We lease approximately 32,300 square feet of office space in an office project at 1301 S. Capital of Texas Highway, Suite C-300, Austin, Texas as our principal executive offices.
The following table sets forth selected historical financial and operating data for the Company and is derived from our consolidated financial statements which management believes incorporate all of the adjustments necessary for the fair presentation of the financial condition and results of operations for such periods in accordance with GAAP. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere in this report. Actual financial results through December 31, 2009 may not be indicative of future financial performance.
We provide, through our wholly-owned subsidiaries, (1) insurance services, specifically medical professional liability insurance, in Texas, Oklahoma and Arkansas and (2) financial services, including brokerage and investment services to institutions and high net worth individuals.
API provides medical professional liability insurance primarily in Texas, where it has written business for over 33 years. API is authorized to do business in the States of Texas, Arkansas and Oklahoma and specializes in writing medical professional liability insurance for physicians and other healthcare providers. API became authorized to do business in Oklahoma in August 2007. Historically, we operated as the attorney-in-fact manager for API since 1975. In April 2007, we acquired API, thus combining our insurance management experience with an insurance underwriting entity to allow for the increased possibility for expansion into new markets and for continued growth in existing markets.
Through our subsidiaries, APS Financial Corporation, or APS Financial, APS Capital Corp., or APS Capital, and APS Asset Management, Inc., or Asset Management, we provide our brokerage and investment services to institutions and high net worth individuals.
Revenue Recognition. Prior to April 1, 2007, our Insurance Services revenues were historically related to management fees based on the earned premiums of API and included a profit sharing component related to API’s annual earnings. Management fees equaled 13.5% of API’s earned premiums before payment of reinsurance premiums plus profit sharing equal to 50% of API’s pre-tax earnings up to a maximum of 3% of earned premiums before payment of reinsurance premiums. Management fees were recorded, based upon the terms of the management agreement, in the period the related premiums are earned by API. API recognizes premiums as earned ratably over the terms of the related policy. The profit sharing component was historically recognized in the fourth quarter when it was certain API would have an annual profit. In 2007, however, since the management contract ended March 31, 2007, we recognized the quarter’s profit in March, based on our ability to fully determine the profit sharing base.
Our Insurance Services segment issues policies written on a claims-made basis. A claims-made policy provides coverage for claims reported during the policy year. Policies are written for a one-year term and premiums are earned on a pro rata basis over the term of the policy. Unearned premiums are determined on a monthly pro rata basis. Upon termination of coverage, policyholders may purchase an extended reporting period, or tail, endorsement for additional periods of time. These extended reporting period coverage endorsement premiums are earned when written.
The fair value of our investment securities are determined by following the guidance and hierarchy in FASB ASC 820-10, Fair Value Measurements. FASB ASC 820-10 describes three levels of inputs that may be used to measure fair value:
Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Investments. In April 2009, the FASB also issued FASB ASC 320-10, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP 115-2”), which replaces the requirement in FASB ASC 320-10, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” for management to assert that it has the intent and ability to hold an impaired fixed maturity security until recovery with the requirement that management assert if it either has the intent to sell the fixed maturity security or if it is more likely than not the entity will be required to sell the fixed maturity security before recovery of its amortized cost basis.
For an equity security, if we do not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, we conclude that an OTTI has occurred, and the cost of the equity security is written down to the current fair value, with a corresponding change to realized gain (loss) in our Consolidated Statements of Operations. We base our review on a number of factors including, but not limited to, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, the length of time we have held the equity security, any third party research reports or analysis, and the financial condition and near-term prospects of the security’s issuer, taking into consideration the economic prospects of the issuer’s industry and geographical location. For additional discussion regarding OTTI and the impact of the adoption of FASB ASC 320-10, see Note 7 herein to our consolidated financial statements.
Business Combinations. We recorded all assets and liabilities acquired in the acquisition of API at fair value. The initial recording of other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets and liabilities.
The medical professional liability insurance policies we offer are written for only a one year period, Thus, the short term nature of the policy makes deferred policy acquisition costs (DAC) and unearned premiums short term items that are amortized over a one year period. This short time frame means that historical GAAP basis reflect fair value at the date of acquisition.
Reserve for Loss and Loss Adjustment Expense. These reserves represent our best estimate of the ultimate cost of all remaining reported and unreported claims for which we provide insurance coverage to our policyholders. The estimation of the ultimate liability for unpaid losses and loss adjustment expenses is an inherently uncertain process, does not represent an exact calculation of the liability and may not represent the ultimate cost of settling our claim obligations. For comparative purposes, we have included detailed claim and loss reserve data and analysis on a “pro forma basis” since we did not acquire API until April 1, 2007. This information is provided to highlight the development of claim and loss reserve data prior to our acquisition of API. Any reference in this Item 7 below to “pro forma” purports to show the impact to us had we acquired API as of January 1 of the year indicated.
(1) Net statutory reserves include an adjustment for reinsurance recoverables on paid loss and loss adjustment expenses. On a statutory basis reinsurance recoverables on paid loss and loss adjustment expenses are not included as a reduction of reserves but are recorded as a statutory asset.
We consider many factors, not just the actuarial central estimate, in determining ultimate expected losses and the level of reserves recorded. Recorded (carried) reserves are selected within our outside consulting actuaries provided range based upon the judgment of management. In addition to considering the central estimate and ranges calculated by the independent consulting actuaries, management’s evaluation includes: (1) information used to price the applicable policies, (2) historical loss trends, (3) any public data for medical professional liability insurance for the Texas, Arkansas and Oklahoma blocks of business, and (4) an assessment of the current market conditions. Management selects a best estimate with due regard for the age, characteristics and volatility of medical professional liability insurance, the volume of data available for review and past experience with respect to the accuracy of estimates. Other external factors such as economic inflation, judicial trends and legislative and regulatory changes can also have a substantial impact on our reserve estimation assumptions. For example, when tort reform is passed in a state, as was the case in Texas and recently in Oklahoma, we will estimate the impact of reform on both frequency and severity of losses. In addition, we evaluate whether or not the legislation will stand if it is legally challenged in the courts. We also consider the effects of various reinsurance treaties and the varying retention levels and co-participations we have on any given year as these will have an impact on the loss reserves we cede to our reinsurers.
We have continued to reserve at the high end of the actuarial range, as determined by our outside consulting actuaries, which has increased our average net reserve per open and IBNR claims to $121,542 as of December 31, 2009 from $116,802 and $94,672 as of December 31, 2008 and 2007, respectively. We believe these increases are merited based on the increase in policyholder exposures and the increase in our retention limits under our reinsurance contracts over this period.
The above tables do not present accident year or policy year development data but are shown on a calendar year basis. Conditions and trends that have affected the development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on these tables.
Prior to our acquisition on April 1, 2007, API had been organized as a Texas reciprocal insurance exchange since its formation in 1975. A reciprocal insurance exchange is an entity, similar to a mutual insurance company, which sells insurance to its subscribers and other eligible healthcare providers, who may pay, at the election of the company, a contribution to the company’s surplus, in addition to their annual premiums.
As noted in the pro forma table above, API’s net reserve estimates for the years 1998 through 2003 were significantly deficient. During this period, API, as well as the medical professional liability industry as a whole, saw increased frequency and claims severity trends on its claims outstanding. API began to address these concerns beginning in 2000 through 2003 with rate increases averaging 22% per year. API also employed stricter underwriting standards including exiting certain specialties, limiting coverage in geographical areas and reducing the policy limits options offered to insureds.
In 2003, Texas voters approved a constitutional amendment providing for tort reform, which gave the Texas Legislature authority to set limits on damages in medical malpractice and other lawsuits. This coincided with the passage of state legislation which became effective on September 1, 2003 and which places a cap on non-economic damages in medical malpractice cases.
While Texas tort reform has generally benefited API due to a lower number of reported claims and stable severity trends, it has increased our exposure to estimation risk and hence, greater estimation uncertainty in regards to loss reserves. Historically deficient trends in our loss reserves may not be indicative of future loss trends in a post-tort reform environment.
During 2006 through 2009, due to improved underwriting practices coupled with tort reform in Texas, we have recognized favorable development related to previously established reserves for accident years 2004 through 2008. Ultimately, as actual results have proven better than suggested historical trends, redundancies have developed, as evident from the favorable trend in our loss reserves from the originally reported net liability in 2005, 2006, 2007 and 2008.
The table below shows our recorded net reserves at December 31, 2009 and December 31, 2008, the actuarial central estimate and the high and low end of the actuarial reserve range, as determined by our independent actuaries (in thousands):
There are several limitations to interpreting reserve ranges. The reserve range represents a range of possible outcomes and while from an actuarial standpoint, a central estimate is considered the expected value over the range of reasonable possible outcomes. There can be no assurance that reserves will develop to this central estimate or within this reserve range.
In addition to an adjustment to premiums ceded, estimates of ultimate reinsurance ceded premium amounts compared to the amounts paid on a provisional basis give rise to a balance sheet asset classified as “Other amounts receivable under reinsurance contracts” or a balance sheet liability classified as “Funds held under reinsurance treaties.” Furthermore, each retrospective treaty requires a 24- or 36-month holding period before any premium adjustments or cash can be returned or paid. The ultimate settlement amount will not be determined until all losses have been settled under the respective treaties. As of December 31, 2009, we had recorded a balance sheet asset, “Other amounts receivable under reinsurance contracts” of $785,000 and a balance sheet liability, “Funds held under reinsurance treaties” of $2,379,000 which represent the differences between the estimates of ultimate reinsurance premiums ceded amounts for the 2002 through 2008 treaty years as compared to the amounts paid on a provisional basis.
For the year ended December 31, 2009, we recorded favorable development to ceded premiums of $4,351,000 primarily related to prior year variable premium reinsurance treaties as a result of lower estimated ultimate loss and loss adjustment expenses for treaty years 2002 and 2006 through 2008. For the year ended December 31, 2008, we recorded favorable development to ceded premiums of $6,802,000 primarily related to prior year variable premium reinsurance treaties as a result of lower estimated ultimate loss and loss adjustment expenses for treaty years 2002 through 2007. Since the acquisition of API on April 1, 2007, for the year ended December 31, 2007, we recorded favorable development to ceded premiums of $10,888,000 primarily related to prior year variable premium reinsurance treaties as a result of lower estimated ultimate loss and loss adjustment expenses for treaty years 2002 through 2006.
Reinsurance Recoverables. Ceded reserves for loss and loss adjustment expenses are recorded as reinsurance recoverables. Reinsurance recoverables are the estimated amount of future loss payments that will be recovered from reinsurers, and represent the portion of losses incurred during the period that are estimated to be allocable to reinsurers.
There are several factors that can directly affect the ability to accurately forecast the reinsurance recoverables. Many of the factors discussed above related to the sensitivities of forecasting total loss and loss adjustment expense reserves also apply when analyzing reinsurance recoverables. Since we cede excess losses pursuant to our reinsurance contracts, the trends related to severity significantly affect this estimate. Current individual claims severity can be above or fall below our retention level over the period it takes to resolve a claim.
Unsecured reinsurance recoverables at December 31, 2009, that exceeded 10% of total reinsurance paid and unpaid loss and loss adjustment expenses are summarized as follows (in thousands):
We also recognize deferred compensation expense for all deferred stock grants to key employees and directors. This non-qualified compensation plan was designed to give us more flexibility in compensating key employees and directors through ownership of our common stock. The amount of deferred compensation expense recognized is based on the closing price of our common stock on the date of the grant and is recorded as compensation expense in our consolidated statements of income for fiscal years 2009, 2008 and 2007.
The accompanying unaudited pro forma statement of operations presents the pro forma effects of our acquisition of API through the issuance of common and preferred shares of our stock. The statements of operations for the year ended December 31, 2007 is presented as though the acquisition occurred on January 1, 2007.
Each share of Series A redeemable preferred stock of API was converted into the right to receive one share of our Series A redeemable preferred stock. The shares of our common stock and Series A redeemable preferred stock issued in the acquisition were subject to a 180-day lock-up period in which the holders of such shares were prohibited from transferring their shares. This lock-up period expired on September 28, 2007.
Records the elimination of intercompany revenue by APS Investment Services for investment trading fees for managing API’s fixed maturities investment portfolio and records related other comprehensive income at API, change in amortization of bond premium and tax expense for the three months ended March 31, 2007.
Reclassifies the salaries, marketing, professional fees and general administrative expenses of the attorney-in-fact supporting the functional areas of claims, underwriting and investments.
Our Financial Services segment rebounded in 2009 from a difficult 2008 when it suffered its first net operating loss since 1996. A combination of increased commission revenue from security trading brought about by improved bond market conditions together with the benefits derived from cost reductions implemented in the latter half of 2008 contributed to returning this segment to profitability. The positive revenue and earnings trend continued into the fourth quarter of 2009 where our financial services segment recorded its best financial results of the year. Even with the positive revenue trends and lower fixed costs we remain cautious as to the future performance of this segment given the continued uncertainty as to the health of the U.S. economy.
The following table sets forth selected historical financial and operating data. Our results of operations for the year ended December 31, 2007 include the historical financial and operating results prior to and subsequent to the acquisition of API on April 1, 2007. The selected historical financial and operating data is derived from our consolidated financial statements which management believes incorporate all of the adjustments necessary for the fair presentation of the financial condition and results of operations for such periods. All information is presented in accordance with GAAP, Actual financial results through December 31, 2009 may not be indicative of future financial performance.
(1) Loss ratio is defined as the ratio of losses and loss adjustment expenses to net premiums earned.
(2) Expense ratio is defined as the ratio of other underwriting expenses and net change in deferred acquisition costs to net premiums earned
Offsetting this decrease was less favorable development in 2009 on prior year swing rated treaties as compared to 2008. The reinsurance contracts we utilized from 2002 through 2008 were variable premium treaties that have various minimum and maximum rates. The actual premium rate is dependent upon the ultimate losses ceded to the reinsurer under the related treaty. The decrease in premiums ceded of $766,000 is primarily the result of the additional retention under the 2009 treaty and recognizing only $4,351,000 of favorable prior reinsurance development for prior years’ reinsurance treaties during the year ended December 31, 2009 as compared to recognizing $6,802,000 of prior years’ favorable development during the year ended December 31, 2008. The favorable development reflects reductions in our estimates of claim severity and loss experience as a result of claim closures at less than reserved amounts.
Net premiums earned increased by $4,102,000 (6%) to $68,183,000 from $64,081,000 for the year ended December 31, 2009 as compared to the same period in 2007. Net earned premiums were up primarily due to lower reinsurance ceding costs for the 2009 treaty, higher written premiums and lower rate reductions.
Net realized capital gains (losses) and OTTI data for the years ended December 31, 2009 and 2008 are included in the following table:
OTTI decreased by $5,242,000 (69%) to $2,345,000 for the year ended December 31, 2009 from $7,587,000 for the year ended December 31, 2008 primarily as a result of lower impairment losses on our Alt-A CMOs securities in 2009 as compared to 2008. The amount of OTTI associated with Alt-A impairments for 2009 and 2008 was $619,000 and $5,819,000, respectively. In addition, we incurred additional “other than temporary” charges in 2008 on two other non-agency CMO securities in the amount of $1,070,000. Included in $2,345,000 of OTTI losses in 2009 is the write-down of $1,373,000 based on our intent to sell our non-agency CMO portfolio. Provided we can obtain an appropriate price on these securities, we will further reduce exposure to continued deterioration of the housing sector.
Financial services revenue for the years ended December 31, 2009 and 2008 are included in the following table:
Loss and loss adjustment expenses for the years ended December 31, 2009 and 2008 are included in the following table:
We continually review and update the data underlying the estimation of the loss and loss adjustment expense reserves and make adjustments that we believe the emerging data warrant. Any adjustments to reserves that are considered necessary are reflected in the results of operations in the period the estimates are changed. As of December 31, 2009, we continue to reserve at the upper end of the actuarially determined reserve range.
Other underwriting expenses and change in deferred acquisition costs for the years ended December 31, 2009 and 2008 are included in the following table:
Other underwriting expenses decreased by $13,000 to $11,061,000 from $11,074,000 for the year ended December 31, 2009 as compared to the same period in 2008. Other underwriting expenses consist primarily of commissions to agents, premium taxes allocated salaries and other general underwriting expenses related to managing our Insurance Services segment. Allocated salaries and related employee benefits increased $171,000 (5%) to $3,458,000 for the year ended December 31, 2009 versus $3,287,000 for the prior 2008 year. These increases were primarily related to annual employee merit increases. Commissions to agents and premium taxes decreased by $100,000 to $4,100,000 for the 2009 year from $4,200,000 for the prior year based on slightly higher non-commissionable direct premium written during the current year. Premium taxes were up slightly due to a small increase in written premiums between years. In addition, legal, auditing, actuarial and other professional fees were $395,000 which represented an increase of $80,000 over the prior year fees of $315,000. This increase was primarily related to additional actuarial services performed for relativity, rate and reserve studies performed in 2009. The net change in deferred acquisition costs, which is comprised of the change in deferred and amortized commissions paid to agents on new and renewal business and deferred and amortized premium taxes, increased for the year ended December 31, 2009 by $151,000 to $165,000 from $14,000 for the comparable period in 2008 due to the amortization of prior deferred expenses exceeding new costs capitalized.
Financial services expenses for the years ended December 31, 2009 and 2008 are included in the following table:
Condensed actual income statement data for the year ended December 31, 2008 and condensed pro forma income statement data for the year ended December 31, 2007 are included in the following table:
On a pro forma basis, premiums ceded expenses increased $863,000 from $2,406,000 to $1,543,000 for the year ending December 31, 2007 as compared to the same period in 2008. The reinsurance contracts beginning in 2002 through 2008 are variable premium treaties that have various minimum and maximum rates. The actual premium rate will depend upon the ultimate losses ceded to the reinsurer under the related treaty. We, supported periodically by outside consulting actuarial reviews, continually monitor the development of claims subject to reinsurance and adjust premiums ceded for estimated profit sharing provisions based on claims development in the reinsurance layers. The pro forma increase in premiums ceded of $863,000 is primarily the result of recognizing $6,802,000 of favorable prior reinsurance development for prior years’ reinsurance treaties during the year ended December 31, 2008 as compared to recognizing $10,888,000 of favorable development during the year ended December 31, 2007. The $4,086,000 variance in favorable development on prior year reinsurance treaties year over year was offset by lower 2008 accident year ceded premiums of $5,259,000 as compared to $8,482,000 for 2007 accident year ceded premiums. The lower ceded premiums for the 2008 accident year is primarily due to the Company retaining 40% of any claim in excess of $250,000 on individual claims and $350,000 on multiple insured claims for the 2008 reinsurance treaty. We retained only 20% of any excess on the 2007 treaty. We are retaining this additional risk in the reinsurance layer in order to lower our ceding costs based on decreases in claims and coverage limits since the passage of tort reform legislation in Texas in 2003. In addition, ceded premiums are lower for the current period due to lower earned premiums in 2008 as compared to 2007.
Investment income, net of investment expenses increased by $3,306,000 (38%) to $11,999,000 from $8,693,000 for the year ended December 31, 2008 as compared to 2007 as a result of recording the benefit of investment income for a full twelve months on a substantially larger invested asset base in 2008 compared to only nine months in 2007 as the acquisition of API took place effective April 1, 2007 resulting in a much larger investment portfolio. In addition, cash received from 2008 operations increased the portfolio balance and consequently, increased investment income.
On a pro forma basis, investment income, net of investment expenses, increased by $1,494,000 (14%) to $11,999,000 from $10,505,000 for the year ended December 31, 2008 as compared to the same period for 2007. Cash and invested assets increased by $8,576,000 (4%) to $231,769,000 at December 31, 2008 from $223,193,000 at December 31, 2007 resulting in the increase in investment income. The increase in invested assets resulted primarily from positive net cash flow from operating activities. Partially offsetting these increases were lower rates earned on investments during the current period.
Net realized capital gains and (losses) and OTTI income statement data for the year ended December 31, 2008 and pro forma income statement data for the year ended December 31, 2007 are included in the following table:
On a pro forma basis, net realized capital losses and OTTI were $7,749,000 for the year ended December 31, 2008 compared to a loss of $5,130,000 for the year ended December 31, 2007. The increase in losses for the current year is primarily due to larger “other than temporary” impairment charges in our investment in Alt-A collateralized mortgage-backed securities of $5,819,000 in 2008 as compared to $4,566,000 in 2007, resulting from fair market value declines. In addition, we incurred additional “other than temporary” charges in 2008 on two other non-agency CMO securities in the amount of $1,070,000 for CMO securities as noted above.
We continually review and update the data underlying the estimation of the loss and loss adjustment expense reserves and make adjustments that we believe the emerging data warrant. Any adjustments to reserves that are considered necessary are reflected in the results of operations in the period the estimates are changed. As of December 31, 2008, we continue to reserve at the top of the actuarially determined reserve range.
Goodwill was originally recorded upon the repurchase of an interest in APS Insurance Services from a non-controlling holder in 2003. Goodwill was determined to exist based on earnings expected to be generated from the management agreement with API. With our purchase of API and termination of the management agreement, we determined that the original circumstances creating the goodwill no longer existed and that the entire $1,247,000 balance was impaired. The goodwill was written off in the quarter ended June 30, 2007.
The primary sources of our liquidity for the year ended December 31, 2009 were funds provided by insurance premiums collected, net investment income, recoveries from reinsurers and proceeds from the maturity and sale of invested assets. The primary uses of cash are losses from insurance claims, loss adjustment expenses, operating expenses, the acquisition of invested and fixed assets and reinsurance premiums.
Capital Expenditures. In April 2007 we entered into a contract with a vendor to provide us with and implement an integrated policy and claims administration system. The total capitalized expenditures for the project is anticipated to be approximately $2,300,000. Our capital expenditures for all equipment including hardware and software costs were $615,000 for the year ended December 31, 2009 of which approximately $569,000 were related to this software implementation project and remainder of $44,000 was primarily related to network and hardware upgrades. We expect to incur additional capitalized expenditures of approximately $550,000 for the remainder of this project, which are expected to be funded from cash on hand over the first half of 2010.
Escrow Account. In connection with the API acquisition effective April 1, 2007, the Texas Department of Insurance (“TDI”) required that funds be set aside in an escrow account with a bank to remain until the aggregate remaining redemption obligation of our Series A redeemable preferred stock is less than the amount of the escrow balance, with no withdrawals to be made from this escrow account without prior approval from TDI. To satisfy this requirement, we maintain a fixed maturity security in escrow in the amount of $2,500,000. This security is included in fixed maturities, available-for-sale.
At December 31, 2009, API had investments with a fair market value of $3,857,000 on deposit with state insurance departments to satisfy regulatory requirements and these securities are included in fixed maturities, available for sale.
There are no participation agreements or purchase commitments as of December 31, 2009. Our primary liability is the reserves for losses and loss adjustment expenses which are estimates of the ultimate expected payouts on existing reported and estimated unreported claims. These reserves totaled $88,668,000 at December 31, 2009. Our reserves for unpaid losses and loss adjustment expenses are an estimate of future cash flows necessary to fulfill insurance obligations based on insured events that have already occurred, but the amount and timing of the cash flow is uncertain. As a result of the acquisition of API on April 1, 2007, we issued Series A manditorily redeemable preferred stock. The holders of our Series A redeemable preferred stock are entitled to cumulative dividends thereon at the rate of three percent per annum payable on the remaining redemption value per share, in priority to the payments of dividends on our common shares. Holders of Series A redeemable preferred stock have no preemptive rights and have the same voting rights as the holders of our common stock. The preferred shares are non-certificated and mandatorily redeemable. They must be redeemed ratably at not less than $1,000,000 per year, with all remaining outstanding shares being redeemed by December 31, 2016. The remaining redemption obligation was $7,000,000 at December 31, 2009.
In addition to an adjustment to premiums ceded, estimates of ultimate reinsurance ceded premium amounts compared to the amounts paid on a provisional basis give rise to a balance sheet asset classified as “Other Amounts Receivable Under Reinsurance Contracts” or a balance sheet liability classified as “Funds Held Under Reinsurance Treaties.” Furthermore, each retrospective treaty requires a 24 or 36 month holding period before any premium adjustments or cash can be returned or paid. The ultimate settlement amount is not determined until all losses have been settled under the respective treaties. As of December 31, 2009, we have recorded a balance sheet asset, “Other Amounts Receivable Under Reinsurance Contracts” of $785,000 and a balance sheet liability, “Funds Held Under Reinsurance Treaties” of $2,379,000, which represent the differences between the estimates of ultimate reinsurance premiums ceded amounts for the 2002 through 2008 treaty years as compared to the amounts paid on a provisional basis.
Other amounts receivable under reinsurance contracts decreased $712,000 (48%) to $785,000 at December 31, 2009 from $1,497,000 at December 31, 2008 due to a net payments of $3,463,000 received from reinsurers primarily for the initial reimbursement for the excess reinsurance premiums paid on a provisional basis for the 2006 treaty year.
The primary effect of inflation on the Company is considered in pricing and estimating reserves for unpaid losses and loss adjustment expense for claims in which there is a long period between reporting and settlement, such as medical malpractice claims. The actual effect of inflation on our results cannot be accurately known until claims are ultimately settled. Based on actual results to date, we believe that loss and loss adjustment expense reserve levels and our rate making process adequately incorporate the effects of inflation.
In April 2009, the FASB issued FASB ASC 320-10 (Prior authoritative literature: FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), which replaces the requirement in FASB ASC 320-10 (Prior authoritative literature: FSP No. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments), for management to assert that it has the intent and ability to hold an impaired debt (“fixed maturity”) security until recovery with the requirement that management assert if it either has the intent to sell the fixed maturity security or if it is more likely than not it will be required to sell the fixed maturity security before recovery of its amortized cost basis. If management intends to sell the fixed maturity security or it is more likely than not it will be required to sell the fixed maturity security before recovery of its amortized cost basis, an other-than-temporary impairment (“OTTI”) shall be recognized in earnings equal to the difference between the fixed maturity security’s amortized cost basis and its fair value at the balance sheet date. After the recognition of an OTTI, the fixed maturity security is accounted for as if it had been purchased on the measurement date of the OTTI, with an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings.
In April 2009, the FASB issued FASB ASC 825-10 (Prior authoritative literature: FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments), which extends the disclosure requirements of FASB ASB 825-10 (Prior authoritative literature: SFAS No. 107, Disclosures about Fair Value of Financial Instruments), to interim financial statements. FASB ASC 825-10 also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments in the financial statements on an interim basis and to highlight any changes of the methods and significant assumptions from prior periods. The disclosures in FASB ASC 825-10 are effective for interim reporting periods ending after June 15, 2009, and are not required for earlier periods that are presented for comparative purposes at initial adoption. In periods after initial adoption, FASB ASC 825-10 requires comparative disclosures only for periods ending after initial adoption. The adoption of these pronouncements did not have a material impact on our results of operations, financial position or cash flows.
In January 2010, the FASB issued Accounting Standards Update No. 2010-06 Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements. New disclosures are required for transfers in and out of Levels 1 and 2, whereby significant transfers will require disclosure of rationales for the transfers. Activity in Level 3 fair value measurements will require the reporting entity to present separately the information about purchases, sales, issuances and settlements. Existing disclosures have been expanded, whereby the reporting entity must provide fair value measurements for each class of assets and liabilities and provide disclosures about the valuation techniques and inputs used to measure fair value. Those disclosures will be required for fair value measurements that fall in either Level 2 or Level 3. This standard shall be effective for interim and annual reporting periods beginning after December 15, 2009, except for the separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements which shall be effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We will adopt the requirements of the Accounting Standards Update upon their effective dates. We do not anticipate that the adoption of this update will have a material impact on our financial position, results of operations or cash flows.
There were no off-balance sheet arrangements as of December 31, 2009 or 2008.