Our principal executive offices are located in leased premises of approximately 33,758 square feet in North Palm Beach, Florida. We also lease a total of approximately 69,264 square feet of office space in 9 states. We believe that there is sufficient office space available at favorable leasing terms both to replace existing office space and to satisfy any additional needs we may have as a result of future expansion.
During 2006, the second injury fund assessment rate in South Carolina decreased to 24.5% on losses. The impact of this rate change was to increase 2006 pre-tax income by $2.8 million.
Beginning in the third quarter of 2005, the second injury fund assessment in South Carolina was doubled, which resulted in a pre-tax charge of $3.3 million in the third quarter of 2005.
Losses and LAE divided by net premiums earned, after the effects of reinsurance.
Policy acquisition expenses, including commissions, assessments, premium tax and general and administrative expenses directly associated with policy acquisition, divided by net premiums earned, after the effects of reinsurance.
AmCOMP Incorporated, a Delaware corporation, is a holding company engaged through its wholly-owned subsidiaries, including AmCOMP Preferred and AmCOMP Assurance, in the workers’ compensation insurance business. Our long-term source of consolidated earnings is principally the income from our workers’ compensation insurance business and investment income from our investment portfolio. Workers’ compensation insurance provides coverage for the statutorily prescribed wage replacement and medical care benefits that employers are required to make available to their employees injured in the course of employment. We are licensed as an insurance carrier in 25 states and the District of Columbia, but currently focus our resources in 17 states that we believe provide the greatest opportunity for near-term profitable growth.
commissions and other underwriting expenses, which consist of commissions we pay to agents, premium taxes and company expenses related to the production and underwriting of insurance policies, less ceding commissions reinsurers pay to us under our reinsurance contracts;
other operating and general expenses, which include general and administrative expenses such as salaries, rent, office supplies and depreciation and other expenses not otherwise classified separately;
We are directly liable for losses and LAE under the terms of insurance policies our insurance subsidiaries underwrite. We are also liable for a proportional share of losses from state mandated involuntary pools. The state mandated involuntary pools are a mechanism used to reinsure the risk underwritten by state created workers’ compensation insurance. Insurance companies are generally required to participate in these state created workers’ compensation insurance programs as a condition to conducting business in these states. The NWCRP, the largest of the state mandated involuntary pools, is administered by NCCI. Each year, NCCI establishes an estimated reserve for losses arising from this pool and notifies us of our proportionate share of loss reserves from this pool. We add our share of the loss reserves from this pool to the loss reserves for the insurance policies our insurance subsidiaries underwrite. Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer’s payment of that loss. To recognize liabilities for unpaid loss and LAE, insurers establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported net losses and loss expenses. Except as mandated by Texas statutes on fatality claims where the calculation takes into account the life expectancy of a surviving spouse, we do not discount our reserves for estimated losses and LAE.
When claims are reported to one of our insurance subsidiaries, its claims personnel establish “case reserves” that represent an estimate of the amount (including LAE) that we will have to pay in respect of these claims. The amount of the reserve is primarily based upon a case-by-case evaluation of the claims involved, the circumstances surrounding each claim, historical loss experience and the policy provisions relating to the type of losses. The estimate reflects the informed judgment of our claims personnel based on general insurance reserving practices, as well as the experience and knowledge of the claims personnel. Our claims professionals continually monitor all open claims. As new information becomes available about the claims, the case reserves may be updated.
Our internal actuaries and the independent actuarial consulting firm we have retained prepare estimates of our insurance subsidiaries’ IBNR reserves by state and loss year using generally accepted actuarial techniques. These estimates are currently prepared quarterly. Our independent actuarial firm participates in our IBNR estimation process three times annually (as of June 30, September 30 and December 31). These estimates are analyzed on a gross of reinsurance basis and on a net of all reinsurance recoverables basis. Estimation of loss reserves is subject to variation as a result of factors such as inflation, claims settlement patterns, legislative activity and litigation trends. Our IBNR estimates are affected by the results of nine separate actuarial reserving methods, our assumptions regarding the adequacy of case reserves, the impact of future wage and medical inflation, litigation trends, the quality of recent underwriting standards and actuarial judgment. Consistent with industry practices, the actuarial judgment of our management plays a significant part in the reserving process. Actuarial judgment takes into account our assumptions regarding future claims emergence, the number of claims to be closed in the future with or without payment, amounts that may be collected from subrogation and any other changes expected to occur in the future. Changes in the assumptions we employ or our estimates associated with such assumptions could result in materially different amounts being reported as reserves. If necessary, we will increase or decrease the level of our reserves, with a corresponding change in our expenses in the period in which the increase or decrease occurs, as experience develops or new information becomes known in the period in which changes to the estimates are determined. As of December 31, 2007, our case reserves and IBNR net of reinsurance were $176.8 million and $81.1 million, respectively. Gross of reinsurance, these amounts were $198.3 million and $125.9 million, respectively.
The amount by which estimated losses, measured subsequently by reference to payments and additional estimates, differ from those originally reported for a period is known as “development.” Development is unfavorable when ultimate losses indicate a basis for increases over the established reserves. Development is favorable when ultimate losses indicate a basis for reducing the established reserves. Favorable or unfavorable development of loss reserves is reflected in the earnings of the period during which the development is identified. A 10-year history of the development of our loss reserves is set forth in the loss development table in this report under “Business-Loss and Loss Adjustment Expense Reserves.” Our current loss reserve estimates may be subject to development in future years and reserve development may take a long time to appear because of the uncertainty inherent in currently estimating long-term liabilities.
The state-specific assumptions regarding the claim payment and claim reporting patterns are established by considering loss development patterns for the industry, as well as our loss development patterns for the state being examined and Florida, the state in which we have the most extensive loss experience. The state-specific assumptions regarding the expected net loss ratios are established by examining historic pricing levels in that state for that accident year and our and the consulting firm’s judgment on the expected difference between our net loss ratio and that of the workers’ compensation insurance industry given the same pricing structure. Claim cost and claim averages are based on AmCOMP’s history and our judgment and that of the independent actuarial firm regarding trends.
We develop our IBNR estimate separately, for each state and accident year, based on our review of the results of nine separate actuarial methods (five separate methods for accident years prior to 1998) and actuarial judgment. After reviewing the nine actuarial methods for each state and accident year, we select an estimate of ultimate losses (the “point estimate”) for each state and accident year. Our point estimate of IBNR is the compilation of the estimate of ultimate losses by state for each accident year and equals the total ultimate loss estimate minus the incurred losses. We book to this point estimate. We observe that the selected estimated ultimate loss is most sensitive to four of the nine actuarial methods examined:
Paid Bornhuetter-Ferguson Method - A method assigning partial weight to the initial expected losses (calculated from the initial expected loss ratio) and partial weight to observed paid losses. The weights assigned to the initial expected losses decrease as the accident year matures.
Incurred Development Method - A method using historical, cumulative incurred losses by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years.
We believe the weightings displayed above are appropriate for a long-tailed line of business such as workers’ compensation insurance. Initially, when loss experience is very immature and the ultimate payout of our largest claims is still unknown, the expected loss ratio should carry relatively more weight than after experience has developed more fully. As loss experience matures, the initial expected loss ratio becomes less important as it does not consider all of the new loss information that has become available. As a result, the weighting of the Bornhuetter-Ferguson methods decreases from 25% to 0% after five years and the weighting of the loss development methods increases from 25% to 50% after 5 years. The 0% weight of the Bornhuetter-Ferguson methods for accident years older than five years should not suggest that the Bornhuetter-Ferguson methods are not considered, but rather that they are typically not given significant weight when selecting our estimate of ultimate losses for older accident years. In the future, as we compare the actual losses with the different estimates of losses for recent accident years, we may change the relative weightings of these and other actuarial methods.
3. Changes in the incurred loss development pattern-We varied the incurred loss development pattern by + / - 10% (e.g., if incurred losses were expected to develop by 30% for a particular state and accident year, we calculated the sensitivity of reserves to a change in incurred loss development factors of 3.0% = 10% ´ 30%). Changes in the incurred loss development factors affect the results of the Incurred Loss Bornhuetter-Ferguson Method and the Incurred Loss Development Method.
We believe that loss ratios 10% above or below our expected loss ratio constitute a reasonable range of expectations for each state and accident year in which we have loss reserves. In addition, we believe the adjustments (10%) that we made to improve or deteriorate the paid and incurred loss development patterns are also reasonably likely outcomes. Assumptions about loss development patterns are made based on our entire claim history back to 1982, while assumptions about expected loss ratios are made based on our current pricing and only up to two years of aggregated industry data. As a result of the longer relevant history of loss patterns, loss development patterns are considerably more stable and warrant a smaller variation. Such changes in the net reserves for losses and loss adjustment expense would not have an immediate impact on our liquidity, but would affect cash flow in future periods as the incremental or reduced amount of losses is paid.
All premium revenue is recognized over the period of the contract in proportion to the amount of insurance protection provided. The insurance premiums we charge are billed to our policyholders either annually or under various installment plans based on the estimated annual premium under the policy terms. We recognize the premium revenue for the proportionate share of the risks assumed from state mandated involuntary pools on a quarterly basis. At the end of the policy term, payroll-based premium audits are performed on substantially all policyholder accounts to determine earned premiums for the policy year. Earned but unbilled premiums include estimated future audit premiums. Estimates of future audit premiums are based on our historical experience. These estimates are subject to changes in policyholders’ payrolls due to growth, economic conditions and seasonality. Although considerable variability is inherent in such estimates, management believes that the accrual for earned but unbilled premiums is reasonable. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations. The reserve for unearned premiums is determined on a daily pro rata basis.
To the extent recoverable from future policy revenues, costs that vary with and are primarily related to the production of new and renewal business, such as commissions paid to agents and our other acquisition expenses, net of reinsurance ceding allowances received, have been deferred and are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits such deferred amounts to their estimated realizable value. The ultimate recoverability of deferred acquisition costs is dependent on the continued profitability of our insurance underwriting. If our insurance underwriting ceases to be profitable, we may have to write off a portion of our deferred policy acquisition costs, resulting in a further charge to income in the period in which the underwriting losses are recognized. At December 31, 2007 and 2006, our deferred acquisition costs were $19.1 million and $20.7 million, respectively.
We continuously monitor our portfolio to preserve principal values whenever possible. All securities in an unrealized loss position are reviewed to determine whether the impairment is other-than-temporary. An investment in a fixed maturity security is impaired if its fair value falls below its book value. Factors considered in determining whether a decline is considered to be other-than-temporary include length of time and the extent to which fair value has been below book value, the financial condition and near-term prospects of the issuer, and our ability and intent to hold the security until its expected recovery. If an impairment of a security is determined to be other-than-temporary, such impairment will result in a charge to net income in the period in which such other-than-temporary determination is made. For details on our investments in an unrealized loss position, see “Business-Investments.”
We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our gross premiums. We measure our operating results by examining our net income, return on equity, and our loss and LAE, expense, dividend and combined ratios. The following provides further explanation of the key measures that we use to evaluate our results:
Net Premiums Written. Net premiums written is the sum of direct premiums written and assumed premiums written less ceded premiums written. Ceded premiums written is the portion of our direct premiums that we cede to our reinsurers under our reinsurance contracts. We use net premiums written, primarily in relation to gross premiums written, to measure the amount of business retained after cession to reinsurers.
Gross Premiums Earned. Gross premiums earned represent that portion of gross premiums written equal to the expired portion of the time for which the insurance policy was in effect during the financial year and is recognized as revenue. For each day a one-year policy is in force, we earn 1/365th of the annual premium.
An accident year loss ratio is calculated by dividing the losses and LAE, regardless of when such losses and LAE are incurred, for insured events that occurred during a particular year by the premiums earned for that year. An accident year net loss ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers. An accident year loss ratio for a particular year can decrease or increase when recalculated in subsequent periods as the reserves established for insured events occurring during that year develop favorably or unfavorably, respectively, whereas the calendar year loss ratio for a particular year will not change in future periods.
Dividend Ratio. The dividends to policyholders ratio equals policy dividends incurred in the current year divided by net premiums earned for the year.
Net Combined Ratio. The net combined ratio is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss, policy acquisition expense, underwriting and other expense, and dividend ratios. If the net combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.
Gross premiums written decreased $48.2 million, or 17.6% in 2007 as compared to 2006. Direct premiums written decreased $46.3 million, while assumed premiums written decreased $1.9 million. Direct premiums written decreased due to decreases in writings in Florida ($37.5 million), Indiana ($7.3 million), Wisconsin ($3.1 million), and Texas ($2.7 million), offset by increases in Illinois ($2.2 million), and Mississippi ($1.6 million), combined with other smaller changes. The decrease in Florida premiums is the result of the 15.7% rate decrease in 2007, a 5.7% decline in in-force policies as of December 31, 2007 from 2006, and a reduction in construction-related payrolls. For all other states with significant changes in direct premiums written, generally, the change in the number of policies is consistent with the change in premiums written. The decrease in assumed premiums written is the result of a decrease in Indiana premiums assumed through involuntary pools. Such increases or decreases in premiums assumed from involuntary pools are the result of changes in the total written premiums in the pool and/or a change in the Company’s premiums as a percentage of total premiums written in the state for the same line of business.
Gross premiums earned increased $0.9 million, or 0.3% in 2006 as compared to 2005. This increase is the direct result of an increase in direct earned premiums, with the largest increases being in Wisconsin ($4.3 million), Texas ($3.7 million) and Illinois ($3.5 million), offset by decreases in Indiana ($5.6 million) and Tennessee ($4.6 million). Florida earned premium decreased $0.7 million.
The table below sets forth the calculation of net premiums earned and this amount as a percentage of gross premiums earned:
Underwriting and other expenses increased $3.8 million, or 11.9% in 2007 as compared to 2006. Underwriting and other expenses were 15.7% and 12.1% of net premiums earned in 2007 and 2006, respectively. The increase in underwriting and other expense is primarily attributable to increases in payroll related expense ($3.2 million), agent entertainment expense ($0.8 million), insurance expense ($0.5 million), and other smaller increases, offset by a decrease in bad debt expense ($1.1 million). The increase in payroll related expense is the result of a 2.7% increase in the average number of employees in 2007 compared to 2006, combined with an increase in the average pay rate, and an increase in management team bonuses paid during the year. The increase in agent entertainment expense is the result of agent events in 2007 related to the 25th anniversary of the Company, and a credit taken in 2006 related to an over-accrual in 2005. The increase in insurance expense is due to an increase in employee insurance, with the greatest increase being for employee health insurance. The increase in the cost of health insurance is the result of an 8% rate increase in 2007 and an increase in the average number of employees. The decrease in bad debt expense is due to the reduction in premiums receivable and a refinement of the allowance for bad debt calculation in the current year. The method used to determine the allowance for doubtful accounts was refined to limit the impact that non-cash premium adjustments have on the allowance calculated, as such premium adjustments are already accounted for in the earned but unbilled premium calculation.
Underwriting and other expenses decreased $2.3 million, or 6.6% in 2006 as compared to 2005. Underwriting and other expenses were 12.1% and 13.4% of net premiums earned in 2006 and 2005, respectively. The decrease in underwriting and other expense is primarily attributable to decreases in agent incentives of $1.0 million and litigation reserve expenses of $1.4 million. In 2005 we recorded a $1.3 million accrual in connection with outstanding litigation, as discussed in Note 10, with no similar amount recorded in 2006. Also in 2006, the positive premiums receivable collection trend continued, resulting in a reduced bad debt expense. These decreases in underwriting and other expenses were partially offset by increases in expenses associated with being a public company including increases in auditing, actuarial, investor relations, Sarbanes Oxley compliance readiness, and directors and officers insurance.
Dividends to policyholders increased $1.3 million, or 15.3% in 2006 as compared to 2005. Dividends to policyholders were 3.7% and 3.4% of net premiums earned in 2006 and 2005, respectively. This is due to an increase in direct premiums earned in Wisconsin, one of the states in which policyholders are eligible for dividend plans. The percentage of direct premiums written in Florida on a dividend plan increased slightly to 37.8% in 2006 from 36.8% in 2005. The percentage of direct premiums written in Wisconsin on a dividend plan decreased to 84.1% in 2006 from 86.4% in 2005. The company wide direct premiums written on a dividend plan increased to 25.7% in 2006 from 24.9% in 2005.
Interest expense was relatively flat, with only a minor decrease of $0.1 million, or 2.4% in 2007 as compared to 2006.
Federal and state income taxes increased $3.2 million, or 38.8% in 2007 as compared to 2006. Federal and state income taxes were 37.8% of pretax income in 2007, and 33.3% in 2006. During 2006, the rate used on the federal deferred tax asset was increased from 34% to 35% as we expected to be in the 35% tax bracket when future tax assets were realized. This change in the effective tax rate on net deferred tax assets decreased the effective tax rate in 2006 by 2.0%. In 2007, the rate used on the state deferred tax asset was decreased from 3.5% to 2.2% to reflect the blended state tax rate that is expected to be in effect with the future tax assets are realized, based on changes in the Company’s mix of business by state. This change in the state tax rate increased the effective tax rate in 2007 by 1.5%. Provision to return adjustments booked in the current year also contributed to the increase in the effective tax rate.
Federal and state income taxes decreased $1.1 million, or 11.5% in 2006 as compared to 2005. Federal and state income taxes were 33.3% of pretax income in 2006, and 35.7% in 2005. The primary causes of the decrease are a change in the federal tax rate applied to the deferred tax assets as described above, and a decrease in state income taxes. The decrease in state tax expense is a result of amending the 2005 and 2004 Florida state income tax returns to apportion interest income between states in which we operate. These amended returns resulted in additional state tax refund amounts recorded in the current period related to prior years. These decreases were partially offset by other increases, including a provision to return adjustment.
Return on Equity - Our annualized return on equity for the years ended December 31, 2007, 2006 and 2005 is 12.7%, 15.7% and 25.8%, respectively.
We have historically met our cash requirements and financed our growth principally from operations, the proceeds of borrowings, investment income and in 2006 the initial public offering completed February 10, 2006 for $48.0 million. Cash flow is summarized in the table below.
In October 2000, we entered into a credit facility with AmSouth Bank (now Regions Bank) under which we borrowed $11.3 million. In April 2003, the loan was amended and the aggregate borrowing increased to $12.5 million. The loan calls for monthly payments of principal and of interest at the 30-day London Interbank Offered Rate (“LIBOR”) rate plus a margin. At December 31, 2006, the principal balance of the loan was $4.5 million and the annual interest rate was 6.83%. The loan contains various restrictive covenants generally pertaining to levels of indebtedness and limitations on incurrence of capital expenditures. Additionally, our insurance subsidiaries must comply with financial covenant restrictions, including ratios of leverage, debt service, current maturity coverage, net premiums written to surplus and risk based capital. The loan is collateralized by $25.5 million of internal surplus notes issued to us by our insurance subsidiaries and the stock of AmCOMP Preferred. The surplus notes bear interest, in the case of $10.0 million principal amount, at an annual rate of 100 basis points in excess of the prime rate, in the case of $10.5 million principal amount, at an annual rate of 450 basis points in excess of LIBOR, and in the case of $5.0 million principal amount, at an annual rate of 10.0%. Interest and principal payments on the surplus notes require prior approval by the Florida OIR.
In 2004, AmCOMP Preferred issued surplus notes to third parties as part of three securitizations of pooled surplus notes of insurance companies. The following table summarizes the terms of these surplus notes
We consummated our initial public offering on February 15, 2006 with the sale by the Company of 6,000,000 shares of common stock. Our net proceeds, after deducting underwriting discounts and commissions and other expenses relating to the offering, were approximately $48.0 million. We utilized substantially all of the proceeds to further capitalize our insurance subsidiaries which enables us to underwrite additional insurance in the states where we currently operate. The balance of the net proceeds we received from the initial public offering are being used for working capital and general corporate purposes.
Our insurance subsidiaries are required to maintain certain minimum amounts of capital as established by the Florida OIR pursuant to risk-based capital standards of the NAIC. These standards require the computation of a risk-based capital amount, which is then compared to the insurance subsidiaries’ actual total adjusted capital. The computation of risk-based capital involves applying various financial factors to address four primary risks: asset risk, insurance underwriting risk, credit risk and off-balance sheet risk. The standards provide for regulatory intervention when the ratio of an insurance company’s total adjusted capital to its risk-based capital is below certain levels. For further information, see the discussion of risk-based capital under “Business-Regulation.”
Our insurance subsidiaries are also subject to statutory insurance laws and regulations that limit the amount of dividends or distributions that may be paid by an insurance company to its stockholders. Pursuant to the Florida Insurance Code, our insurance subsidiaries may not, without the prior approval of the Florida OIR, pay to us dividends or other distributions of cash or property, the total fair market value of which generally exceeds the larger of 10% of surplus, as of the preceding December 31st or 100% of its prior year’s net income, not including realized capital gains, or net investment income plus a three-year carryforward. At December 31, 2007, our insurance subsidiaries were authorized to pay approximately $17.6 million in dividends without additional regulatory approval. No dividends were paid by the insurance subsidiaries during 2007, 2006 or 2005.
Effective January 1, 2006, the Illinois Department of Insurance removed the $9.0 million cap premium writings requirement previously applicable in that state. Historically, the regulatory authorities’ primary concern was the capitalization of AmCOMP Assurance and its reliance on an inter-company pooling arrangement with AmCOMP Preferred, which is not licensed to do business in those states. Should we choose to expand our operations in Illinois, we would be required to negotiate an increase in the current limit on premium writing and there is no assurance that we would be able to do so. In North Carolina, we were subject to a $12.0 million cap on written premiums during the 2002-2004 periods. Effective July 6, 2005, the cap was removed.
We have historically operated with a limited amount of capital and, as a result, have made extensive use of the reinsurance market to maintain our net exposures within our capital resources. We have ceded premiums and losses to unaffiliated insurance companies under quota share, excess of loss and catastrophe reinsurance agreements. We evaluate the financial condition of our reinsurers and monitor various credit risks to minimize our exposure to losses from reinsurer insolvencies. However, we remain obligated for amounts ceded irrespective of whether the reinsurers meet their obligations. We ceded a high percentage of our premiums and the associated losses prior to July 1, 2004. A failure of one of our reinsurers to pay could have a significant adverse effect on our capital and our financial condition and results of operations. At December 31, 2007 and 2006, reinsurance recoverables on paid and unpaid losses and LAE were $67.8 million and $75.4 million, respectively. Our largest recoverable from a single reinsurer as of December 31, 2007 was $32.2 million owed to us by Continental Casualty Company, a subsidiary of CNA Financial Corporation, representing 20.3% of our total stockholders’ equity as of that date. Of the $32.2 million, $1.4 million was the current recoverable on paid losses. The balance of $30.8 million is recoverable from Continental Casualty Company on losses that may be paid by us in the future and therefore is not currently due. The unpaid losses will become current as we pay the related claimants.
Our insurance subsidiaries employ an investment strategy that emphasizes asset quality to minimize the credit risk of our investment portfolio. As economic conditions change, our insurance subsidiaries’ investment committees recommend strategy changes and adjustments to our investment portfolio. We have maintained a high portion of our portfolio in short-term investments recently to mitigate the risk of falling prices for fixed maturity securities if rates should rise. Changes in interest rates impact our investment income and cause fluctuations in the carrying values of the majority of our investments (these changes are reflected as changes in stockholders’ equity, net of tax).
We may sell securities due to changes in the investment environment, our expectation that fair value may deteriorate further, our desire to reduce our exposure to an issuer or an industry and changes in the credit quality of the security. In addition, depending on changes in prevailing interest rates, our investment strategy may shift toward long-term securities, and we may adjust that portion of our investment portfolio that is held-to-maturity rather than available-for-sale. Except for recognizing other-than-temporary impairments, our held-to-maturity portfolio is carried at amortized cost because we have the ability and intent to hold those securities to maturity. As of December 31, 2007 and 2006, 77.9% and 81.9%, respectively, of our entire portfolio was classified as available-for-sale.
The table below contains information concerning the composition of our investment portfolio at December 31, 2007:
Based on the stated maturities of the securities. Actual maturities may differ as obligors may have the right to call or prepay obligations.
AmCOMP and both of our insurance subsidiaries are defendants in an action commenced in Florida by the Insurance Commissioner of Pennsylvania, acting in its capacity as liquidator of Reliance Insurance Company. The complaints in those actions allege that preferential payments were made to us by Reliance under the formerly existing reinsurance agreement with the insurance subsidiaries and seek damages in the amount of approximately $2.3 million. We have answered the complaint and we expect the matter to be scheduled for trial. We believe that we have multiple factual and legal defenses to the claim made in this action, including, but not limited to a right of recoupment related to the statement of claim filed by us in the Reliance liquidation proceeding for the recovery of approximately $7.8 million under the reinsurance agreement. However, on November 14, 2007 the trial court in Florida granted the plaintiff liquidator’s motion for partial summary judgment, finding that the approximate $2.3 million in payments were “preferential” under Pennsylvania law. This order is not yet a final, appealable order under Florida law. There are a number of remaining issues, including AmCOMP’s affirmative defenses, which must be determined by the court before a final order or judgment could be entered. Although the ultimate results of these legal actions and related claims (including any future appeals) cannot presently be determined, the Company had accrued a $1.2 million liability as of each of December 31, 2007 and 2006, related to those matters.
In August 1998, in an effort to expand its customer base, AmCOMP began selling insurance policies for a third party insurance company. This arrangement included insurance policies with effective dates of August 1, 1998 through November 1, 2000. Pinnacle Administrative performed marketing, underwriting, loss prevention and other administrative functions, and Pinnacle Benefits provided claim adjusting services, including the payment of claims, related to these policies. Included in other assets at December 31, 2007 is approximately $2.1 million in loss and LAE payments on the administered business that is currently due from the third-party insurer. Management is currently in discussion with the insurer regarding payment, and expects to recover the balance due.
Long-Term Debt Obligations reflect payments for the principal and estimated interest expense that is based on variable LIBOR rates plus a margin. The estimated interest expense was based on the contractual obligations of the debt as of December 31, 2007. The rates ranged from 6.83% to 9.28%.
Estimated pay out dates for the loss reserves are determined in the actuarial process. As a result, our calculation of loss reserve payments due by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our reserving process, see “Business-Loss and Loss Adjustment Expense Reserves.” Actual payments of losses and LAE by period will vary, perhaps materially, from the above table to the extent that current estimates of loss reserves vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors-Our loss reserves are based on estimates and may be inadequate to cover our actual losses” for a discussion of the uncertainties associated with estimating loss reserves.
The effects of inflation could impact our financial statements and results of operations. Our estimates for losses and loss expenses include assumptions about future payments for closure of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established, we will be required to increase reserves for losses and loss expenses with a corresponding reduction in our earnings in the period in which the deficiency is identified. We consider inflation in the reserving process by reviewing cost trends and our historical reserving results. Additionally, an actuarial estimate of increased costs is considered in setting adequate rates, especially as it relates to medical and hospital rates where historical inflation rates have exceeded general inflation rates. We are able to mitigate the effects of inflation on medical costs due to the fee schedules imposed by most of the states where we do business and the utilization of preferred provider networks. However, providers are not obligated to invoice us per the fee schedule or the negotiated rate. We review medical bills for appropriate coding and pay the lower of the negotiated or fee schedule rate. Disputes are resolved by negotiation.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. This statement addresses how to calculate fair value measurements required or permitted under other accounting pronouncements. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this statement will change current practice. SFAS No. 157 is effective for the Company beginning January 1, 2008. The Company is currently evaluating the impact of this standard.
Financial Statements as of December 31, 2007 and 2006 and for the three years ended December 31, 2007:
As disclosed in Note 19, on January 10, 2008 the Company announced that it had executed a definitive agreement to be acquired by Employers Holdings, Inc., an unrelated insurance holding corporation. The transaction, which is subject to regulatory approvals, is expected to be completed during the second quarter of 2008.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AmCOMP Incorporated and subsidiaries at December 31, 2006, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
AmCOMP Preferred Insurance Company (“AmCOMP Preferred”), a wholly owned property and casualty insurance company (formerly known as Pinnacle Assurance Corporation);
AmServ Incorporated (“AmServ”), a wholly owned company established to provide administrative services to external customers.
Investments-Fixed maturity investments are designated at purchase as held-to-maturity or available-for-sale. Held-to-maturity fixed maturity investments are reported at amortized cost. Securities classified as available-for-sale are reported at fair value with unrealized appreciation and depreciation, net of deferred taxes, included as a component of accumulated other comprehensive income. The Company has the intent and ability to hold securities that have fair value below cost until their expected recovery and to hold to maturity securities designated as held-to-maturity.
Debt and equity securities are exposed to various risks such as interest rate, market, and credit risk. Fair values of securities fluctuate based on the magnitude of changing market conditions; significant changes in market conditions could materially affect portfolio value in the near term. The Company continually monitors its portfolio for pricing changes, which might indicate potential impairments and performs detailed reviews of securities with unrealized losses based on predetermined criteria. When a security in the Company’s investment portfolio has an unrealized loss in fair value that is deemed to be other-than-temporary, the Company reduces the book value of such security to its current market value, recognizing the decline as a realized loss in the accompanying consolidated statements of operations. Any future increases in the fair value of securities previously written down are recorded and presented as changes in unrealized gains (losses) as part of accumulated other comprehensive income within stockholders’ equity.
Cash and Cash Equivalents-The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Deferred Policy Acquisition Costs-To the extent recoverable from future policy revenues, costs that vary with and are primarily related to the production of new and renewal business, including premium tax, commissions, assessments and other general acquisition expenses have been deferred and are amortized over the effective period of the related insurance policies.
Impairment of Long-Lived Assets-The Company’s policy is to record an impairment charge against the balance of a long-lived asset in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), in the period when it is determined that the carrying amount of the asset may not be recoverable. This determination is based on an evaluation of such factors as the occurrence of a significant event or a significant change in the environment in which the business assets operate. The Company considers assets to be impaired when the expected future undiscounted cash flows of the assets are determined to be less than the carrying value. If impairment is deemed to exist, the related asset is written down to fair value. Management also evaluates events and circumstances to determine whether revised estimates of useful lives are warranted. As of December 31, 2007, management expects the carrying value of its remaining long-lived assets to be fully recoverable.
Reinsurance-Reinsurance premiums, losses, and loss adjustment expenses (“LAE”) are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance ceding commissions, if any, received are deferred and amortized over the effective period of the related insurance policies.
Federal and State Income Taxes-The Company provides deferred federal and state income taxes for certain differences between the financial statement amounts and tax basis of assets and liabilities.
Comprehensive Income-Comprehensive income encompasses all changes in stockholders’ equity (except those arising from transactions with stockholders) and includes net income and changes in net unrealized investment gains and losses on fixed maturities investments classified as available-for-sale securities net of the related tax effect. During the years ended December 31, 2007, 2006 and 2005, realized losses, net of tax, of $0.3 million, $0.2 million and $0.2 million, respectively, were reclassified out of accumulated comprehensive income into earnings.
Policyholder Deposits-Policyholders are required to maintain deposits with the Company for certain installment pay plans. Based on the selected pay plan, management determines the deposit amount, which is based on a percentage of the policyholders’ estimated annual premium. Deposits are analyzed annually and adjusted as considered necessary.
The following table illustrates the pro forma effect on net earnings and earnings per share for the year ended December 31, 2005 (as reported) if the Company had applied the fair value recognition provisions of SFAS 123(R) to stock-based employee compensation (in thousands, except per share data):
The Company has adopted SFAS 123R using the modified prospective transition method. Under this transition method, compensation cost recognized in 2007 and 2006 includes:
Compensation cost for all share based awards (expected to vest) granted prior to, but not yet vested as of January 1, 2006, based upon grant-date fair value estimated in accordance with the original provisions of SFAS 123; and
Upon adoption of SFAS 123R, the Company continued to use the Black-Scholes option pricing model for valuing all stock options. Compensation for non-vested stock awards is measured at fair value on the grant-date based upon the number of shares expected to vest and the quoted market price of the underlying common stock. Compensation cost for all awards is recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. As a result of the adoption of SFAS 123R, the Company recognized approximately $0.7 million and $0.6 million of stock option compensation expense in the years ended December 31, 2007 and 2006, respectively. Basic and diluted earnings per share for the years ended December 31, 2007 and 2006 were reduced by $0.05 and $0.04, respectively. Additionally, as a result of adoption, cash flows from financing increased less than $0.1 million and $0.2 million for the years ended December 31, 2007 and 2006, respectively. Cash flows from operations decreased by the same amount.
New Accounting Pronouncements- In July 2006, the Financial Accounting Standards Board (“FASB”) issued an interpretation of FASB Statement No. 109, Accounting for Uncertainty in Income Taxes (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation establishes a “more likely than not” recognition threshold for tax benefits to be recognized in the financial statements. The “more likely than not” determination is to be based solely on the technical merits of the position. This interpretation was adopted by the Company on January 1, 2007. As of the adoption date and as of December 31, 2007, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which permits entities to elect to measure many financial instruments and certain other items at fair value. Upon adoption of SFAS No. 159, an entity may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option should only be made at the initial recognition of the asset or liability or upon a re-measurement event that gives rise to the new-basis of accounting. All subsequent changes in fair value for that instrument are reported in earnings. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be recorded at fair value nor does it eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective as of January 1, 2008. The Company is currently evaluating the impact of this standard.
AmCOMP Preferred and AmCOMP Assurance are required to periodically submit financial statements prepared in accordance with prescribed or permitted statutory accounting practices (“SAP”) to the Florida Department of Financial Services (“FDFS”). Such practices vary from GAAP. Prescribed SAP includes state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC”). Permitted SAP encompasses all accounting practices that are not specifically prescribed, but have been permitted by the regulatory authority; such practices may differ from company to company and may not necessarily be permitted in subsequent reporting periods.
AmCOMP Preferred and AmCOMP Assurance are subject to comprehensive supervision and regulation by the FDFS. Florida statute Section 624.408 requires AmCOMP Preferred and AmCOMP Assurance to maintain minimum capital and surplus of the greater of $4.0 million or 10% of total liabilities. Florida statute Section 624.4095 requires AmCOMP Preferred and AmCOMP Assurance to maintain a ratio of written premiums times 1.25 to surplus of no greater than 10-to-1 for gross written premiums and 4-to-1 for net written premiums. During the years ended December 31, 2007 and 2006, AmCOMP Preferred and AmCOMP Assurance were in compliance with these statutes.
Statutory-basis capital and surplus for AmCOMP Preferred and AmCOMP Assurance as of December 31, 2007 and 2006 is as follows (in thousands):
Under Florida insurance regulations, the maximum dividend to stockholders that may be paid without prior approval by the FDFS is specifically defined by the Florida insurance laws and regulations and is generally based on operating results and capital and surplus. For AmCOMP Preferred and AmCOMP Assurance, no dividends were paid during 2007 and 2006. As of December 31, 2007 and 2006, AmCOMP Preferred had $17.6 million and $15.6 million, respectively, available to pay dividends without prior approval. As of December 31, 2007 and 2006, AmCOMP Assurance had $10.2 million and $7.4 million, respectively, available to pay dividends without prior approval. These amounts represent 10% of statutory surplus, not to exceed unassigned funds.
The Company submits claims to the appropriate state’s second injury fund for recovery of applicable claims paid on behalf of the Company’s insureds. Because of the uncertainty of the collectability of such amounts, second injury fund recoverables are reported in the accompanying consolidated financial statements when received. Cash collections from the second injury funds were approximately $2.3 million, $1.4 million, $2.2 million in the years ended December 31, 2007, 2006 and 2005, respectively.
The Company’s investments in available-for-sale securities and held-to-maturity securities are summarized as follows at December 31, 2007 and 2006 (in thousands):
The foregoing data is based on the stated maturities of the securities. Actual maturities may differ as borrowers may have the right to call or prepay obligations.
Major categories of the Company’s net investment income for the years ended December 31, 2007, 2006 and 2005 are summarized as follows (in thousands):
The Company continuously monitors its portfolio to preserve principal values whenever possible. An investment in a fixed maturity security is impaired if its fair value falls below its book value. All securities in an unrealized loss position are reviewed to determine whether the impairment is other-than-temporary. Factors considered in determining whether an impairment is considered to be other-than-temporary include length of time and the extent to which fair value has been below cost, the financial condition and near-term prospects of the issuer, and the Company’s ability and intent to hold the security until its expected recovery.
Major categories of the Company’s premiums receivable at December 31, 2007 and 2006 are summarized as follows (in thousands):
Certain premiums and losses are ceded to other insurance companies under quota share reinsurance arrangements and various aggregate and specific excess of loss reinsurance agreements. The ceded reinsurance agreements are intended to provide the Company with the ability to maintain its exposure to loss within its capital resources. Losses ceded under these treaties are estimated based on ultimate losses. These estimates are subject to the effects of trends in loss severity. Although considerable variability is inherent in such estimates, management believes that their estimates of losses ceded under these treaties are reasonable. These estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations. Effective July 2004, the Company discontinued the use of quota share reinsurance on new and renewal business.
AmCOMP Preferred and AmCOMP Assurance offer workers’ compensation policies at statutory limits. A summary of specific and aggregate reinsurance retention limits, as well as limits above which retention reverts to the Company are as follows (in thousands):
(a) For policies effective in 2002, the specific retention is $500,000. The reinsurer’s limit on policies effective in 2002 was $50 million. The Company also retained 10% of the layer from $1 million to $10 million for the first half of 2002 on policies effective in 2002 and 10% of the layer from $5 million to $10 million for the second half of 2002 for policies effective in 2002.
(b) For in-force, new and renewal policies effective in 2004, the specific retention is $1 million. The Company also retained 10% of the layer from $5 million to $10 million.
Reinsurance recoverables on paid and unpaid losses and loss adjustment expenses were $67.8 million and $75.4 million at December 31, 2007 and 2006, respectively, of which $32.2 million and $39.1 million, respectively, was recoverable from a single reinsurer, Continental Casualty Company, a subsidiary of CNA Financial Corporation. Management evaluates the financial condition of its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses from reinsurer insolvencies. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company.
Significant components of income tax expense for the years ended December 31, 2007, 2006 and 2005 are as follows (in thousands):
The effective federal income tax rates on income before income taxes differ from the maximum statutory rates as follows for the years ended December 31, 2007, 2006 and 2005 (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and tax liabilities as of December 31, 2007 and 2006 are presented below (in thousands):
The following table provides a reconciliation of the beginning and ending balances for unpaid losses and LAE, reported in the accompanying consolidated balance sheets as of December 31, 2007 and 2006 (in thousands):
The Company’s estimate for losses and LAE related to prior years, net of related reinsurance recoverables, decreased during the years December 31, 2007 and 2006 by $36.5 million and $14.2 million, respectively, as a result of actual loss development emerging more favorably than expected. Excluding business assumed from state mandated pools, the redundancy in the year ended December 31, 2007 was attributable to prior year reserve decreases in Florida ($17.6 million), Tennessee ($4.9 million), Wisconsin ($2.8 million), Indiana ($2.8 million), South Carolina ($2.2 million), Texas ($2.2 million), North Carolina ($1.7 million), Georgia ($1.2 million) and less significant decreases in several other states. The accident years with the largest redundancies were 2006 ($13.4 million), 2005 ($11.1 million) and 2004 ($6.4 million). Excluding assumed business, the redundancy in the year ended December 31, 2006 was attributable to prior year reserve decreases in Florida ($10.9 million), Tennessee ($7.2 million), Indiana ($4.3 million), and Texas ($3.7 million), offset by increases in North Carolina ($4.7 million), and Wisconsin ($3.8 million), with the remaining offset being attributable to other states and assumed business. The redundancy in the year ended December 31, 2005 was attributable to loss development experience being lower than our selected development factors. Because of the Company’s extensive history in Florida, Florida loss development factors significantly influence the results of our actuarial reserving methods. The results of these methods, in turn, influence the IBNR estimate. In years leading up to 2005, Florida loss development experience decreased from previous levels.
Certain policyholders have entered into agreements that provide the opportunity for dividends. Dividends are accrued on such policies based on specific dividend contract provisions, and the policies’ earned premiums and loss ratios. Additionally, dividend agreements also allow management to reduce the amount to be paid at management’s discretion, based on the overall profitability of the Company. Should management choose to reduce the ultimate dividends to be paid, once the amount of the total dividend that will be paid for a policy year is determined, the dividend accrued would be reduced down to the level determined by management. The reduced dividend amount would be allocated ratably to the participating policies, based on the dividend amount calculated prior to the reduction. Approximately 28%, 26% and 25% of the total business was subject to dividend participation during the years ended December 31, 2007, 2006 and 2005, respectively. The dividends are ultimately paid at the sole discretion of the Board of Directors (the “Board”) and must be approved by the Board prior to payment.
Board-mandated dividends accrued for 2007, 2006 and 2005 policies reflect the full potential amount allowed under the respective policies.
Leases-The Company leases office space, equipment and automobiles under noncancelable lease agreements, with various renewal and escalation clauses. Rental expense was $3.2 million, $3.2 million and $2.6 million for 2007, 2006 and 2005, respectively. Future minimum payments under noncancelable capital and operating leases with initial terms of one year or more as of December 31, 2007 are as follows (in thousands):
Employment Contracts-The Company has entered into employment contracts with certain of its executives. These contracts generally provide for continuing compensation for a period of 12 to 18 months if the executives are released without cause, except the contract of the chief executive officer provides for compensation for a period equal to the greater of 18 months or the number of months then remaining in the term of the contract.
Cash and Cash Equivalents-The carrying amount reported in the balance sheet for cash and cash equivalents approximates fair value due to the short-term nature of those items.
Investment Securities-Fair values for fixed maturity securities and other invested assets are based on quoted market prices where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services (see Note 4).
Notes Payable-The Company’s note payable is a floating rate long-term debt. Accordingly, the carrying amount is estimated to approximate the fair value.
The Company sponsors a 401(k) tax-deferred retirement savings plan (the “Plan”) for its employees. The Plan is approved by the Internal Revenue Service and is administered by a national financial management service. The Company matches the employee’s contribution at 100% for the first 2% of salary and 50% for the next 4% of salary. Expenses relating to the Plan were $753,000, $619,000 and $570,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Effective January 1, 2007, eligibility into the plan was changed to allow entrance into the plan following the first full month of employment, which was a change from the six months previously required.
Convertible Preferred Stock Series A-At December 31, 2005, 2.4 million shares of $1.00 par value, voting, participating, convertible preferred stock (“CPS”) was authorized, issued, and outstanding. If the Company declared and paid a dividend on the common stock, the CPS stockholders were entitled to a dividend equal to the dividend that would have been payable to such holder if the shares had been converted. The CPS had a liquidation preference of $10 per share and was convertible, at the holder’s option, into 1.7464 shares of the Company’s common stock for each share of CPS held. The CPS automatically converted into 4,191,399 shares of common stock upon consummation of the qualified public offering.
Common Stock-There were 45 million authorized shares of $.01 par value common stock as of December 31, 2007 and 2006, respectively. At December 31, 2007 and 2006, 15,921,540 and 15,893,162 shares, respectively, were issued and 15,290,181 and 15,758,252, respectively, were outstanding. Dividends are payable as declared by the Board.
During 1997, the Board of Directors approved a director stock option plan (the “Directors Plan”) and reserved 87,320 shares of common stock for issuance under this plan. Under the Directors Plan, options vest over a period determined at the time of grant and are exercisable over a five-year period after the date of grant for an exercise price equal to fair value of the common stock (prior to the initial public offering management’s estimate of the fair market value) on the date of grant . In January 2006, the Directors’ Plan was amended. The amended plan states that all directors who are not employees of AmCOMP are eligible to receive grants of options under the Directors Plan. Each eligible director receives an automatic, nondiscretionary grant of (1) an option to purchase shares of common stock with an aggregate fair market value at the time of grant equal to $66,000 upon election to the Board and (2) options to purchase shares of common stock with an aggregate fair market value at the time of grant equal to $13,200 annually on each January 1 thereafter so long as he remains an eligible director. In addition, the Board has the authority to make discretionary grants of options under the Plan. In April 2007, the Directors plan expired, which had no effect on options outstanding thereunder.
Prior to 1999, the Company granted two executives options to purchase shares under nonqualified stock option agreements. Of the options granted, options to purchase 54,575 and 272,877 common shares are still outstanding as of December 31, 2007 and 2006, respectively. These options vested over a three to five-year period and are exercisable over a 10 year period after the date of grant at an exercise price of $13.74 per share.
Effective January 1, 2006, the Company adopted SFAS No. 123R, using the modified prospective application transition method. Under this method, all outstanding employee stock options are being expensed over the remaining vesting period based on the fair value of the options at the date they were granted. Additionally, SFAS No. 123R requires the estimation of forfeitures in calculating the expense related to stock-based compensation. As a result of the adoption of SFAS No. 123R, the Company recognized approximately $0.7 million and $0.6 million of stock option compensation expense and less than $0.1million of related tax benefit in the years ended December 31, 2007 and 2006, respectively. As of December 31, 2007, total unrecognized compensation expense related to non-vested stock options was approximately $1.3 million. This cost is expected to be recognized over the weighted average period of 1.9 years.
For the years ended December 31, 2005 and prior, the Company has elected to follow APB No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock options granted to employees and directors. Under APB No. 25, because the exercise price of the Company’s employee stock options equals or is greater than the estimated fair value of the underlying stock on the date of grant, no compensation expense is recognized.
As of December 31, 2007, 2006 and 2005, options to purchase 304,515, 360,505 and 588,453 shares were exercisable. The weighted average remaining contractual life of the exercisable options was 2.4 years and 0.6 years as of December 31, 2007 and 2006, respectively. The per-share weighted average grant date fair value of options granted in the years ended December 31, 2007 and 2006 were $3.78 and $3.05, respectively. The fair value of stock options granted was estimated on the dates of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used to perform the calculation of 2007 grant date fair value: zero expected dividend yield, 4.63% risk-free interest rate, 5 year expected life, and 30.3% volatility. The expected life was based on historical exercise behavior and the contractual life of the options. Due to unavailability of historical company information, volatility was based on average volatilities of similar entities for the appropriate period. Forfeitures were estimated at 20% for board members, 5% for executives and 10% for all remaining employees. No options were granted in 2005. The weighted-average grant date fair value of options vesting during 2007, 2006 and 2005 was $2.84, $1.48 and $1.68, respectively. As of December 31, 2007 the aggregate intrinsic value of options outstanding and options exercisable was approximately $0.6 million and $0.2 million, respectively. The total aggregate intrinsic value of options exercised during 2007 and 2006 was approximately $0.1 million and $0.3 million, respectively. No options were exercised in 2005.
For the years ended December 31, 2007, 2006 and 2005, outstanding employee stock options of 879,856, 1,134,979 and 558,483 have been excluded from the computation of diluted earnings per share since they are anti-dilutive.
All share and per share amounts in the condensed consolidated financial statements have been restated to give effect to the 1-for-2.2904 reverse common stock split effected by AmCOMP on February 6, 2006. The stock split was effected as a stock dividend.
On January 10, 2008, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Employers Holdings, Inc., a Nevada corporation ("Employers") and Sapphire Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Employers ("Merger Sub"), providing for the acquisition of the Company by Employers.
The Merger Agreement and related transactions are subject to the approval of the Company's stockholders, the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, the receipt of other material regulatory approvals, including from the Florida Office of Insurance Regulation, and certain other customary closing conditions. The merger and related transactions are expected to be completed by the end of the second quarter of 2008.
Under the Severance Agreements, each of the Executive’s employment with the Company will terminate on the date that is 60 calendar days following the closing of the Merger (the “Separation Date”). The Executives have each agreed to use best efforts to ensure a smooth transition and integration in the Merger and to perform certain other duties prior to and following the closing of the Merger. In consideration of the above, and subject to the consummation of the Merger, provided that the Executive either remains employed by the Company through the Separation Date or is terminated by Employers or the Company other than for cause on or prior to the Separation Date, the Executive will be entitled to receive a bonus in an amount equal to $200,000 in the case of Ms. Cerre-Ruedisili and $110,000 in the case of Mr. Gursahaney, as soon as practicable, but in no event later than, 15 calendar days following the Separation Date.
Each Executive has also acknowledged and agreed that such Executive will continue to be subject to the terms and conditions of the restrictive covenants set forth in Section 9 of such Executive’s employment agreement with the Company for the 18-month period set forth therein (the “Restricted Period”). The Executives have each further agreed to be available to the Company and Employers and to assist the Company and Employers during the Restricted Period in performing such duties as the Company or Employers may request from time to time.