 million. Approximately 99% of these receivables were due from American Re, which is rated “A” (Excellent) by A.M. Best, and General Re, which is rated “A++” (Excellent) by A.M. Best.
Our cost of acquiring new and renewal insurance and reinsurance contracts is capitalized as deferred acquisition costs and amortized over the period in which the related premiums are earned. The costs of acquiring new and renewal insurance and reinsurance contracts include commissions, premium taxes and certain other costs, which are directly related to and vary with the production of business. The method followed in computing such amounts limits them to their estimated realizable value, which 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 was $53.2 million, $16.7 million, and $14.7 million, respectively.
We provide for income taxes in accordance with the provisions of Statement of Financial Accounting Standards (“FAS”) No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are recognized consistent with the asset and liability method required by FAS 109. Our deferred tax assets and liabilities primarily result from temporary differences between the amounts recorded in our consolidated financial statements and the tax basis of our assets and liabilities.
The Company accounts for stock-based compensation in accordance with FAS 123, “Accounting for Stock-Based Compensation,” which establishes a fair value-based method of accounting for stock-based compensation plans.
In November 2004, the Executive Committee of the American Institute of Certified Public Accountants issued an exposure draft Statement of Position, “Accounting by Insurance Enterprises for Deferred Acquisition Costs on Internal Replacements.” The exposure draft provides guidance on accounting by insurance companies for deferred acquisition costs on certain internal replacements other than those specifically described in FAS 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” The accounting provisions of the exposure draft will be effective for fiscal years beginning after December 15, 2005. We are in the process of reviewing the exposure draft and determining how it will be applied and its impact, if any, on our financial statements.
Our E&S segment focuses on writing insurance for hard-to-place risks and risks that standard admitted insurers specifically choose not to write.
Our reinsurance segment includes assumed business written in support of a select group of direct writing reinsurers. The underwriting exposure under this segment has been commuted. We did not write any of this business in 2004, 2003, or 2002.
We evaluate segment performance based on gross and net premiums written, net premiums earned and net losses and loss adjustment expenses. The following table sets forth an analysis of financial data for our segments during the periods indicated:
E&S gross premiums written were $260.8 million for 2004, compared with $465.9 million for 2003, a decrease of $205.1 million or 44.0%. This decrease primarily resulted from the termination of 12 products within our four product classes during 2003 and 11 products within our four product classes during 2002, combined with a reduction in gross premiums written of $43.7 million relative to our umbrella and excess product class, exclusive of the terminated products, offset by rate increases of approximately 9% (as measured against expiring rates) on other products. E&S gross premiums written relative to the terminated products were $13.0 million for 2004, compared with $169.3 million for 2003.
E&S net premiums written were $157.4 million for 2004, compared with $116.9 million for 2003, an increase of $40.5 million or 34.6%. The ratio of net premiums written to gross premiums written was 60.3% for 2004, compared with 25.1% for 2003. The increase in net premiums written was largely due to our increasing our retention relative to individual products and due to rate increases of approximately 9%. These increases in net premiums written were partially offset by decreases in net premiums written due to the termination of the products previously mentioned. Net premiums written relative to the terminated products were $1.2 million for 2004, compared with $13.0 million for 2003.
Specialty admitted net premiums written were $122.8 million for 2004, compared with $83.5 million for 2003, an increase of $39.3 million or 47.1%. The ratio of net premiums written to gross premiums written was 82.8% for 2004, compared with 41.2% for 2003. The increase in net premiums written was
largely due to these increases in retentions and due to rate increases of approximately 8%. These increases in net premiums written were partially offset by decreases in net premiums written due to the termination of the products previously mentioned. Net premiums written relative to terminated products were $1.4 million for 2004, compared with $7.7 million for 2003.
E&S net premiums earned were $131.4 million for 2004, compared with $108.1 million for 2003, an increase of $23.3 million or 21.6%. The increase in net premiums earned was primarily due to the previously mentioned retention increases and rate increases, partially offset by the impact of the previously mentioned product terminations.
Specialty admitted net premiums earned were $98.7 million for 2004, compared with $72.0 million for 2003, an increase of $26.7 million or 37.1%. This increase in net premiums earned was primarily due to the previously mentioned retention increases and rate increases, partially offset by the impact of the previously mentioned product terminations.
Net losses and loss adjustment expenses were $133.8 million for 2004, compared with $123.7 million for 2003, an increase of $10.1 million or 8.2%. The loss ratio for 2004 was 58.1% compared with 68.6% for 2003. The loss ratio is calculated by dividing net losses and loss adjustment expenses by net premiums earned. The loss ratio for 2004 and 2003, excluding the impact of purchase accounting adjustments, would have been 57.1% and 66.0%, respectively. The improvement in the loss ratio was attributable to continuing rate increases in 2004 and the termination of products that did not meet our profitability targets in 2003. These improvements were offset by $1.7 million of net losses related to Hurricanes Charley, Frances, Ivan, and Jeanne for 2004, which had the impact of increasing our loss ratio by 0.7 percentage points. A further breakdown of losses incurred is as follows:
E&S net losses and loss adjustment expenses were $76.9 million for 2004, compared with $75.3 million for 2003. The loss ratio was 58.5% for 2004, compared with 69.7% for 2003. The improvement in the loss ratio was attributable to continuing rate increases in 2004 and the termination of products that did
Acquisition costs and other underwriting expenses were $79.8 million for 2004, compared with $44.0 million for 2003, an increase of $35.8 million. This increase can be primarily attributed to a $36.8 million increase in acquisition costs and $1.0 million decrease in other underwriting expenses.
Other operating expenses were $1.5 million for 2004, compared with $0.8 million for 2003, an increase of $0.7 million.
We perform annual underwriting reviews on all our products. During 2002, as part of this annual review process, and as a result of reviews of our net loss reserves described in the next bullet point, we terminated a number of products as a result of factors such as unsatisfactory underwriting results and the absence of reinsurance capacity at pricing levels acceptable to us. These unsatisfactory underwrit-
We perform quarterly reviews of our net loss reserves. As a result of our review of net loss reserves during the second and third quarters of 2002, we noted what appeared to be faster than expected development of known incurred losses relative to several recent accident years. This resulted in our strengthening our net loss reserves by a total of $3.3 and $4.6 million, in the second and third quarters of 2002, respectively. Furthermore, a review of our net loss reserves performed in the fourth quarter of 2002 indicated the possible need for additional reserve strengthening. To more fully evaluate the adequacy of our loss reserves, we performed an extensive study of our loss reserves. As a result we increased our loss reserves for accident years 2001 and prior, inclusive of the $7.9 million strengthening noted above, by $47.8 million, with the increase relating primarily to accident years 1997 through 2001.
As a result of our loss experience and our expectations concerning future losses on policies written during and after 1997, we identified specific sources of business written during those periods that we expected to be unprofitable. We have taken what we believe to be appropriate steps to discontinue writing additional business from these sources.
increases of approximately 25% (as measured against expiring rates) on other products. E&S gross premiums written relative to the terminated products were $169.3 million for 2003.
E&S net premiums written were $116.9 million for 2003, compared with $112.1 million for 2002, an increase of $3.7 million or 3.3%. The ratio of net premiums written to gross premiums written was 25.1% for 2003, compared with 20.6% for 2002. The increase in net premiums written was largely due to our increasing our retention relative to individual products and due to rate increases of approximately 21%. These increases in net premiums written were partially offset by decreases in net premiums written due to the termination of the products previously mentioned. Net premiums written relative to the terminated products were $13.0 million for 2003.
Net realized investment gains were $5.8 million for 2003, compared with a $11.7 million net realized investment loss for 2002, a decrease of $5.9 million or 50.4%. The net investment gains for the current period consists of net gains of $6.4 million relative to our equity portfolio, net gains on fixed income investments of $0.3 million and $0.9 million of net losses relative to other invested assets. The net investment gain in 2002 consisted of net losses of $12.1 million relative to our equity portfolio, $1.7 million of gains relative to our fixed income investments, and net losses of $1.3 million relative to other invested assets.
The $16.1 million increase in acquisition costs was primarily the result of a reduction in ceding commission of $48.4 million partially offset by a decrease in direct commission of $30.8 million. Contingent commission expense increased $7.8 million due to favorable loss experience and the deferral of acquisition costs increased by $9.2 million. The reduction in ceding commission income was a result of a decrease in ceded premiums written combined with an increase in our level of retention. The reduction in direct commission was consistent with the reduction in gross premiums written. While increased retentions have the impact of increasing acquisition costs, our underwriting profit nonetheless increased based upon an improvement in our loss experience.
The $9.0 million increase in other underwriting expenses was primarily due to payments made to our executive officers in settlement of certain stock appreciation rights and for retention payments relating to services in connection with the closing of the acquisition.
We recorded a charge for an allowance for doubtful reinsurance receivables of $1.8 million in 2003 as compared to $44.0 million in 2002.
Our combined ratio was 94.0% for 2003, compared with 162.6% for 2002. This improvement was primarily the result of the increase in our level of premium retention and an improvement in our loss experience resulting from continuing rate increases in 2003. The 2002 combined ratio also includes the effect of reserve strengthening.
Other operating expenses were $0.8 million for 2003, compared with $6.0 million for 2002, a decrease of $5.2 million. The decrease can primarily be attributed to the reduction of management fees paid during 2003.
Equity in net earnings of partnerships was $2.6 million for 2003, compared with a loss of $0.3 million for 2002, an increase of $2.9 million. The gain is primarily attributable to the performance of our investment in a high yield limited partnership.
The factors described above resulted in net income of $77.1 million for 2003, compared with a net loss of $61.7 million for 2002. Net operating income was $27.0 million for 2003, compared with a net operating loss of $54.1 million for 2002. Net operating income for 2003 is equal to 2003 net income less $3.7 million for after-tax realized investment gains and $46.4 million for an extraordinary gain recorded in connection with the Acquisition. Net operating loss for 2002 is equal to 2002 net loss less $7.6 million for after-tax realized investment losses.
United America Indemnity Combined is a holding company. Its principal asset is its ownership of the shares of its direct and indirect subsidiaries, including United National Insurance Company, Diamond State Insurance Company, United National Specialty Insurance Company, United National Casualty Insurance Company, Wind River Barbados, Wind River Bermuda, Penn-America Insurance Company, Penn-Star Insurance Company, and Penn-Patriot Insurance Company.
The principal sources of funds at Wind River Barbados, Wind River Bermuda and the Combined U.S. Insurance Operations include underwriting operations, investment income and proceeds from sales and redemptions of investments. Funds are used by Wind River Barbados, Wind River Bermuda and the Combined U.S. Insurance Operations principally to pay claims and operating expenses, to purchase investments and to make dividend payments. United America Indemnity Combined’s future liquidity is dependent on the ability of Wind River Barbados, Wind River Bermuda and the Combined U.S. Insurance Operations to pay dividends.
Net cash was provided by operating activities in 2004, 2003, and 2002 of $59.3 million, $40.4 million, and $105.0 million, respectively. In 2004, net income before extraordinary gain increased from 2003 by $5.2 million. As a result, we were able to realize an increase of approximately $18.9 million in cash flows primarily as a result of the following items: (1) a decrease in gross premiums collected of $207.8 million, offset by a decrease in reinsurance premiums paid of $287.6 million; (2) an increase in gross losses of $165.2 million offset, by an increase in ceded losses of $168.9 million; (3) an increase in acquisition costs and other underwriting expenses of $40.3 million; (4) a decrease in the amount of federal income taxes recovered of $17.5 million; and (5) a decrease in other miscellaneous items of $6.8 million. In 2003, cash flows decreased by approximately $64.9 million despite an increase in net income of approximately $138.8 million from 2002. This decrease in cash flow was due to an extraordinary gain of $46.4 million in 2003 that resulted from the acquisition of Wind River Investment Corporation, and a decrease of $42.3 million in the provision for doubtful reinsurance in 2003 compared with 2002.
Net cash was used for investing activities in 2004, 2003, and 2002 of $39.5 million, $87.4 million, and $109.1 million, respectively. The decrease in cash used for investing activities in 2004 from 2003 was primarily due to an additional $60.9 million of cash proceeds from the sales of bonds and stocks in 2004, offset against $14.7 million of additional purchases of bonds and stocks in 2004. In 2003, the decrease in cash used from 2002 was primarily due to the use of $11.5 million for the acquisition of business net of cash acquired, and $62.1 million of additional purchases of bonds and preferred stocks in 2003, offset by the additional $79.1 million of net cash proceeds from the sales and purchases of bonds and stocks in 2003.
There are two intercompany pooling agreements in place. The first pooling agreement governs policies that were written prior to July 1, 2002. The second pooling agreement governs policies that are written on or after July 1, 2002. The method by which intercompany reinsurance is ceded is different for each pool. In the first pool, the United National Insurance Companies cede all business to United National Insurance
The Penn-America Insurance Companies participate in an intercompany pooling arrangement whereby premiums, losses, and expenses are shared pro rata among the members of the group. Penn-Star Insurance Company is not an authorized reinsurer in all states. As a result, any losses and unearned premium that are ceded to Penn-Star Insurance Company by the other companies in the group must be collateralized. The state insurance departments that regulate the parties to the intercompany pooling agreements require Penn-Star Insurance Company to place assets on deposit subject to trust agreements for the protection of other group members.
Reinsurance premiums ceded by the United National Insurance Companies through October 2004 were paid to Wind River Bermuda and Wind River Barbados. Since Wind River Barbados and Wind River Bermuda are not authorized reinsurers in the United States, the insurance laws and regulations of Pennsylvania, Indiana and Wisconsin require the establishment of reinsurance trusts for the benefit of the United National Insurance Companies. The funding requirement includes the amount due on ceded paid loss and loss adjustment expenses, ceded unearned premium reserves, and ceded loss and loss adjustment reserves. Wind River Bermuda and Wind River Barbados have each established independent reinsurance trust accounts for the benefit of each of the U.S. Insurance Subsidiaries in the amount of $138.4 million and $19.8 million, respectively. We intend to invest the funds in securities that have durations that closely match the expected duration of the liabilities assumed. We believe that each of Wind River Bermuda and Wind River Barbados will have sufficient liquidity to pay claims prospectively.
Pending regulatory approvals, the Penn-America Insurance Companies intend to enter into a quota share arrangement with Wind River Bermuda. As a result of this arrangement, a portion of their net retained insurance liability on new and renewal business bound in 2005 may be ceded to Wind River Bermuda.
On September 30, 2003, AIS, a wholly owned indirect subsidiary of United America Indemnity, sold $10.0 million (aggregate liquidation amount) of floating rate trust preferred securities to Dekania CDO I, Ltd., an exempted company incorporated with limited liability under the law of the Cayman Islands, in a private placement through AIS’ wholly owned statutory trust, Trust I.
AIS, through Trust I, together with other insurance companies and insurance holding companies, issued trust preferred securities to the collateralized debt obligation pool organized by Dekania Capital Management LLC, which in turn, issued its securities to institutional and accredited investors. Trust I issued 10,000 trust preferred securities, having a stated liquidation amount of $1,000 per security, that mature on September 30, 2033 and bear a floating interest rate, reset quarterly, equal to the London Interbank Offered Rate
On October 29, 2003, AIS sold $20.0 million (aggregate liquidation amount) of floating rate trust preferred securities to I-Preferred Term Securities III, Ltd., an exempted company incorporated with limited liability under the law of the Cayman Islands, in a private placement through AIS’ wholly owned statutory trust, Trust II.
We have commitments in the form of operating leases, obligations to fund limited partnerships, revolving line of credit senior notes payable, junior subordinated debentures and unpaid losses and loss expense obligations. As of December 31, 2004, contractual obligations related to United America Indemnity’s commitments were as follows:
As of January 24, 2005, the combined contractual obligations relating to Penn-America Group’s and Penn Independent Group’s commitments were as follows:
Penn-America Group, Inc. and Penn Independent Group lease their home office space as part of normal operations. The amounts shown above represent future commitments under such capital leases.
Penn-America Group, Inc. and Penn Independent Group lease their equipment as part of normal operations. The amounts shown above represent future commitments under such operating leases.
can be deferred for up to five years, but in the event of such deferral, Penn-America Group, Inc. may not declare or pay cash dividends on its common stock. Penn-America Group, Inc. guarantees all obligations of the Penn-America Statutory Trust I with respect to distributions and payments of these securities.
In May, 2003, Penn-America Statutory Trust II, a business trust subsidiary formed by Penn-America Group, Inc., issued $15.0 million of floating rate trust preferred securities. These securities have a thirty-year maturity, with a provision that allows Penn-America Group, Inc. to call these securities at par after five years from the date of issuance. Cash distributions will be paid quarterly in arrears at a rate of 410 basis points over three-month London Interbank Offered Rates. Distributions on these securities can be deferred for up to five years, but in the event of such deferral, Penn-America Group, Inc. may not declare or pay cash dividends on its common stock. Penn-America Group, Inc. guarantees all obligations of the Penn-America Statutory Trust II with respect to distributions and payments of these securities.
Proceeds from the sale of these securities issued by Penn-America Group, Inc.’s business trust subsidiaries were used to acquire $30.0 million of Floating Rate Junior Subordinated Deferrable Interest Rate Debentures issued by Penn-America Group, Inc. These junior subordinated debentures have the same terms with respect to maturity, payments, and distributions as the floating rate trust preferred securities issued by the Penn-America Statutory Trust II. Penn-America Group, Inc. entered into an interest rate swap to fix the variable interest rate on the junior subordinated debentures issued to Penn-America Statutory Trust I at 7.4% through December 2007.
Penn Independent Financial Services Inc. maintains a $4,500,000 revolving line of credit which expires in November 2005. These funds are used to finance the loan, collateralized by a money market account with a balance of $4,500,000.
terminology, and include discussions of strategy, financial projections and estimates and their underlying assumptions, statements regarding plans, objectives, expectations or consequences of the transactions, and statements about the future performance, operations, products and services of the companies.
Our business and operations are and will be subject to a variety of risks, uncertainties and other factors. Consequently, actual results and experience may materially differ from those contained in any forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following: (1) the ineffectiveness of our business strategy due to changes in current or future market conditions; (2) the effects of competitors’ pricing policies, and of changes in laws and regulations on competition, including industry consolidation and development of competing financial products; (3) greater frequency or severity of claims and loss activity than our underwriting, reserving or investment practices have anticipated; (4) decreased level of demand for our insurance products or increased competition due to an increase in capacity of property and casualty insurers; (5) risks inherent in establishing loss and loss adjustment expense reserves; (6) uncertainties relating to the financial ratings of our insurance subsidiaries; (7) uncertainties arising from the cyclical nature of our business; (8) changes in our relationships with, and the capacity of, our general agents; (9) the risk that our reinsurers may not be able to fulfill obligations; and (10) uncertainties relating to governmental and regulatory policies.
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included under “Business-Risk Factors.” We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
Also, in our opinion, management’s assessment, included in “Management’s Report on Internal Control over Financial Reporting” appearing in Item 9A of the Company’s Form 10-K, that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on Internal Control - Integrated Framework issued by COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
In our opinion, the accompanying consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Wind River Investment Corporation and its subsidiaries at December 31, 2002 and the results of their operations and their cash flows for the period January 1, 2003 through September 5, 2003 and for year ended December 31, 2002 (“Predecessor Basis”) in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the Predecessor Basis financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The consolidated financial statements include the accounts of United America Indemnity, Ltd. (formerly United National Group, Ltd.) and its wholly owned subsidiaries, (“United America Indemnity” or the “Company”), Wind River Insurance Company (Barbados) Ltd. (“Wind River Barbados”), U.A.I. (Gibraltar) Limited, U.A.I. (Luxembourg) I S.ar.l., U.A.I. (Luxembourg) II S.ar.l., U.A.I. (Luxembourg) III S.ar.l., U.A.I. (Luxembourg) IV S.ar.l., U.A.I. (Luxembourg) Investment S.ar.l., Wind River (Luxembourg) S.ar.l., Wind River Insurance Company, Ltd. (“Wind River Bermuda”), Wind River Services, Ltd., U.N. Holdings II, Inc., U.N. Holdings Inc., Wind River Investment Corporation, American Insurance Service, Inc. (“AIS”), American Insurance Adjustment Agency, Inc. (“AIAA”), International Underwriters, LLC. (“IU”), United National Insurance Company (“UNIC”), Diamond State Insurance Company (“Diamond State”), United National Specialty Insurance Company (“United National Specialty”), United National Casualty Insurance Company (“United National Casualty”), J.H. Ferguson & Associates, LLC (“J.H. Ferguson”), Emerald Insurance Company, and Loyalty Insurance Company. All significant intercompany balances and transactions have been eliminated in consolidation.
As discussed below in Note 2, the Company acquired all of the outstanding common stock of Wind River Investment Corporation and its subsidiaries (“Wind River” or the “Predecessor”) on September 5, 2003 (the “Acquisition”). As a result of the Acquisition, the capital structure and basis of accounting of the Company differ from those of Wind River prior to the Acquisition. Therefore, the financial data with respect to periods prior to the Acquisition (“Predecessor” period) may not be comparable to data for periods subsequent to the Acquisition.(“Successor” period).
The Company offers four general classes of insurance products across both its excess and surplus lines (“E&S”) and specialty admitted business segments. These four classes of products are specific specialty insurance products, umbrella and excess insurance products, property and general liability insurance products and non-medical professional liability insurance products. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Company’s non-U.S. insurance subsidiaries are licensed in Bermuda and Barbados and Wind River Bermuda is eligible to write surplus lines business in certain U.S. jurisdictions.
On September 5, 2003, the Company acquired 100% of the outstanding common stock of Wind River from a group of family trusts affiliated with the Ball family of Philadelphia, Pennsylvania (the “Ball Family Trusts”) for a purchase price of $250.4 million. The purchase price for Wind River consisted of $100.0 million in cash, the issuance to the Ball Family Trusts of 2.5 million Class A common shares valued at $10.00 per share, the issuance to the Ball Family Trusts of 3.5 million Series A preferred shares valued at $10.00 per share and the issuance of senior notes by Wind River having an aggregate principal amount of approximately $72.8 million. The fair market valuations of the Class A common shares and Series A preferred shares were determined by using the GAAP book value of the shares on September 5, 2003, since the Company received its initial capitalization on that date.
In connection with the acquisition on September 5, 2003, the $250.4 million purchase price, which includes transaction-related expenses, was allocated to the estimated fair values of the acquired assets and liabilities as follows (dollars in thousands):
As a result of these adjustments, the fair values of the reserve for losses and loss adjustment expenses and reinsurance receivables were reduced by $49.4 million as of the acquisition date. Based on the nature of Wind River’s reinsurance program and expected future payout patterns.
As of the acquisition date, Wind River adjusted its gross and net unearned premium reserves to fair value by (1) discounting the unearned premium reserves and (2) applying a risk margin to the unearned premium reserves. The risk margin utilized to record the gross unearned premium reserves at fair value was 25%. A slightly lower 20% risk margin was utilized to calculate the net unearned premium reserves because of the shorter period of the underlying exposures, which produces a lower degree of variability in the embedded future profits. Wind River discounted the unearned premium reserves based on the present value of the expected underlying cash flows using a risk-free interest rate of 3%, which approximated the U.S. Treasury rate on the acquisition date. The discounting pattern was developed by Wind River’s actuarial department based on historical loss data.
The Company’s investments in bonds are classified as available for sale and are carried at their fair value. The difference between book value and fair value of bonds, excluding the derivative components, 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. The difference between book value and fair value of the derivative components of the bonds is included in income. Although bonds are generally held to maturity, the Company regularly reevaluates this position based upon market conditions.
As of September 5, 2003, the Predecessor owned approximately $15.3 million of convertible securities, which were classified as trading. After the acquisition, the Company’s convertible securities were classified as available for sale, and the Company bifurcated the embedded derivative component of these securities from the host contract. At December 31, 2004 and 2003, respectively, the Company owned approximately $24.0 million and $21.1 million of convertible securities.
The Company’s investments in preferred stocks are classified as available for sale and are carried at fair value. The difference between book and fair value of preferred stocks, excluding derivative components, are 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. The difference between book value and fair value of the derivative components of the preferred stocks is included in income.
The Predecessor’s investments in preferred stocks were classified as trading and were carried at fair value. The change in the difference between book value and fair value of preferred stocks is included in income.
The Predecessor’s investments in common stocks were classified as trading and were carried at fair value. The change in the difference between book value and fair value of common stocks is included in income.
Other invested assets are comprised primarily of limited liability partnership interests and uncollateralized commercial loans. Partnership interests of 3% ownership or greater are accounted for using the equity method. The change in the difference between book value and fair value of partnership interests of 3% ownership or greater, net of the effect of deferred income taxes, is reflected in income. Partnership interests of less than 3% ownership are carried at their fair value. The change in the difference between book value and 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. Uncollateralized commercial loans are stated at unpaid principal balances, net of allowances.
Fair value is defined as the amount at which the instrument could be exchanged in a current transaction with willing parties. The fair values of the Company’s investments in bonds and stocks are determined on the basis of quoted market prices. The Company also holds other invested assets, including investments in several limited partnerships, which were valued at $53.8 million and $45.4 million as of December 31, 2004 and 2003, respectively. Several of these partnerships invest solely in securities that are publicly traded and are valued at the net asset value as reported by the investment manager. As of December 31, 2004 and 2003, respectively, the Company’s other invested assets portfolio includes $20.4 million and $16.9 million in securities for which there is no readily available independent market price. The estimated fair value of such securities is determined by the general partner of each limited partnership based on comparisons to transactions involving similar investments. 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.
On February 28, 2003, AIS converted from a C Corporation to an S Corporation. AIS and its subsidiaries filed a consolidated federal tax return as of February 28, 2003. For the tax period from March 1, 2003 to September 5, 2003, United National Insurance Company and its subsidiaries filed a consolidated federal income tax return and AIS and its other subsidiaries, AIAA, IU and URP, will each file a separate, stand-alone federal income tax return.
On September 5, 2003, Wind River and AIS converted from an S Corporation to a C Corporation. A consolidated income tax return was filed for all U.S. entities for the stub period from September 6, 2003 to December 31, 2003.
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. The costs of acquiring new and renewal insurance and reinsurance contracts include commissions, premium taxes and certain other costs that are directly related to and vary with the production of business. 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 year ended December 31, 2004, the period from September 6, 2003 to December 31, 2003, the period from January 1, 2003 to September 5, 2003, and the year ended December 31, 2002 were $53.2 million, $4.7 million, $12.0 million, and $14.6 million, respectively.
Certain professional general agencies receive special incentives when certain premium thresholds are met or when loss results of business produced by these agencies are more favorable than predetermined thresholds. These costs are estimated and charged to other underwriting expenses when incurred.
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 weighted-average common shares outstanding and the weighted-average share equivalents outstanding.
In March 2004, the Financial Accounting Standards Board (the “FASB”) issued Emerging Issues Task Force (“EITF”) Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” which provides new guidance for assessing impairment losses on debt and equity
In December 2004, the FASB issued FAS 123R, “Share-Based Payment,” which revises the original FAS 123. The Company has previously adopted the requirements of FAS 123, which require companies to expense the estimated fair value of employee stock options and similar awards. The accounting provisions of FAS 123R will be effective for interim periods beginning after June 15, 2005. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed in FAS 123R will be applied to valuing stock-based awards granted, modified or vested and the impact on compensation expense related to such awards will have on the Company’s consolidated financial statements.
The cost and estimated fair value of investments classified as available for sale were as follows as of December 31, 2004 and 2003:
The Company held no debt or equity investments in a single issuer that was in excess of 10% of shareholders’ equity at December 31, 2004 or 2003.
Subject to the risks and uncertainties in evaluating the impairment of a security’s value, the impairment evaluation conducted by the Company as of December 31, 2004, concluded the unrealized losses discussed above are not other than temporary impairments.
The amortized cost and estimated fair value of bonds classified as available for sale at December 31, 2004, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investments in debt and preferred stocks classified as available for sale were $187.4 million during 2002. Gross gains of $3.2 million and gross losses of $1.6 million were realized on those sales during 2002. During 2002, the Predecessor recorded realized losses, net of tax, of $0.8 million for other invested assets that experienced other than temporary declines in their estimated market value.
There were no investments in bonds that were non-income producing for the year ended December 31, 2004, the period from September 6, 2003 to December 31, 2003, the period from January 1, 2003 to September 5, 2003 or the year ended December 31, 2002.
The Company cedes insurance to unrelated insurers on a pro rata and excess of loss basis in the ordinary course of business to limit its net loss exposure. Reinsurance ceded arrangements do not discharge the Company of primary liability as the originating insurer.
Since the Wind River acquisition date, no allowance for uncollectible reinsurance has been established since management believes its reinsurance receivables are recorded at their net realizable amounts. The need for an allowance for uncollectible reinsurance is based on the results of the Company’s regular review of the collectibility of recorded reinsurance receivables due from its external reinsurers.
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 2004 of $32.3 million represents $26.0 million from foreign operations and $6.3 million from domestic operations. The following table summarizes the differences between the tax provision for financial statement purposes and the expected tax provision at the weighted average tax rate:
Federal operating loss carryforwards in the amount of $2.3 million are available at December 31, 2004. The operating losses can be carried forward for a period of 20 years and are available to offset taxable income through the year 2024.
The federal tax returns for the Company’s U.S. operations are open to review by the IRS. Management believes that adequate provisions have been made in the financial statements to cover any potential audits and tax related matters for all years for which the statute of limitations has not expired. The statute of limitation has not yet expired for years 2000 through 2003.
Net loss and loss adjustment expenses relating to prior accident years for 2004 and 2003 were $(0.8) million and $0.4 million, respectively.
In 2002, the increase in net losses and loss adjustment expenses of $71.4 million relating to prior accident years is primarily attributable to higher than anticipated losses of $47.8 million in the multiple peril and other liability lines of both the Company’s E&S and specialty admitted segments and the results of an arbitration
In the past, the Predecessor underwrote multi-peril business insuring general contractors and developers that has resulted in significant exposure to construction defect (“CD”) claims. Management believes its reserves for CD claims ($28.5 million and $36.8 million as of December 31, 2004 and 2003, 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 Company has exposure to asbestos and environmental (“A&E”) claims. The asbestos exposure primarily arises from the sale of product liability insurance, and the environmental exposure arises from the sale of general liability and commercial multi-peril insurance. In establishing the liability for unpaid losses and loss adjustment expenses related to A&E exposures, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated continually. Developed Case law and claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience. Included in net unpaid losses and loss adjustment expenses as of December 31, 2004 and 2003 were IBNR reserves of $8.2 million and $6.4 million, respectively, and case reserves of approximately $3.6 million and $1.6 million, respectively, for known A&E-related claims.
AIS, through Trust I, together with other insurance companies and insurance holding companies, issued trust preferred securities to the collateralized debt obligation pool organized by Dekania Capital Management LLC, which in turn, issued its securities to institutional and accredited investors. Trust I issued 10,000 trust preferred securities, having a stated liquidation amount of $1,000 per security, that mature on September 30, 2033 and bear a floating interest rate, reset quarterly, equal to the London Interbank Offered Rate (“LIBOR”) plus 4.05%. AIS, through Trust I, has the right to call the trust preferred securities at par after September 30, 2008, five years from the date of issuance.
As a result of the Acquisition, senior notes in an aggregate principal amount of approximately $72.8 million, subject to adjustment, were issued to the Ball Family Trusts by Wind River, as part of the purchase price. These senior notes have an interest rate of 5%, which may be paid either in cash or in kind. These senior notes mature on September 5, 2015; however, in certain circumstances, Wind River is required to make mandatory prepayments on these senior notes on October 1 of each year until maturity. Wind River is required to make such mandatory prepayments if “excess cash flow,” as defined, was generated in the preceding fiscal year. “Excess cash flow” generally means an amount equal to consolidated net income, less such amounts as the Company’s Board of Directors may determine are necessary to: (1) maintain an A.M. Best rating of at least “A” (Excellent) for each of the Company’s U.S. insurance subsidiaries; (2) make permitted dividend payments; (3) maintain the statutory surplus of the Company’s U.S. insurance subsidiaries at acceptable levels; and (4) provide the Company’s United National Insurance Companies with adequate levels of working capital. Under the terms of the senior notes, the earliest prepayment date is October 1, 2005 with the Company’s Board of Directors’ determination of “excess cash flow” being based on the Company’s 2004 results of operations and financial position at the time of the payment. The Company’s Board of Directors has not yet determined if excess cash flow was generated in 2004.
At December 31, 2004 and 2003, Wind River Barbados was a limited partner in investment funds managed by Fox Paine & Company. The Company’s investment in these limited partnerships was valued at $6.2 million and $4.0 million at December 31, 2004 and 2003, respectively. At December 31, 2004, the Company had an additional capital commitment of $4.0 million to these limited partnerships.
In November 2004, the Company prepaid $1.5 million of management fees to Fox Paine & Company ($1.3 million) and The AMC Group, L.P. (“The AMC Group”) ($0.2 million), both of which are affiliates. The prepaid management fees cover the period from September 5, 2004 through September 4, 2005 and will be recognized ratably over that period. On September 5, 2003, the Company prepaid $1.5 million of management fees to Fox Paine & Company ($1.2 million) and The AMC Group ($0.3 million), both of which are affiliates. The prepaid management fees cover the period from September 5, 2003 through September 4, 2004 and were recognized ratably over that period.
In 2003, the Company issued 1,610,295 Class A common shares and 187,500 Class B common shares for payment of preferred stock dividends of $29.3 million. These shares were issued to Fox Paine & Company and the Ball Family Trusts.
On September 5, 2003, the Company paid Fox Paine & Company a transaction fee of $12.0 million related to the Company’s acquisition of Wind River and reimbursed Fox Paine & Company for $0.5 million of related expenses.
On August 25, 2003, the Predecessor sold a series of limited partnership interests to Wind River Investments, LLC, an affiliate. Proceeds from the sale of those investments totaled $6.0 million. A loss of $0.7 million was realized on the sale to Wind River Investments, LLC.
Total rental expense under operating leases for the year ended December 31, 2004, the period from September 6, 2003 to December 31, 2003, the period from January 1, 2003 to September 5, 2003, and the year ended December 31, 2002 aggregated $2.6 million, $0.7 million, $1.4 million, and $1.8 million, respectively. At December 31, 2004, future minimum payments under non-cancelable operating leases were as follows:
On November 23, 2004, UNIC settled, in consideration of a payment in the amount of $1.8 million by Gulf Underwriters Insurance Company (“Gulf”) to UNIC, a lawsuit instituted by Gulf pending in the Superior Court of Fulton County, Georgia. The lawsuit had sought to rescind a facultative reinsurance certificate issued by Gulf to UNIC with regard to an individual insurance policy. The reinsurance certificate provided 100% reinsurance to UNIC for loss and loss adjustment expenses paid under the insurance policy.
In September 2003, the Company issued 14,000,000 Series A preferred shares in connection with the initial capitalization of United America Indemnity and 3,500,000 Series A preferred shares in connection with the Acquisition. Also during September 2003, 2,500,000 Series A preferred shares were exchanged for 2,687,500 Class B common shares, including 187,500 Class B common shares for payment of preferred stock dividends of $1.9 million.
The Company follows SFAS No. 123, which establishes a fair value-based method of accounting for stock-based compensation plans.
The options exercisable at December 31, 2004, include 256,074 with an exercise price of $6.50 per share, 78,875 with an exercise price of $10.00 per share, and 33,777 with an exercise price of $17.00 per share.
The weighted average fair value of options granted under the Plan was $3.03 and $3.04 in 2004 and 2003, respectively, using a Black-Scholes option-pricing model and the following weighted average assumptions:
Incentive awards under the Awards Plan are determined and paid in cash based upon objective performance-based criteria as set forth in the Awards Plan. The criteria relate to certain performance goals, such as net income and individual performance expectations as established and approved by the compensation committee.
The Company maintains a 401(k) defined contribution plan covering substantially all U.S. employees. The Company matches 75% of the first 6% contributed by the employee. In addition, the Company contributes 1% of the employee’s salary regardless of whether the employee contributes to the plan. Eligible employees are vested in the Company’s contribution and relative investment income after three years of service. Total expenses related to this plan for the year ended December 31, 2004, the period from September 6, 2003 to December 31, 2003, the period from January 1, 2003 to September 5, 2003, and the year ended December 31, 2002 were $0.9 million, $0.2 million, $0.2 million, and $0.3 million, respectively.
The Predecessor had a qualified deferred compensation plan for certain key executives. Through September 5, 2003, the Predecessor had accrued $7.6 million in other liabilities related to this plan. This plan was settled and terminated upon completion of the Acquisition.
Under SAP, investments in debt securities are carried at amortized cost, while under GAAP the Company records its debt securities at estimated fair value.
Under SAP, receivables are non-admitted and are charged against surplus based upon aging criteria.
The NAIC issues model laws and regulations, many of which have been adopted by state insurance regulators, relating to: (a) risk-based capital (“RBC”) standards; (b) codification of insurance accounting principles; (c) investment restrictions; and (d) restrictions on the ability of insurance companies to pay dividends.
the same accounting policies used for the Company’s consolidated financial statements as described in the summary of significant accounting policies. The assumed reinsurance segment was de-emphasized in 2002. Management evaluates a segment’s performance based upon premium production and the associated losses and loss adjustment expense experience. Investments and investment performance, acquisition costs and other underwriting expenses including commissions, premium taxes and other acquisition costs; other operating expenses are managed at a corporate level and are included in the “Corporate segment.”
In connection with the Acquisition, the Company issued 2.5 million Class A common shares and 3.5 million Series A preferred shares to the Ball Family Trusts. Additionally, Wind River Investment Corporation issued $72.8 million of senior notes payable to the Ball Family Trusts. In September 2003, 2,500,000 Series A preferred shares were exchanged for 2,687,500 Class B common shares, including 187,500 Class B common shares for payment of preferred stock dividends of $1.9 million. In December 2003, 1,610,295 Class A common shares were issued for payment of preferred stock dividends of $27.4 million in connection with the redemption of 15,000,000 Series A preferred shares.
Through a series of transactions on January 24, 2005, the Company acquired 100% of the voting equity interest of Penn-America Group, Inc., (together with its subsidiaries, “Penn-America Group”). The Company acquired 67.3% through the merger with Penn-America Group, 30.5% through the purchase of Penn Independent Corporation, which held common shares of Penn-America Group, Inc., and 2.2% in two separate transactions with individual shareholders. In connection with these transactions, the Company paid a $6.0 million transaction fee to Fox Paine & Company.
The transaction was accounted for using the purchase method of accounting. In connection with the acquisition of Penn Independent Group, the assets and liabilities acquired by the Company were adjusted to estimated fair value. The $34.1 million excess of cash and acquisition costs over the estimated fair value of assets acquired was recognized as goodwill. Under the purchase method of accounting, goodwill is not amortized, but is tested for impairment at least annually.
An identification and valuation of intangible assets was performed that resulted in the recognition of intangible assets of $2.3 million with values assigned as follows:
Penn Independent Group leases its home office facility in Hatboro, Pennsylvania from Irvin Saltzman, father of United America Indemnity’s former President, Jon S. Saltzman, and a director of Penn Independent Corporation through January 24, 2005. The lease is accounted for as a capital lease, and management believes
that the lease terms are at market rates. Penn-America Group also leases a portion of the building in which Penn Independent Group’s home office facility is located. In connection with the acquisition, the Company is under a post-closing obligation to either (i) enter into a lease for the Hatboro facility for a term of at least 10 years or (ii) purchase the Hatboro facility and related land on terms to be agreed upon. At this time, the Company is still exploring both options.
On January 24, 2005, in a series of related transactions, the Company acquired all shares of Penn-America Group, Inc. common stock owned by members of the Saltzman family, including all shares of common stock issued upon the exercise of vested options to acquire shares of Penn-America Group, Inc. common stock, for $13.53 a share in cash. The Saltzman family and trusts controlled by them constituted 100% of the Penn Independent Group shareholders prior to the acquisition by United America Indemnity. Under the purchase method of accounting, goodwill is not amortized, but is tested for impairment at least annually.
On January 24, 2005, the Company acquired 67.3% of the voting equity interest of the Penn-America Group, Inc., a specialty property and casualty insurance holding company, for $15.3 million in cash and approximately 7.9 million Class A common shares of United America Indemnity in a transaction classified as a merger. Under the terms of the merger agreement, Penn-America Group, Inc. shareholders received $15.375 of value for each share of Penn-America Group, Inc. common stock as follows: 1) 0.7756 of a Class A common share of United America Indemnity, based on $13.875 divided by the volume weighted average sales price of United America Indemnity’s Class A common shares for the 20 consecutive trading days ending January 21, 2005, which was $17.89, and 2) $1.50 per share in cash. Penn-America Group’s results of operations will be included in the Company’s results of operations subsequent to the date of the merger.
The transaction was accounted for using the purchase method of accounting. In connection with the merger with Penn-America Group, the assets and liabilities acquired by the Company were adjusted to estimated fair value. The $64.6 million excess of cash, fair value of United America Indemnity’s Class A common shares exchanged, other consideration, and acquisition costs over the estimated fair value of the net assets acquired was recognized as goodwill. Under the purchase method of accounting, goodwill is not amortized, but is tested for impairment at least annually.