In March, 2013, the Company purchased a building and the adjacent real estate in Carmel, Indiana, approximately 14 miles from downtown Indianapolis. The Company relocated all operations to this new building by the end of 2013. The new building contains a total of 184,000 usable square feet and the Company occupies approximately 60% of this space with the remainder being leased to non-affiliated entities.
The Company's entire operations are conducted from these facilities. The current facilities are expected to be adequate for the Company's operations for the foreseeable future.
The primary sources of the Company’s liquidity are (1) funds generated from insurance operations including net investment income, (2) proceeds from the sale of investments and (3) proceeds from maturing investments. The Company generally experiences positive cash flow from operations resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the Insurance Subsidiaries, other than loss and loss expense payments, generally average less than 33% of net premiums earned on a consolidated basis and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, become negative as loss settlements on claim reserves established in prior years exceed current revenues. During 2013, cash flow from operations totaled $35.9 million compared to $55.8 million total for 2012. The decrease in operating cash flow resulted from the timing of the payment and reinsurance recovery of catastrophic claim losses partially offset by higher premium volume in 2013.
The Company’s assets at December 31, 2013 included $56.9 million in short-term and cash equivalent investments which are readily convertible to cash without market penalty and an additional $99.4 million of fixed maturity investments (at par) maturing in less than one year. The Company believes that these liquid investments, plus the expected cash flow from current operations, are more than sufficient to provide for projected claim payments and operating cost demands. In the event competitive conditions produce inadequate premium rates and the Company chooses to further restrict volume, the liquidity of its investment portfolio would permit management to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, the Company’s reinsurance program is structured to avoid significant cash outlays that accompany large losses.
Net premiums written by the Company’s Insurance Subsidiaries for 2013 equaled approximately 56% of the combined statutory surplus of these subsidiaries. Premium writings of 100% to 200% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the Insurance Subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
Premiums written by the Property and Casualty Insurance segment for 2013 totaled $314.8 million, an increase of $30.6 million (11%) from 2012. This increase is primarily attributable to a $50.2 million (21%) increase in premiums generated by fleet transportation products resulting from increased revenue and miles driven by our insureds, which is immediately reflected in premium, rate increases and the addition of several new accounts during 2013. This increase was partially offset by a decrease of $21.1 million in premiums generated by commercial multi-peril business as the result of management’s decision to exit this business as part of its program to reduce property catastrophe exposures. Premiums ceded to reinsurers on direct business averaged 35.9% for 2013 compared to 37.1 % for 2012, with the decrease attributable to the above described changes in mix of business.
Pre-tax investment income of $8.8 million during 2013 was 12% lower than the 2012 total as pre-tax yields were down nearly 11% on average, reflecting the impact of continuing depressed worldwide available rates on the reinvestment of maturing fixed maturity investments and the redeployment of a portion of invested assets into securities that emphasize capital gains over interest income. After tax investment income decreased by a similar 12% during 2013, compared to the prior year.
Net income for 2013 of $36.6 million compares to net income of $31.9 million during 2012. Diluted earnings per share of $2.45 were recorded in 2013 compared to per share income of $2.15 in 2012.
Direct premiums written for 2012 totaled $284.2 million, an increase of $10.1 million (4%) from 2011. This increase is primarily attributable to (1) a $23.5 million (11%) increase in premiums generated by fleet transportation products attributable to increased revenue and miles driven by our insureds, which is immediately reflected in premium, and the addition of several new accounts during 2012; and (2) an increase of $6.3 million in premiums generated by planned growth in the Company’s relatively new professional liability business, partially offset by decreases of (1) $15.2 million in premiums generated by commercial multi-peril business as the result of management’s decision to exit this business as part of its program to limit property catastrophe exposures; and (2) $6.0 million from personal automobile products attributable to rate increases instituted late in 2011 and throughout 2012 which returned this product line to profitability but restricted premium volume. Premiums ceded to reinsurers on direct business averaged 37.1% for 2012 compared to 30.7 % for 2011, with the increase attributable to increased direct premium writings in products which are more heavily reinsured.
Losses and loss expenses incurred during 2012 decreased $77.5 million (36%) from 2011 to $138.1 million, with virtually all of the decrease attributable to a decrease in major catastrophe losses of $65.6 million with the remainder associated with the decreased premium volume described above. The 2012 consolidated loss and loss expense ratio was 58.1% compared to 88.1% for 2011. The Company's loss and loss expense ratios for major product lines are summarized in the following table:
The Company produced an overall savings on the handling of prior year claims during 2012 of $9.9 million. This net savings is included in the computation of loss ratios shown in the previous table, as is the similar $9.7 million savings produced during 2011 on prior year claims. The $7.1 million net savings attributable to the property and casualty insurance segment was distributed among all of the Company’s products, with the majority attributable to the Company's fleet transportation and personal automobile businesses, and is generally consistent with recent prior years. The $2.8 million savings attributable to the reinsurance segment related solely to property catastrophe business. Because of the high limits provided by the Company to its fleet transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company's reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
Reinsurance ceded credits were $3.7 million (32%) higher in 2012, resulting from increased business ceded to other companies under quota share reinsurance treaties which provide commissions to the Insurance Subsidiaries. After consideration of these expense offsets, operating expenses increased $4.1 million, or 6% from the prior year.
The effective federal tax rate on the consolidated pre-tax income for 2012 was 31.5%. The effective rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.
All marketable securities are included in the Company’s balance sheets at current fair market value.
Amounts recoverable under the terms of reinsurance contracts comprise approximately 18% of total Company assets as of December 31, 2013. In order to be able to provide the high limits required by the Company’s insureds, we share a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts. Some reinsurance contracts provide that a loss be shared among the Company and its reinsurers on a predetermined pro-rata basis (“quota-share”) while other contracts provide that the Company keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount (“excess of loss”). Some risks are covered by a combination of quota-share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by the Company’s insurance policies for fleet transportation liability, workers’ compensation and professional liability risks provide more variability in the estimation process than lines of business with lower coverage limits.
The Company’s loss and loss expense reserves for each segment are shown in the following table on both a gross (before consideration of reinsurance) and on a net of reinsurance basis at December 31, 2013 and 2012 (dollars in thousands).
The variation in impact from loss ratio increases and decreases is attributable to minimum and maximum premium rate factors included in the various reinsurance contracts.
There is an inverse relationship between interest rate fluctuations and the fair value of the Company's fixed maturity investments. Additionally, the fair value of interest rate sensitive instruments may be affected by the financial strength of the issuer, prepayment options, relative values of alternative investments, liquidity of the investment and other general market conditions. The Company monitors its sensitivity to interest rate risk by measuring the change in fair value of its fixed maturity investments relative to hypothetical changes in interest rates.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Realized gains and losses on disposals of investments are determined by specific identification of cost of investments sold and are included in income. All fixed maturity and equity securities are considered to be available for sale; the related unrealized net gains or losses (net of applicable tax effect) are reflected directly in shareholders’ equity. Included within available for sale fixed maturity securities are insurance linked securities and convertible debt securities. The changes in fair values of insurance-linked securities and portions of the changes in fair values of convertible debt securities are reflected as a component of net realized gains (losses) on investments.
In May 2011, the FASB issued updated accounting guidance that changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between GAAP and International Financial Reporting Standards. The guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The guidance, which was effective January 1, 2012, had no financial impact on the Company’s consolidated financial statements.
Reclassification: Certain prior year balances have been reclassified to conform to the current year presentation.
The fair value and the cost or amortized cost of fixed maturity investments at December 31, 2013, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.
Major categories of investment income for the years ended December 31 are summarized as follows:
Shareholders' equity includes approximately $24,461, net of deferred federal income taxes, of undistributed earnings from limited partnerships as of December 31, 2013.
The fair value of regulatory deposits with various insurance departments in the United States and Canada totaled $63,447 and $47,791 at December 31, 2013 and 2012, respectively.
The Company’s fixed maturities are over 89% invested in investment grade fixed maturity investments. The Company has a total of $20,324, representing 11 different investments, of fixed maturity investments which were originally issued with guarantees by three different third party insurance companies, with the largest exposure to a single investment being $4,035. The average S&P credit rating of such investments, with consideration of the guarantee, is AA. The average S&P underlying credit rating of such investments, without consideration of the guarantee, would remain AA. The Company does not have any direct exposure to any guarantor.
Approximately $44,800 of fixed maturity investments (6.4% of total invested assets) consists of bonds rated as less than investment grade at year end. These investments include a diversified portfolio of over 40 investments including catastrophe bonds and have a $662 net unrealized gain position at December 31, 2013. As of December 31, 2013, the Company had committed funds totaling $12,000 related to two bridge loan agreements. The Company retains possession of these funds which will only be loaned in the unlikely event that long-term financing is unavailable to the counter party in the market.
The following table summarizes the impact of reinsurance ceded and assumed on the Company’s net premium written and earned for the most recent three years:
Cash flows related to federal income taxes paid, net of refunds received, for 2013, 2012 and 2011 were $17,250, $3,661 and $2,859, respectively.
The Company's Class A and Class B common stock has a stated value of approximately $.04 per share. The Company paid a total of $14,943, $14,886 and $14,846, or $1.00 per share, in dividends for the years 2013, 2012 and 2011, respectively.
The Company maintains a defined contribution 401(k) Employee Savings and Profit Sharing Plan (the “Plan”) which covers nearly all employees who have completed one year of service. The Company's contributions to the Plan for 2013, 2012 and 2011 were $1,798, $1,539 and $1,452, respectively.
Under the Director Option Plan (the “Director Plan”), which is shareholder approved, the Company has reserved 300,000 shares of Class B common stock for the granting of discounted and market value options to non-employee directors. Approximately 167,000 shares of Class B common stock are available for future grants. No options were granted to directors during the three year period ended December 31, 2013. Additionally, no discounted options were outstanding or exercised at any time during this three year period. Accordingly, no compensation cost was charged against income for the Director Plan for 2013, 2012 and 2011.
Director compensation cost associated with restricted stock grants of $440 was charged against income for the restricted stock units for 2013, 2012 and 2011.
The Company operates within two reportable business segments: property and casualty insurance and reinsurance. The property and casualty insurance segment provides multiple line insurance coverage primarily to fleet transportation companies and to independent contractors who contract with fleet transportation companies, as well as individual personal automobile coverage, professional liability coverages and business owners’ and commercial property policies. The reinsurance segment accepts cessions from other insurance companies as well as retrocessions from selected reinsurance companies, providing property catastrophe and casualty reinsurance coverages.
An additional $177,389, $146,447 and $129,508 for 2013, 2012 and 2011, respectively, is placed with the Company by a non-affiliated broker on behalf of independent contractors of this same customer but is not dependent upon the direct business with this customer.
During 2011 the Company sustained a net loss. Accordingly, the anti-dilutive effect of 19,983 shares was excluded from the calculation of the average shares outstanding.
Acceptable collateral may be provided in the form of letters of credit on Company approved banks, Company approved marketable securities or cash. At December 31, 2013, the Company held collateral in the aggregate amount of $223,232.
The Company maintains a revolving line of credit with a $30,000 limit, with an expiration date of September 23, 2014. Interest on this line of credit is referenced to LIBOR and can be fixed for periods of up to one year at the Company’s option. Outstanding drawings on this line of credit were $10,000 as of December 31, 2013 and 2012. At December 31, 2013, the effective interest rate was 1.06%. The Company has $20,000 remaining unused under the line of credit at December 31, 2013. The current outstanding borrowings were used principally for general corporate purchases.
Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The carrying amounts reported in the consolidated balance sheets for cash, accounts receivables, reinsurance recoverable, notes receivable, accounts payable and accrued expenses, income taxes payable, short term borrowings and unearned income approximate fair value because of the short term nature of these items. The following tables summarize fair value measurements by level for assets measured at fair value on a recurring basis:
Limited partnerships: The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to carry the investment at its proportionate share of the limited partnership’s equity. The underlying assets of the Company’s investments in limited partnerships are carried primarily at fair value, and, therefore, the Company’s carrying value of limited partnerships approximates fair value. As these investments are not actively traded and the corresponding inputs are based on data provided by the investees, they are classified as Level III.
A summary of the carrying value and fair value by level of financial instruments not recorded at fair value on the Company’s consolidated balance sheet at December 31, 2013 and 2012 is as follows:
Net income (loss) of the insurance subsidiaries, all of which are wholly owned, as determined in accordance with statutory accounting practices, was $30,886, $29,262 and ($19,120) for 2013, 2012 and 2011, respectively. Consolidated statutory capital and surplus for these subsidiaries was $377,209 and $338,857 at December 31, 2013 and 2012, respectively, of which $60,628 may be transferred by dividend or loan to the parent company during calendar year 2014 with proper notification to, but without approval from, regulatory authorities. An additional $223,086 of shareholders’ equity of such insurance subsidiaries could, under existing regulations, be advanced or loaned to the parent company with prior notification to and approval from regulatory authorities, although it is unlikely that transfers of this size would be practical.