MIC also owns a 32,000 square foot office facility in Lock Haven, Pennsylvania. MIC sub-leases a portion of this facility.
FPIC owns a 41,000 square foot building it constructed in 2009 at a cost of $5.1 miilion, which serves as its headquarters and operations facility. FPIC also owns a townhouse, used for corporate purposes, in Rocklin, California carried at $0.4 million at December 31, 2009.
Includes Net Income and the change in Unrealized Gains and Losses of the investment portfolio as well as a defined benefit pension adjustment.
general economic conditions and economic conditions in sectors in which the group offers insurance products, such as the construction industry;
We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.
Unpaid losses and loss adjustment expenses, also referred to as loss reserves, are the largest liability of our property and casualty subsidiaries. Our loss reserves include case reserve estimates for claims that have been reported and bulk reserve estimates for (a) the expected aggregate differences between the case reserve estimates and the ultimate cost of reported claims and (b) claims that have been incurred but not reported as of the balance sheet date, less estimates of the anticipated salvage and subrogation recoveries. Each of these categories also includes estimates of the loss adjustment expenses associated with processing and settling all reported and unreported claims. Estimates are based upon past loss experience modified for current and expected trends as well as prevailing economic, legal and social conditions.
We apply the following general methods in projecting loss and loss adjustment expense reserves for the Group:
In addition, we apply several diagnostic ratio tests of the reserves for long-tailed liability lines of business, including but not limited to:
Retrospective tests of the ratios of IBNR reserves to earned premiums and to estimated ultimate incurred losses;
Ratios of cumulative and incremental paid losses to cumulative incurred losses and ratios of incremental paid losses to prior case loss and LAE reserves;
Ratios of cumulative average incurred loss per claim and cumulative average incurred loss per reported claim; and
The Bornhuetter-Ferguson expected loss projection method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are selected judgmentally based upon the historical relationship between premiums and losses for more mature accident years, adjusted to reflect changes in average rates and expected changes in claims frequency and severity. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative reported loss development factors. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses.
predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort the historical development of losses.
Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at December 31, 2009.
Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in stockholders’ equity as a component of accumulated other comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an investment below its cost that is deemed other than temporary and due to credit concerns is charged to earnings as a realized loss. We monitor our investment portfolio and review investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. These evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. Adverse investment market conditions, poor operating performance, or other adversity encountered by companies whose stock or fixed maturity securities we own could result in impairment charges in the future. Our policy on impairment of value of investments is as follows: if a security has a market value below cost it is considered impaired. For any such security a review of the financial condition and prospects of the company will be performed by the Investment Committee to determine if the decline in market value is other than temporary. If it is determined that the decline in market value is “other than temporary” and caused by credit concerns, the carrying value of the security will be written down to “realizable value” and the amount of the write down accounted for as a realized loss. “Realizable value” is defined for this purpose as the market price of the security. Write down to a value other than the market price requires objective evidence in support of that value.
In 2009, the Group recorded a pre-tax charge to earnings of $0.8 million for write-downs of other-than-temporarily impaired securities, of which $0.4 million related to fixed income securities, and $0.4 million related to equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.3 million) which experienced increased delinquency and default rates, as well as two asset-backed securities whose underlying collateral deteriorated. The equity security impairments related to thirteen common stock securities and two preferred stock securities, which demonstrated weakening fundamentals in their businesses.
Besides claims related to its insurance products, the Group is subject to proceedings, lawsuits and claims in the normal course of business. The Group assesses the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. There can be no assurance that actual outcomes will be consistent with those assessments.
Revenue and income by segment is as follows for the years ended December 31, 2009, 2008 and 2007.
Other revenue of $2.1 million and $2.0 million in 2009 and 2008, respectively, represents primarily service charges recorded on insurance premium payment plans.
Total revenues declined to $157.3 million in 2009 from $161.5 million in 2008 due to lower net premiums written, offset by a net realized gain in 2009 as compared to a net realized loss in 2008. Net premiums written decreased $9.5 million, or 6.5%, to $137.8 million in 2009, as compared to $147.3 million in 2008. Net premiums earned totaled $140.4 million in 2009, as compared to $152.6 million in 2008, representing a 8.0%, or $12.2 million, decrease.
Direct premiums written decreased 7.5%, or $12.3 million, to $153.0 million as a result of the weak economy, particularly in California, and competition in our all of our market places. The decline in net premiums written and net premiums earned is attributable to the decline in direct written premium, offset by the positive impact on net premiums written of changes in the Group’s reinsurance structure (in 2009 retention increased to $1,000,000 from $850,000 in 2008, and to $850,000 in 2008 from $750,000 in 2007 on the property, casualty and workers’ compensation lines). Direct premiums written and earned were also negatively impacted by the increased negative audit premium recorded during 2009, which is earned immediately upon booking (see the discussion below for discussion of audit premium. See the “Reinsurance ceded” discussion in Item 1. Business for further discussion of the Group’s reinsurance arrangements).
Net realized investment gains amounted to $0.6 million in 2009, as compared to a realized loss of $7.1 million in 2008. The Group had gains on the sales of securities of $0.9 million and $0.6 million, and write-downs of other than temporary impairments of $0.8 million and $6.2 million, in 2009 and 2008, respectively. The Group also recorded a gain on the mark-to-market of interest rate swaps in 2009 of $0.5 million, and a loss in 2008 of $1.5 million. We have three ongoing interest rate swap agreements to hedge against interest rate risk on our floating rate trust preferred securities obligations. The estimated fair value of the interest rates swaps is obtained from the third-party financial institution counterparty. We mark the investments to market using these valuations and record the change in the economic value of the interest rate swaps as a realized gain or loss in the consolidated statement of earnings. See also the discussion of other than temporary impairments on investment securities in the “Critical Accounting Policies” section.
Among our portfolio holdings, the only direct subprime exposure consists of asset-backed securities (ABS) within the home equity subsector. The ABS home equity subsector totaled $0.5 million on December 31, 2009, representing 3.21% of the ABS holdings and 0.14% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by monolines against default of principal and interest. However, since FGIC is no longer rated and AMBAC has been downgraded to Caa2/CC, the two insured securities are now rated according to the higher of the underlying collateral or the monoline rating. One bond is rated Ba3/BB while the other is rated Caa2/CCC. With regard to the remaining security without monoline insurance, it is rated A3/B by Moody’s and S&P, respectively.
One of our strategies in this market is to introduce new products leveraging our core skills. In the fourth quarter of 2008, a new Business Owners Policy for California risks was introduced. This product targets small to medium sized businesses, which have been shown to be somewhat less price sensitive and demonstrating higher renewal retention than larger accounts. This product also helps to balance FPIC’s
business between property and casualty exposures. In 2009, a new contracting product which specializes in covering artisan contractors was introduced in Arizona and California, and is being developed for Nevada and Oregon with a targeted introduction in early 2010. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations compared to the construction industry. During 2009, a new Garage Program was introduced in New Jersey and Pennsylvania, which targets repair shops, auto body shops, and gas stations.
As previously disclosed in our SEC filings, we paid an aggregate of $3.5 million, including accrued interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, we filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division of taxation.
Our GAAP combined ratio for 2008 was 98.1%, as compared to a combined ratio for the prior year of 95.8%. On a pro-forma basis, after removing the effect of the non-recurring retaliatory tax refund described above, the GAAP combined ratio for 2007 was 98.3%. The statutory combined ratio for 2008 and 2007 was 98.5% and 94.4%, respectively. See the discussion below relating to commercial and personal lines performance.
Total revenues remained consistent at $161.5 million and $161.7 million in 2008 and 2007, respectively. Revenues were flat year-on-year due to the significant realized loss on OTTI write-downs in 2008, which offset the growth in net premiums earned and net investment income. Net premiums earned totaled $152.6 million in 2008 as compared to $146.7 million in 2007, representing a 4.0% or $5.9 million increase. Net premiums written decreased $12.3 million or 7.7% to $147.4 million in 2008 as compared to $159.7 million in 2007. Net premiums earned increased 4.0% despite the 7.7% decline in net premiums written. The decline in net premiums written is attributable to the 9.6% decline in direct premiums written, offset by the positive impact on net premiums written of the change in reinsurance structure (in 2007 retention increased to $750,000 from $250,000 and $350,000 in 2006 on FPIC’s casualty and property lines, respectively, and from $500,000 on MIC’s, MICNJ’s and FIC’s 2006 property, casualty and workers’ compensation lines, and in 2008 to $850,000 from $750,000). Direct premiums written and earned were negatively impacted by the reduction in audit premium recorded during 2008, which is earned immediately upon booking (see the discussion below for discussion of audit premium and changes in reinsurance arrangements).
Net investment income totaled $13.9 million in 2008, as compared to $13.1 million in 2007, representing a 6.8% or $0.9 million increase. Net investment income for 2007 was impacted by the $720,000 non-recurring impact of the retaliatory tax refund. Net realized investment losses amounted to $7.1 million in 2008 as compared to net realized investment gains of $24,000 in 2007. The net realized investment loss in 2008 is primarily driven by other than temporary impairments on investment securities, a realized loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities, offset in part by realized gains on the sales of investments. The net realized investment gain in 2007 is primarily driven by realized gains on the sales of investments, offset in part by other than temporary impairments on investment securities and a realized loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities. See the discussion of other than temporary impairments on investment securities in the “Critical Accounting Policies” section.
Commercial multiple peril policies constitute a majority of the business written in FPIC’s contractor book of business. The premium on these policies is estimated at policy inception based on a prediction of the volume of the insured’s business operations during the policy period. In addition to endorsing the policy throughout the policy period based on known information, at policy expiration FPIC conducts an audit of the insured’s business operations in order to adjust the policy premium from an estimate to actual. Contractor liability policy premium tends to vary with local construction activity as well as changes in the nature of the contractor’s operations. The decline in construction related activity and failing businesses in the construction industry has impacted both the volume of premium for the contractor in-force book of business (and related exposures) and the related audit premium on expiring policies. Audits, primarily of construction related policies, generated return premium of $2.6 million in 2008, representing a decline of $5.7 million as compared to $3.1 million of additional premium that was generated in 2007.
Fixed maturity investments represent 99.6% of invested assets, and as of December 31, 2008, the fixed income portfolio consists of 99.6% investment grade securities, with the remaining 0.4% non-investment grade rated securities. The 0.4% includes three corporate securities held with a combined market value of $1.2 million, and one asset-backed security held with a market value of $0.2 million. The fixed income portfolio has an average rating of Aa2/AA, an average effective maturity of 5.0 years, an average duration of 3.5 years with an average tax equivalent book yield of 5.06%.
The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2008 are as follows:
Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment and anomalies in pricing in the current difficult market. At December 31, 2008 we had 11 fixed maturity securities with unrealized losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them have fair values of no less than 72% of book value. We do not believe these declines are other than temporary due to the credit quality of the holdings.
In the years ended December 31, 2008, 2007 and 2006, we recorded a pre-tax charge to earnings of $6.2 million, $0.1 million and $0.1 million, respectively, for write-downs of other than temporarily impaired securities. See the discussion of recent downgrades and other than temporary impairments on investment securities in the “Critical Accounting Policies” section.
There are 12 common stock securities that are in an unrealized loss position at December 31, 2008. All of these securities have been in an unrealized loss position for less than 6 months. There are 4 preferred stock securities that are in an unrealized loss position at December 31, 2008. Three preferred stock securities have been in an unrealized loss position for less than 8 months. One preferred stock security has been in an unrealized loss position for more than twelve months. We do not believe these declines are other than temporary as a result of reviewing the circumstances of each such security in an unrealized loss position. We currently have the ability and intent to hold these securities until recovery.
In 2008 our commercial lines direct premiums written decreased by $16.8 million or 10.5% to $143.3 million as compared to direct premium written in 2007 of $160.0 million. The decline in direct premiums written is attributed to several factors, including a decline in construction related activity and related audit premium in California, increased competition on large accounts, and the return of a number of competitors to the California contractor market and the East Coast habitational market. Our California contractors book reflects the decreased economic activity in the California construction market. Since the insurance premiums for these contractors generally reflect their level of economic activity, the average premium per policy has fallen as the insured’s business has contracted, resulting in lower insurance exposures for these contractors. The retention levels in this book remain attractive, and policy count is up year-over-year, despite the decline in direct premiums written. See additional discussion above in the “2008 vs. 2007 Revenue” discussion.
The principal source of liquidity for the Holding Company (which has modest expenses and does not currently, or for the foreseeable future, need a significant regular source of cash flow to cover these expenses other than its debt service on its indebtedness to MIC, its quarterly dividend to shareholders, and the funding necessary for any stock repurchases pursuant to the currently authorized stock repurchase program) is dividend payments and other fees received from the insurance subsidiaries, and payments it receives on the 10-year note it received from the ESOP (see below) when the ESOP purchased shares at the time of the conversion from a mutual to a stock form of organization (the “Conversion”). The Holding Company also has access to an existing credit line under which it can draw up to $7.5 million dollars, of which $3.0 million was drawn upon at December 31, 2009.
Additionally, there is a covenant in the Group’s line of credit agreement that requires the Group to maintain at least 50% of its insurance companies’ capacity to pay dividends without pre-approval by state regulatory authorities.
of 4.75%, repayable in 20 equal annual installments. MIG has no special limitations on its ability to take periodic dividends from its insurance subsidiaries except for normal dividend restrictions administered by the respective domiciliary state regulators as described above. The Group believes that the resources available to MIG will be adequate for it to meet its obligation under the note to MIC, the line of credit and its other expenses.
Total liabilities increased 1% or $3.4 million, to $435.1 million at December 31, 2009 as compared to $431.7 million at December 31, 2008, primarily as a result of the increases in loss and loss adjustment expense reserves of $7.3 million or 2%, and other reinsurance balances of $0.9 million or 8%, offset by declines in unearned premiums of $3.8 million or 5%, and accounts payable and accrued expenses of $1.1 million or 9%. The unearned premiums decline primarily reflected the reduction in written premiums. Accounts payable and accrued expenses declined primarily due to cost saving measures reducing operating expenses. Other reinsurance balances increased primarily as a result of increased contingent ceding commissions payable on reinsurance contracts.
In April 2009, the FASB issued guidance relating to required disclosures concerning the fair value of financial instruments when a publicly traded company issues financial information for interim reporting periods. The requirements are effective for interim reporting periods ending after June 15, 2009. The disclosures required by the guidance have been included in the notes to the consolidated financial statements.
In April 2009, the FASB issued guidance which changes the amount determined to be an other-than-temporary impairment when there are non-credit losses on a debt security which management does not intend to sell and for which it is more-likely-than-not the entity will not have to sell the security prior to recovery of the non-credit impairment. In these situations, the portion of the total impairment that is related to the credit loss would be recognized as a charge against earnings, and the remaining portion would be included in other comprehensive income. These pronouncements are effective for interim and annual reporting periods ending after June 15, 2009. The guidance also required the Group to analyze securities held as of the adoption date which were the subject of previous other-than-temporary impairment charges in order to determine a cumulative effect adjustment to the opening balance of retained earnings and other comprehensive income at adoption. The Group reviewed the securities held prior to adoption which were the subject of previous other-than-temporary impairment charges, and concluded that no material amount of non-credit impairment had been previously recognized. Adoption did not have a material impact on the Group’s results of operations, financial condition, or liquidity.
In April 2009, the FASB issued guidance which addresses the factors that determine whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared to the normal market activity. This guidance provides that if it has been determined that the volume and level of activity has significantly decreased and that transactions are not orderly, further analysis is required and significant adjustments to the quoted prices or transactions might be needed. The guidance is effective for interim and annual reporting periods ending after June 15, 2009. Adoption did not have a material impact on the Group’s results of operations, financial condition, or liquidity.
The Group was not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2009 that would give rise to previously undisclosed market, credit or financing risk.
We have audited the accompanying consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Mercer Insurance Group, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2010, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The Group’s business activities are separated into three operating segments, which are commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and commercial auto coverage. These two commercial lines represented 60%, 62% and 64%, and 19%, 17% and 17%, respectively, of the Group’s net premiums written in 2009, 2008 and 2007. The personal lines business consists primarily of homeowners insurance in Pennsylvania and New Jersey and private passenger automobile insurance in Pennsylvania. These two personal lines represented 9%, 8% and 8%, and 4%, 4% and 4%, respectively, of the Group’s net premiums written in 2009, 2008 and 2007.
Realized investment gains and losses are determined on the specific identification basis. An invested asset is considered impaired when its fair value declines below cost. The Group recognizes as a realized investment loss any impairment of a fixed maturity investment which is determined to be other-than-temporarily impaired because the present value of future cash flows expected to be collected from the security is less than the amortized cost of the security (i.e. a credit loss exists) or where the Group intends to sell or more-likely-than-not will be required to sell the security prior to recovering the security’s amortized cost basis. Impaired equity securities are other-than-temporarily impaired when it becomes apparent that the Group will not recover its cost over a reasonable period of time, in which case the impairment is recorded as a realized investment loss. Factors considered in determining whether a credit loss exists and over what period of time the security is expected to recover include the length of time and the extent to which fair value has been below cost, adverse conditions specifically related to the security, the industry or the geographic area, the financial condition and near-term prospects of the issuer, analysis and guidance provided by rating agencies and analysts, and changes in fair value subsequent to the balance sheet date. Where a realized investment loss is recognized for an impairment, the cost basis of the security is written down to fair value. Where a fixed income security is impaired and the impairment is not attributable to credit issues, this impairment loss, or portion of a larger impairment loss, is included within other comprehensive income. Subsequent recoveries in the fair value of other-than-temporarily impaired securities are recognized at disposition.
Cash and cash equivalents as of December 31, 2009 and 2008 include restricted cash of $57 and $264, respectively, consisting of funds held for surety bonds.
Interest rate swaps - The estimated fair value of the interest rate swaps is based on valuations received from the financial institution counterparties.
The Group applies the provisions of Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” to account for internally developed computer software costs. In accordance with SOP 98-1, the Group has capitalized $2,067, $4,530 and $2,499 in software development costs, respectively, in 2009, 2008 and 2007. These costs are amortized over their useful lives, ranging from three to five years, from the dates the systems technology becomes operational. At December 31, 2009 and 2008, the unamortized cost of capitalized software was $7,615 and $7,556, respectively.
The Group can make grants of qualified (ISO’s) and non-qualified stock options (NQO’s), and non-vested shares (restricted stock) under its stock incentive plan. Stock options are granted at exercise prices that are not less than market price at the date of grant, vest over a period of three or five years, and are outstanding for a period of ten years for ISO’s and ten years and one month for NQO’s. Restricted stock grants vest over a period of three to five years.
Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Group determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Group has two reporting units with goodwill as of December 31, 2009
and 2008. The Group performed the annual impairment tests as of December 31, 2009 and 2008, and the results indicated that the fair value of the reporting units exceeded their carrying amounts.
Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of Diluted EPS reflects the effect of potentially dilutive securities. The denominator for basic and diluted EPS includes ESOP shares committed to be released.
In April 2009, the FASB issued guidance relating to required disclosures concerning the fair value of financial instruments when a publicly traded company issues financial information for interim reporting periods. The requirements are effective for interim reporting periods ending after June 15, 2009.
In April 2009, the FASB issued guidance modifying the requirements for recognizing other-than-temporarily impaired debt securities and significantly changes the existing impairment model for such securities. This guidance also modifies the presentation of other-than-temporary impairment losses. Such modifications include changing the amount of the other-than-temporary impairment that is recognized in earnings when there are credit losses on a debt security that the entity does not intend to sell and it is not more-likely-than-not that the entity will be required to sell prior to recovery. In these situations, the portion
of the total impairment that is related to the credit loss would be recognized as a charge against operations, and the remaining portion would be included in other comprehensive income. The guidance also increases the frequency of and expands already required disclosures about the other-than-temporary impairment of debt and equity securities. This guidance is effective for fiscal years ending after June 15, 2009.
As of the beginning of the period of adoption of this guidance, entities are required to recognize a cumulative-effect adjustment to reclassify the non-credit component of a previously recognized other-than-temporary impairment loss from beginning retained earnings to beginning accumulated other comprehensive income if the entity does not intend to sell the security and it is not more-likely-than-not that the entity will be required to sell the security before recovery.
Investment expenses include salaries, advisory fees and other miscellaneous expenses attributable to the maintenance of investment activities.
Original cost of equity and fixed-income securities adjusted for other than temporary impairment writedowns and amortization of premium and accretion of discount.
Includes approximately $55,092 and $66,576 (cost) and $57,874 and $68,696 (fair value) of mortgage-backed securities implicitly or explicitly backed by the U.S. government and government agencies as of December 31, 2009 and 2008, respectively.
The estimated market value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2008 are as follows:
Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2008 the Group had 11 fixed maturity securities with unrealized losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them had fair values of no less than 72% of book value.
There are 12 common stock securities that are in an unrealized loss position at December 31, 2008. All of these securities had been in an unrealized loss position for less than 6 months. There were 4 preferred stock securities that were in an unrealized loss position at December 31, 2008. Three preferred stock securities had been in an unrealized loss position for less than 8 months. One preferred stock security had been in an unrealized loss position for more than twelve months.
In 2009, the Group recorded a pre-tax charge to earnings of $0.8 million for write-downs of other-than-temporarily impaired securities, of which $0.4 million related to fixed income securities, and $0.4 million related to equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.3 million) which experienced increased delinquency and default rates, as well as two asset-backed securities whose underlying collateral deteriorated. All write-downs of fixed income securities were attributable to credit issues, and accordingly recognized as realized investment losses in the consolidated statement of earnings. The equity security impairments related to thirteen common stock securities and two preferred stock securities, which demonstrated weakening fundamentals in their businesses.
A roll-forward of the amount related to credit losses for fixed income securities recognized in earnings is presented in the following table:
Proceeds from sales and maturities of securities were $66,975, $46,845 and $39,027 in 2009, 2008, and 2007, respectively.
Accumulated other comprehensive income was net of deferred income taxes of $6,390 and $1,353 applicable to net unrealized investment gains at December 31, 2009 and 2008, respectively.
As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses increased by $0.1 million, $6.1 million and $8.2 million in 2009, 2008 and 2007, respectively.
With $180.0 million, $163.0 million, and $140.0 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008 and 2007, respectively, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 78%, 75%, and 73%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008, and 2007.
The commercial multi-peril line of business experienced adverse prior year development of $5.3 million in 2009, $9.2 million in 2008, and $5.9 million in 2007. The majority of this development relates to the west coast contractor liability book of business. Contractor liability claims, particularly construction defect claims, are long-tailed in nature and develop over a period of ten to twelve years.
The adverse development in 2009, 2008 and 2007 was driven by higher than expected reported construction defect claim activity, particularly on the 1998 through 2002 accident years. The adverse development in 2009, 2008 and 2007 includes $0.3 million, ($0.4) million, and $0.7 million, respectively, in reserve increases (decreases) related to accident years 1997 and prior.
The adverse development in 2009, 2008 and 2007 also includes ($0.8) million, $1.9 million, and $0.5 million, respectively, in post-commutation reserve (decreases) increases for losses formerly subject to reinsurance treaties.
In 2009, there was $2.0 million in favorable development on accident year 2008 due to lower than expected loss emergence, primarily on west coast commercial multi-peril property which was offset in part by $1.7 million in higher than expected reserve development on the 2007 accident year, primarily on east coast commercial multi-peril liability. In 2008 there was $3.5 million in favorable development on west coast commercial multi-peril liability accident years 2003 through 2005, due to lower than expected loss emergence. In 2007 there was no development on the 2003 through 2005 accident years. The favorable
development in 2008 was driven by a decrease in claim frequency for accident years 2003 through 2005 which reflects the impact of both rate increases and changes in underwriting.
With $23.3 million, $23.5 million, and $18.3 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008, and 2007, respectively, commercial automobile is the Group’s second largest reserved line of business, representing 10%, 11%, and 10%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008, and 2007.
Workers compensation losses are impacted heavily by medical cost increases which have been significant recently.
The Group has geographic exposure to catastrophe losses in its operating territories. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the
In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group’s retention not exceeding $1,000, $850 and $750 per occurrence in 2009, 2008 and 2007, respectively. Insurance ceded by the Group does not relieve it of its primary liability as the originating insurer.
The effect of reinsurance on premiums written and earned and losses incurred is as follows:
The Group maintains a 401(k) qualified retirement savings plan covering substantially all employees. Benefits are based on an employee’s annual compensation, with new employees participating after a six-month waiting period. The Group matches a percentage of each employee's pre-tax contribution and also contributes an amount equal to 2% of each employee’s annual compensation. Deferral amounts in excess of the qualified plan limitations, as well as Group contributions on such compensation, are funded into nonqualified plans benefiting affected individuals. The cost for these benefits was $628, $628 and $510 for 2009, 2008 and 2007, respectively. In addition, the Group generally makes a discretionary contribution each year, based on Group profitability, to both the qualified 401(k) plan, and, where applicable, to the nonqualified plans. The cost for this portion of the retirement plan was $0, $492 and $463 for 2009, 2008 and 2007, respectively.
The Group also maintains nonqualified deferred compensation plans for its directors and officers. Under the plans, participants may elect to defer receipt of all or a portion of their fees or salary or bonus amounts, but without any match by the Group. Amounts deferred by directors and officers, together with accumulated earnings, are distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred compensation, including accumulated earnings, amounted to $1,764 and $1,505 at December 31, 2009 and 2008, respectively.
On December 15, 2003, the Group established an Employee Stock Ownership Plan (ESOP) and issued 626,111 shares to the ESOP at a cost of $10 per share. The ESOP signed a promissory note in the amount of $6,261 to purchase the shares, which is due in 10 equal annual installments with interest at 4%. The shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid, and are allocated to participants based on compensation as provided for in the plan. During 2009, 2008 and 2007, 62,611 shares were allocated to employee participants. Compensation expense equal to the fair value of the shares allocated is recognized ratably over the period that the shares are committed to be allocated to the employees. In 2009, 2008 and 2007 the Group recognized compensation expense of $1,019, $1,014 and $1,175, respectively, related to the ESOP. As of December 31, 2009, the cost of the 187,833 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.
The tax effect of temporary differences that give rise to the Group’s net deferred tax asset as of December 31 is as follows:
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes it is more likely than not the Group will realize the benefits of the deferred tax assets at December 31, 2009 and 2008.
On January 1, 2007, the Group adopted FIN 48. As a result of adoption, the Group recognized a previously unrecognized tax benefit of approximately $0.2 million relating to merger-related expenses for the FPIG acquisition that took place October 1, 2005. The application of FIN 48 for this unrecognized tax benefit resulted in a corresponding reduction to goodwill relating to the FPIG acquisition of $0.2 million. The adoption of FIN 48 did not result in any adjustments to beginning retained earnings, nor have a significant effect on operations, financial condition or liquidity. As of December 31, 2009, the Group has no unrecognized tax benefits. The Group’s policy is to account for interest and penalties as a component of other expenses. The Group files income tax returns in the federal jurisdiction and various states.
All dividends from MIC to MIG require prior notice to the Pennsylvania Insurance Department. All “extraordinary” dividends require advance approval. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income (excluding realized capital gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2009, the amount available for payment of dividends from MIC in 2010, without the prior approval, is approximately $7.6 million.
All dividends from FPIC to FPIG (wholly owned by MIG) require prior notice to the California Department of Insurance. All “extraordinary” dividends require advance approval. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2009, the amount available for payment of dividends from FPIC in 2010, without prior approval, is approximately $7.2 million.
The Group adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on June 16, 2004. Awards under the Plan may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee Directors. At adoption, the Plan initially limited to 250,000 the number of shares that may be awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options may be granted. The total number of shares initially authorized in the Plan was 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of each year. As of December 31, 2009, the Plan’s authorization has been increased under this feature to 1,206,091 shares. The Plan provides that stock options and restricted stock awards may include vesting restrictions and performance criteria at the discretion of the Compensation Committee of the Board of Directors. The term of options may not exceed ten years for incentive stock options, and ten years and one month for nonqualified stock options, and the option exercise price may not be less than fair market value on the date of grant. All grants made under the Plan employ graded vesting over vesting periods of 3 or 5 years for restricted stock, incentive stock options, and nonqualified stock option grants, and include only service conditions. During 2009 and 2008, the Group made no grants of restricted stock, incentive stock options and non-qualified stock options. There were 2,500 stock options and 1,000 shares of restricted stock forfeited in 2008, and in 2009 10,000 incentive stock options expired unexercised.
In determining the charge to the consolidated statement of earnings for 2009, 2008 and 2007, the fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model. The significant assumptions utilized in applying the Black-Scholes-Merton option pricing model are the risk-free interest rate, expected term, dividend yield, and expected volatility. The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the assumption in the model. The expected term of an option award is based on expected experience of the awards. The dividend yield is determined by dividing the per share-dividend by the grant date stock price. The expected volatility is based on the volatility of the Group’s stock price over a historical period.
Information regarding unvested restricted stock activity in the Plan in 2009 is below:
Information regarding stock option activity in the Plan in 2007 is presented below:
The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group’s business practices are regularly subject to review by various state insurance regulatory authorities. These reviews may result in changes or clarifications of the Group’s business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group.
As of December 31, 2009, the Group leased equipment and vehicles under various operating leases that have remaining non-cancelable lease terms in excess of one year. A summary of minimum future lease commitments as of December 31, 2009 follows:
Pursuant to the protests, the Group received $4.3 million in 2007 as a reimbursement of protested payments of retaliatory tax, including accrued interest, previously made by the Group for the periods 1999-2004. The refund has been recorded, after reduction for Federal income tax, in the amount of $2.8 million in the 2007 consolidated statement of earnings. The allocation of the refund to pre-tax earnings included an increase to net investment income of $720,000, for the interest received on the refund, and $3.6 million as a reduction to Other Expense to recognize the recovery of amounts previously charged to Other Expense.
Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided equities investment management services to the Group since the year 1980. Fees to Van Rensselaer, Ltd. amounted to $79, $124 and $128 in 2009, 2008 and 2007, respectively.
Thomas & Hafer amounted to $56, $77 and $60 in 2009, 2008 and 2007, respectively.
As of December 31, 2009 and 2008, FPIG owed $3,000 under a $7,500 bank line of credit. The line of credit bears interest at the bank’s base rate or an optional rate based on LIBOR. The effective annual interest rate as of December 31, 2009 and 2008 was 3.25%. The line of credit includes covenants to maintain certain financial requirements including a minimum A.M. Best rating, minimum statutory surplus and a requirement that no more than 50% of allowable dividends be distributed from subsidiaries. The Company was in compliance with all covenants as of December 31, 2009 and 2008.
The Trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption. The Group has the right to redeem the Junior Subordinated Debentures after December 4, 2007 for Trust I, after May 15, 2008 for Trust II and after September 30, 2008 for Trust III. The Group has not exercised these rights as of December 31, 2009.
As of December 31, 2009 and 2008 the Group was party to interest-rate swap agreements with an aggregate notional principal amount of $15,500. For the year ended December 31, 2009 and 2008, the Group recognized the change in the estimated fair value of the interest rate swap agreements which is recognized in the consolidated statement of earnings as a realized gain or (loss) of $519 and ($1,500), respectively. The estimated fair value of the interest-rate swap was a liability of $1,360 and $1,879 as of December 31, 2009 and 2008, respectively.
The pricing service utilized by the Group has indicated that they will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Group would be required to produce an estimate of fair value using some of the same methodologies as the pricing service, but would have to make assumptions for market based inputs that are unavailable due to market conditions.
The fair value estimates of most fixed maturity investments are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturities, other than U.S. Treasury securities, provided by the pricing service are included in the amount disclosed in Level 2 of the hierarchy. The estimated fair values of U.S. Treasury securities are included in the amount
disclosed in Level 1 as the estimates are based on unadjusted market prices. The Group determined that Level 2 securities would include corporate bonds, mortgage backed securities, municipal bonds, asset-backed securities, certain U.S. government agencies, non-U.S. government securities, certain short-term securities and investments in mutual funds.
The tables below present the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2009 and 2008.
For the year ended December 31, 2009, there were no assets or liabilities measured at fair value on a nonrecurring basis.
The Group accepts various forms of collateral for issuance of its surety bonds including cash, irrevocable letters of credit and certificates of deposit. The Group’s policy is to record in the accompanying consolidated financial statements only those funds received as cash deposits. The off-balance sheet collateral held by the Group consists solely of irrevocable letters of credit totaling $138 and $278 as of December 31, 2009 and 2008, respectively.