Our principal executive offices are located in leased premises of approximately 32,536 square feet in North Palm Beach, Florida. We also lease a total of approximately 70,152 square feet of office space in 10 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.
Year Ended December 31, ----------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---------- --------- --------- ---------- ---------- (Dollars and shares in thousands, except per-share data) STATEMENT OF OPERATIONS DATA: REVENUES: Net premiums earned $ 266,456 $ 256,603 $ 181,186 $ 164,287 $ 196,478 Net investment income 17,461 10,798 6,077 4,803 5,689 Net realized investment (loss) gain (307) (385) 982 2,644 320 Other income (loss) 333 285 332 (2,464)(1) 1,446 --------- --------- --------- --------- --------- Total revenue $ 283,943 $ 267,301 $ 188,577 $ 169,270 $ 203,933 --------- --------- --------- --------- --------- EXPENSES: Losses and loss adjustment expenses(2) $ 163,670 $ 143,663 $ 119,121 $ 109,518 $ 126,386 Policy acquisition expenses 49,547(3) 51,508(4) 19,499 21,735 40,925 Underwriting and other expenses 32,175 34,447 32,280 30,244 25,579 Dividends to policyholders 9,926 8,612 6,983 5,796 5,931 Interest expense 3,807 2,960 1,389 410 352 --------- --------- --------- --------- --------- Total expenses $ 259,125 $ 241,190 $ 179,272 $ 167,703 $ 199,173 --------- --------- --------- --------- --------- Income before income taxes 24,818 26,111 9,305 1,567 4,760 Income tax expense 8,256 9,326 4,275 632 1,379 --------- --------- --------- --------- --------- Net income before cumulative effect of accounting change 16,562 16,785 5,030 935 3,381 --------- --------- --------- --------- --------- Cumulative effect of accounting change -- -- -- -- 2,455(5) --------- --------- --------- --------- --------- Net income $ 16,562 $ 16,785 $ 5,030 $ 935 $ 5,836 ========= ========= ========= ========= ========= OPERATING DATA: Direct premiums written $ 266,827 $ 270,331 $ 260,173 $ 231,083 $ 227,241 Gross premiums written 273,713 277,095 270,981 239,484 232,536 Net premiums written 264,788 267,652 217,472 144,952 209,537 PER SHARE DATA: Earnings per share Basic $ 1.15 $ 3.13 $ 0.94 $ 0.17 $ 1.07 Diluted 1.11 1.76 0.53 0.10 0.61 Weighted average common shares outstanding Basic 14,452 5,367 5,368 5,368 5,437 Diluted 14,931 9,562 9,564 9,562 9,628
As of December 31, -------------------------------------------------------- 2006 2005 2004 2003 2002 ----------- ---------- ---------- ---------- ----------- (Dollars and shares in thousands, except per share data) Balance Sheet Data: ASSETS Cash and investments $436,775 $338,546 $265,407 $183,884 $141,532 Premiums receivable--net 106,270 104,522 101,638 96,818 94,133 Reinsurance recoverables 75,360 83,880 115,870 99,894 84,907 Deferred policy acquisition costs 20,749 19,413 14,695 4,902 16,149 Deferred income taxes 21,613 20,871 17,646 19,368 12,065 Other assets 23,730 22,455 32,814 52,506 64,351 -------- -------- -------- -------- -------- Total assets $684,497 $589,687 $548,070 $457,372 $413,137 -------- -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Unpaid losses and loss adjustment expenses $334,363 $309,857 $297,698 $251,122 $227,714 Unearned and advance premiums 115,218 115,574 114,235 102,804 89,350 Notes Payable 38,250 40,036 41,821 11,607 7,438 Other liabilities 57,378 52,239 35,981 37,055 32,492 -------- -------- -------- -------- -------- Total liabilities 545,209 517,706 489,735 402,588 356,994 Preferred stock -- 23,098 23,098 23,098 23,098 Total stockholders' equity 139,288 71,981 58,335 54,784 56,143 -------- -------- -------- -------- -------- Total liabilities and stockholders' equity $684,497 $589,687 $548,735 $457,372 $413,137 -------- -------- -------- -------- --------
(1) Includes a pre-tax loss of $2.1 million from the commutation of two reinsurance agreements in 2003.
(4) 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.
(6) Losses and LAE divided by net premiums earned, after the effects of reinsurance.
(9) Sum of ratios computed in footnotes 6, 7 and 8.
THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE ACCOMPANYING NOTES APPEARING ELSEWHERE IN THIS REPORT.
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 to provide workers' compensation insurance in 23 states, but currently focus our resources in 15 states that we believe provide the greatest opportunity for near-term profitable growth.
o premiums we earn from the sale of workers' compensation insurance policies and from the portion of the premiums assumed from the National Workers' Compensation Reinsurance Pool ("NWCRP") and other state mandated involuntary pools, which we refer to as gross premiums, less the portion of those premiums that we cede to other insurers, which we refer to as ceded premiums. We refer to the difference between gross premiums and ceded premiums as net premiums; and
o insurance losses and LAE relating to the insurance policies we write directly and to the portion of the losses assumed from the state mandated involuntary pools, including estimates for losses incurred during the period and changes in estimates from prior periods, which
we refer to as gross losses and LAE, less the portion of those insurance losses and LAE that we cede to our reinsurers, which we refer to as ceded losses and LAE. We refer to the difference as net losses and LAE;
In accordance with industry practice, we also maintain estimates of reserves for losses and LAE incurred but not reported, or IBNR. IBNR reserves, unlike case reserves, do not apply to a specific claim, but rather apply to the entire body of claims arising from a specific time period. IBNR primarily provides for costs due to:
The range of estimates for IBNR as of December 31, 2006 produced by the various separate actuarial reserving methods we reviewed ranged from $31.7 million above the point estimate (for the reserve development method) and $31.1 million below the point estimate (for the paid loss development method). This range does not necessarily constitute a range of reasonable estimates and does not imply that each of these loss estimates is equally likely. No one actuarial reserving method has consistently been found to be more predictive than any other.
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.
3. Paid Development Method - A method using historical, cumulative paid 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.
SENSITIVITY OF NET LOSS RESERVES TO CHANGES IN ACTUARIAL ASSUMPTIONS as of December 31, 2006 (all dollar amounts in thousands)
Improve Expected Loss Ratio by 10% and Improve Loss Development Patterns by 10% (20,418)
Deteriorate Expected Loss Ratio by 10% and Improve Loss Development Patterns by 10% (5,403)
Deteriorate Expected Loss Ratio by 10% and Deteriorate Loss Development Patterns by 10% 20,892
SENSITIVITY OF GROSS LOSS RESERVES TO CHANGES IN ACTUARIAL ASSUMPTIONS as of December 31, 2006 (all dollar amounts in thousands) Change in Gross Loss Change in Assumptions Reserves -------------------------------------------------------- -------------------- Improve Expected Loss Ratio by 10% $(10,710)
Improve Expected Loss Ratio by 10% and Deteriorate Loss Development Patterns by 10% 7,966
1. Changes in the initial expected loss ratio--We varied the initial expected loss ratio utilized in the Bornhuetter-Ferguson methods by + / - 10% (e.g., if the initial expected loss ratio was 60% for a particular state and accident year, we calculated the sensitivity of reserves to a change in loss ratio of 6% = 10% x 60%). Changes in the initial expected loss ratio affect the results of the two Bornhuetter-Ferguson methods.
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, 2006 and 2005, our deferred acquisition costs were $20.7 million and $19.4 million, respectively.
balance sheet in accumulated other comprehensive income as a separate component of stockholders' equity. We have historically held until maturity those securities designated as held-to-maturity and intend to maintain our investment guidelines so that we would do so in the future.
GROSS PREMIUMS WRITTEN. Gross premiums written is the sum of direct premiums written and assumed premiums written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten by our insurance subsidiaries. Assumed premiums written represent our share of the premiums assumed from state mandated involuntary pools. We use gross premiums written, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.
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. For each day a one-year policy is in force, we earn 1/365th of the annual premium.
POLICY ACQUISITION EXPENSE RATIO. The policy acquisition expense ratio is a measure of an insurance company's operational efficiency in producing and underwriting its business. Expressed as a percentage, this is the ratio of policy acquisition expenses to net premiums earned.
UNDERWRITING AND OTHER EXPENSE RATIO. The underwriting and other expense ratio is a measure of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of underwriting and other expenses to net premiums earned. For underwriting and other expense ratio purposes, underwriting and other expenses of an insurance company exclude investment expenses and dividends to policyholders.
Year Ended December 31, --------------------------------------- Increase Increase (decrease) (decrease) 2006 over 2005 over 2006 2005 2004 2005 2004 ---------- ---------- ---------- ---------- ----------- (Dollars in thousands) SELECTED FINANCIAL DATA: Gross premiums written $ 273,713 $ 277,095 $ 270,981 (1.2)% 2.3% Net premiums written 264,788 267,652 217,472 (1.1) 23.1 Gross premiums earned 277,018 276,117 259,445 0.3 6.4
Net premiums earned 266,456 256,603 181,186 3.8 41.6 Net investment income 17,461 10,798 6,077 61.7 77.7 Net realized investment (loss) gain (307) (385) 982 (20.3) (139.2) Other income 333 285 332 16.8 (14.2) --------- --------- --------- Total revenue $ 283,943 $ 267,301 $ 188,577 6.2% 41.7% --------- --------- --------- Losses and loss adjustment expenses 163,670 143,663 119,121 13.9 20.6 Policy acquisition expenses 49,547 51,508 19,499 (3.8) 164.2 Underwriting and other expenses 32,175 34,447 32,280 (6.6) 6.7 Dividends to policyholders 9,926 8,612 6,983 15.3 23.3 Interest expense 3,807 2,960 1,389 28.6 113.1 Federal and state income taxes 8,256 9,326 4,275 (11.5) 118.2 --------- --------- --------- ------ ------ Net income $ 16,562 $ 16,785 $ 5,030 (1.3)% 233.7% ========= ========= ========= ====== ======
KEY FINANCIAL RATIOS: Net loss ratio 61.4% 56.0% 65.7% Net policy acquisition expense ratio 18.6 20.1 10.8 Underwriting and other expense ratio 12.1 13.4 17.8 --------- --------- --------- Net combined ratio, excluding policyholder dividends 92.1% 89.5% 94.3% Dividend ratio 3.7 3.4 3.9 --------- --------- --------- Net combined ratio, including policyholder dividends 95.8% 92.9% 98.2% ========= ========= =========
Gross premiums written increased $6.1 million, or 2.3% in 2005 as compared to 2004. Gross premiums written were relatively flat in 2005 primarily due to a decrease in assumed premiums from the NWCRP involuntary pool, which declined $4.0 million to $6.8 million in 2005 from $10.8 million in 2004. Direct written premium increased 3.9% to $270.3 million in 2005 from $260.1 million in 2004.
This is attributable to an increase in the number of policies written. The average policy premium did not change significantly from 2004 to 2005.
NET PREMIUMS WRITTEN decreased $2.9 million, or 1.1% in 2006 as compared to 2005. This decrease is the result of the decrease in gross premiums written. The retention in our 2006 and 2005 excess-of-loss treaties was unchanged at $2.0 million.
Net premiums written increased $50.2 million, or 23.1% in 2005 as compared to 2004. Net premiums written were significantly impacted by the changes in our quota share reinsurance arrangements. In 2004, we terminated our quota share reinsurance arrangement for new and renewal business effective July 1, 2004. The premium associated with quota share reinsurance was completely run off by July 1, 2005. The increase in the retention in our 2005 excess-of-loss reinsurance program reduced our ceded premiums written for the $1.0 million excess of $1.0 million layer.
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.
NET PREMIUMS EARNED increased $9.9 million, or 3.8 % in 2006 as compared to 2005. This increase is in part attributable to the elimination of the quota share reinsurance on all new and renewal business after July 1, 2004. During 2006 the activity on quota share treaties was minimal and attributable to premium audits performed on prior year policies. In 2005, $7.3 million of earned premiums was ceded under quota share reinsurance agreements The remaining increase in 2006 net premiums earned is primarily the result of the reduction in the excess-of-loss reinsurance contractual rate from 4.5% of direct premiums written in 2005 to 3.2% in 2006. The rate decrease in the excess-of-loss reinsurance is due to the elimination of ceding commission in the 2006 contract.
Net premiums earned increased $75.4 million, or 41.6 % in 2005 as compared to 2004. The increase in net premiums earned in 2005 is greater than the increase in gross premiums earned due to the elimination of quota share reinsurance on all new and renewal business after July 1, 2004 and the reduction in excess-of-loss reinsurance premiums from 7.5% of gross premiums earned in 2004 to 4.5% for 2005 as a result of an increase in our retention level.
Percent of Percent of Percent of Gross Gross Gross Premiums Premiums Premiums 2006 Earned 2005 Earned 2004 Earned ---------- ---------- ---------- ---------- ---------- ---------- (Dollars in thousands)
Gross premiums earned $ 277,018 100.0% $ 276,117 100.0% $ 259,445 100.0% Excess reinsurance premiums (10,814) (3.9) (12,224) (4.5) (19,322) (7.5) Facultative reinsurance premiums 221 0.1 -- -- -- -- Quota share reinsurance premiums 31 0.0 (7,290) (2.6) (58,937) (22.7) --------- ---- --------- ------ --------- ------ Net premiums earned $ 266,456 96.2% $ 256,603 92.9% $ 181,186 69.8% ========= ==== ========= ====== ========= ======
Net realized investment (loss) gain was ($0.4) in 2005, as compared to $1.0 in 2004. In 2005 we sold two bonds due to credit issues, which accounted for the majority of our realized loss. In 2004, due to a decline in interest rates, we sold securities in our investment portfolio and recognized gains.
We observed that a general downward trend in loss development factors in place for some time accelerated in 2003. We believe that much of this trend is due to the effects of Florida Senate Bill 50A, enacted on October 1, 2003. This law was a workers' compensation reform act that reduced attorney fees and involvement on open workers' compensation claims in Florida. In this environment, there is less uncertainty surrounding the ultimate cost of claims, and there is a greater ability to settle claims promptly. Both of these factors lower loss development. Based on the entirety of our loss development history, including the observations noted above, with each passing quarter of favorable loss development, the loss development experience becomes more credible, and the expected future development decreases. This resulted in a change in 2005 in selected loss development factors affecting all accident years. Excluding ULAE and state mandated involuntary pools, Florida experienced $11.0 million in redundancy, Texas $5.3 million, Georgia $3.0 million, Virginia $2.7 million and Indiana $2.7 million. Overall, the 2005 accident year net loss ratio was 61.3% at December 31, 2005, compared to a 2004 accident year net loss ratio of 67.1 at December 31, 2004. In 2005, NWCRP pool losses of $7.3 million were allocated to us, representing 88.1% of net premiums earned from that pool during 2005.
POLICY ACQUISITION EXPENSES decreased $2.0 million, or 3.8% in 2006 as compared to 2005. Policy acquisition expenses were 18.6% and 20.1% of net premiums earned in 2006 and 2005, respectively. This decrease is the result of decreases in premium taxes and assessments, partially offset by increases in commissions and the general and administrative expense component of policy acquisition expenses. Premium taxes represented 1.6% of net premiums earned, compared to 1.9% for 2005. This decrease is the result of the application of
state income tax credits allowed on the Florida premium tax return in the current year. Assessments represented 3.0% of net premiums earned, compared to 6.5% for 2005. This is due in part to a approximately 30% decrease in the South Carolina SDTF rate during the third quarter of 2006, and a 90% increase in the rate in the third quarter of 2005. Additionally, in 2006 the rate used for the 2005 premium assessment by the Florida Guarantee Fund assessment was reduced to zero from the original 2% accrued during 2005. The Florida Workers' Compensation Insurance Guarantee Association did not assess the 2005 premiums in 2005; however, it reserved the right to assess the 2005 premiums in 2006 if any solvency issues arose that required additional cash flow for the Association. As no assessment was made during 2006 for premiums written in 2005, and the time period in which the Association was able to assess the 2005 premiums has passed, the accrual for assessment on the 2005 premium was reduced to zero. These decreases were partially offset by an increase in commissions. The commissions increase is the result of receiving no ceding commission to offset commission expense on the 2006 excess-of-loss treaty, compared to a 35% commission received on the 2005 treaty. In 2005, ceding commissions reduced policy acquisition expenses by $7.4 million, which decreased the expense ratio by 2.9%. In 2006, ceding commission was reduced to $1.9 million, which decreased the expense ratio by 0.7%. The general and administrative expenses associated with policy acquisition costs represented 3.9% of net premiums earned, compared to 3.4% for 2005. This increase is primarily the result of an increase in the payroll expense attributed to underwriting in 2006.
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 increased $0.8 million, or 28.6% in 2006 as compared to 2005. The increase is attributable to an interest rate increase of approximately 1% on our $38.3 million of variable rate debt. Additionally, during 2006, interest expense increased as the result of accruing approximately $0.3 million of interest in connection with an interest bearing payable.
Federal and state income taxes increased $5.1 million, or 118.2% in 2005 as compared to 2004. Federal and state income taxes were 35.7% of pretax income in 2005, and 46.0% of pretax income in 2004. The effective tax rate for 2005 includes a 35% federal tax rate. The state of Florida's tax rate is 5.5%. We apportion our pretax income to the State of Florida according to the State's apportionment factors. For 2005, this decreased the effective state tax rate to 3.5%. This was an increase compared to our 2004 apportioned rate used of 2.5%. The tax exempt interest lowered our effective tax rate by 2.2%. The increase in the effective rate for 2004 was due to an adjustment in 2004 in the effective rate used in calculating the value of the deferred tax assets. The rate was adjusted to 34.0% from 35.0% to reflect the current federal tax rate and to 3.5% from 5.5% to reflect the current Florida state tax rate after its apportionment of income. These are the rates at which we expect to be taxed when the deferred tax asset is utilized. The adjustment in the rates caused an additional deferred tax expense of approximately $1.2 million to be recognized in 2004, creating the higher effective tax rate.
regarding solvency. The cash requirements of these non-insurance subsidiaries are primarily for the payment of salaries, employee benefits and other operating expenses.
We have historically met our cash requirements and financed our growth principally from operations, the proceeds of borrowings, investment income and more recently the initial public offering completed February 10, 2006 for $48.0 million. Cash flow is summarized in the table below.
For the Twelve Months Ended December 31, ------------------------------------ 2006 2005 2004 ---------- ---------- ---------- Cash and cash equivalents provided by (used in): Operating activities $ 54,154 $ 83,602 $ 59,047 Investing activities (98,160) (108,877) (102,862) Financing activities 48,176 (1,789) 30,214 ------- -------- -------- Change in cash and cash equivalents $ 4,170 ($ 27,064) ($ 13,601) ======= ======== ========
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."
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, 2006 and December 31, 2005, reinsurance recoverables on paid and unpaid losses and LAE and ceding commissions were $75.4 million and $83.9 million, respectively. Our largest recoverable from a single reinsurer as of December 31, 2006 was $39.1 million owed to us by Continental Casualty Company, a subsidiary of CNA Financial Corporation, representing 28.1% of our total stockholders' equity as of that date. Of the $39.1 million, $1.6 million was the current recoverable on paid losses. The balance of $37.5 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.
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, 2006, 81.9% of our entire portfolio was classified as available-for-sale and as of December 31, 2005, approximately 90.3% of our entire portfolio was classified as available-for-sale.
The amount and types of investments that may be made by our insurance subsidiaries are regulated under the Florida Insurance Code and the rules and regulations promulgated by the Florida OIR. As of December 31, 2006 and December 31, 2005, our insurance subsidiaries' combined portfolio consisted entirely of investment grade fixed-income securities. As of December 31, 2006, our investments (excluding cash and cash equivalents) had an average duration of 3.9 years, and the bond portfolio was heavily weighted toward short- to intermediate-term securities.
The table below contains information concerning the composition of our investment portfolio at December 31, 2006:
Carrying Yield to Percentage of Amount (1) Maturity Carrying Amount (1) ---------- -------- ------------------- (Dollars in thousands) Bonds:(2) U.S. government $ 34,162 4.8% 7.8% Agencies 41,846 5.2 9.6 Municipalities(3) 74,055 5.2 16.9 Corporate "A" rated and above 169,689 5.4 38.9 Corporate "BBB"/"Baa" rated 17,949 5.6 4.1 Mortgage-backed securities 83,815 5.6 19.2 -------- --- ----- Total Bonds $421,516 5.4% 96.5% Cash and cash equivalents 15,259 5.5 3.5 -------- --- -----
(1) Carrying amount is amortized cost for bonds held-to-maturity. Carrying value is market value for bonds available-for-sale and common stock. As of December 31, 2006, $345.3 million of our bonds was classified as available-for-sale and $76.2 million were classified as held-to-maturity.
(2) Standard & Poor's highest rating is "AAA" and signifies that a company's capacity to meet its financial commitment on the obligation is extremely strong, followed by "AA" (very strong), "A" (strong) and "BBB" (adequate). Ratings may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. Moody's Investors Service, Inc.'s highest rating is "Aaa" (best quality), followed by "Aa" (high quality), "A" (strong) and "Baa" (adequate). For investments with split ratings, the higher rating has been used.
The table below sets forth the maturity profile of our bond portfolio at amortized cost and fair market values as of December 31, 2006:
Available-for-Sale Held-to-Maturity ----------------------- ------------------------ Amortized Amortized Cost Fair Value Cost Fair Value --------- ----------- --------- ----------
The following table summarizes, for all fixed maturity securities in an unrealized loss position at December 31, 2006, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
Unrealized Number of Fair Value Losses Issues ---------- ---------- --------- (In thousands) Less than 12 months: U.S. Treasury securities $ 1,097 $ 12 5 Agency 7,966 25 4 Municipalities 15,669 132 7 Corporate debt securities 33,493 230 17 Mortgage-backed securities 28,930 54 11 -------- -------- --- Total $ 87,155 $ 453 44 ======== ======== === Greater than 12 months: U.S. Treasury securities $ 27,148 $ 695 22 Agency 21,676 422 15 Municipalities 36,116 687 26 Corporate debt securities 134,240 2,967 102 Mortgage-backed securities 28,160 666 20 -------- -------- --- Total $247,340 $ 5,437 185 ======== ======== === Total fixed maturity securities: U.S. Treasury securities $ 28,245 $ 707 27 Agency 29,642 447 19 Municipalities 51,785 819 33 Corporate debt securities 167,733 3,197 119 Mortgage-backed securities 57,090 720 31 -------- -------- --- Total fixed maturity securities $334,495 $ 5,890 229 ======== ======== ===
In August 1998, in an effort to expand its customer base, AmCOMP Assurance 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. This arrangement also provided for a reinsurance agreement between AmCOMP Assurance as the reinsurer and the third party insurance company as the reinsured. At December 31, 2006, the amount to be recovered from this insurance company on these claims and LAE expenses paid by us that is included in other assets on the balance sheet was $1.7 million.
------------------------------- (1) 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, 2006. The rates ranged from 7.85% to 9.62%.
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 attribute 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 is effective January 1, 2007 The Company is currently evaluating the impact of this standard.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, CONSIDERING THE EFFECTS OF PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS ("SAB 108"). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The Company was required to adopt the provisions of SAB 108 in its annual financial statements for fiscal year 2006. The adoption of SAB 108 did not have a material impact on our financial condition or results of operations.
Statement of Position ("SOP") 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts, issued September 2005, became effective January 1, 2007. SOP 05-1 provides guidance on accounting for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverage that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The Company does not anticipate a significant impact upon adoption.
Financial Statements as of December 31, 2006 and 2005 and for the Three Years Ended December 31, 2006: Page ---- Report of Independent Registered Public Accounting Firm.................. 67 Consolidated Balance Sheets.............................................. 68 Consolidated Statements of Operations.................................... 69 Consolidated Statements of Changes in Stockholders' Equity............... 70 Consolidated Statements of Cash Flows.................................... 71 Notes to Consolidated Financial Statements............................... 72-92
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
AMCOMP INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2006 AND 2005 (In thousands)
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (In thousands, except per share amounts)
Convertible Accumulated Preferred Additional Other Total Common Stock Paid-In Treasury Retained Comprehensive Stockholders' Stock Series A Capital Stock Earnings Income (Loss) Equity --------- --------- --------- ---------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 2003 ......... $ 54 $ 23,098 $ 536 $ (195) $ 29,613 $ 1,678 $ 54,784 Net income ......................... -- -- -- -- 5,030 -- 5,030 Unrealized loss on investments (net of tax benefit of $939) .......... -- -- -- -- -- (1,479) (1,479) Comprehensive income ............... -- -- -- -- -- -- 3,551 --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2004 ......... 54 23,098 536 (195) 34,643 199 58,335 Net income ......................... -- -- -- -- 16,785 -- 16,785 Unrealized loss on investments (net of tax benefit of $1,789) ........ -- -- -- -- -- (3,135) (3,135) Comprehensive income ............... -- -- -- -- -- -- 13,650 Purchase of treasury stock ......... -- -- -- (4) -- (4) --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2005 ......... 54 23,098 536 (199) 51,428 (2,936) 71,981 Net income ......................... -- -- -- -- 16,562 -- 16,562 Unrealized loss on investments (net of tax benefit of $121) .......... -- -- -- -- -- 323 323 Comprehensive income ............... -- -- -- -- -- -- 16,885 Conversion of Series A Preferred into Common Stock ................ 42 (23,098) 23,056 -- -- -- -- Stock issued during initial public offering (net of offering costs of $2,341) .......................... 60 -- 47,912 -- -- -- 47,972 Stock option compensation expense .. -- -- 545 -- -- -- 545 Stock option exercise .............. 2 -- 1,826 -- -- -- 1,828 Tax benefit on stock options ....... -- -- 77 -- -- -- 77 --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2006 ......... $ 158 $ -- $ 73,952 $ (199) $ 67,990 $ (2,613) $ 139,288 ========= ========= ========= ========= ========= ========= =========
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.
PROPERTY AND EQUIPMENT--Property and equipment is stated on the basis of cost. Depreciation is computed using the straight-line method over the estimated useful lives, generally 3 to 7 years for financial reporting purposes. Depreciation expense was $1.7 million, $2.1 million and $2.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. Accumulated depreciation was $12.8 million and $14.3 million at December 31, 2006 and 2005 respectively.
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.
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 and taxes.
UNPAID LOSSES AND LAE--Unpaid losses and LAE represent the estimated ultimate net cost of all reported and unreported losses incurred through December 31, 2006 and 2005. The reserves for unpaid losses and LAE are estimated using individual case basis valuations and statistical analyses. Those estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in such estimates, management believes that the reserves for losses and LAE are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations.
RECOGNITION OF PREMIUM REVENUE--The Company's insurance premiums are billed annually or under various installment plans based on the estimated annual premium under the policy terms. 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 included in premiums receivable include estimated future audit premiums and collateralized premiums. Collateralized premiums include policies where the final calculated premium is paid after the end of the policy term and the receivable balance is collateralized by letters of credit and financial guarantee bonds. Estimated future audit premiums are based on the Company's historical earned premium development experience. All premium revenue is recognized over the period of the contract in proportion to the amount of insurance protection provided.
SECOND INJURY FUND ASSESSMENTS AND RECOVERIES-- Many states have laws that established second injury funds to reimburse employers and insurance carriers for workers' compensation benefits paid to employees who are injured and whose disability is increased by a prior work-related injury. The Company accrues a liability for second injury fund assessments as net premiums are written or as losses are incurred based on individual state guidelines, and for premium based assessments, we defer these costs and recognize them as an expense as the related premiums are earned. The Company recognizes recoveries from the second injury funds when they are received (see Note 3).
GUARANTY FUND ASSESSMENTS-- Most states have guaranty fund laws under which insurers doing business in the state are required to fund policyholder liabilities of insolvent insurance companies. The Company accrues a liability for estimated assessments as net premiums are written and defers these costs and recognizes them as an expense as the related premiums are earned. The Company is continually notified of assessments from various states relating to insolvencies in that particular state; however, there are no expense accruals recorded when the Company is unable to estimate the potential future assessment.
EARNINGS PER SHARE--The Company computes earnings per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128. In the calculation of basic earnings per share, the dilutive effects of options,
CONCENTRATIONS OF CREDIT RISK--Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, investments, premiums receivable, and reinsurance recoverables (see Notes 4, 5, and 6). Concentrations of credit risk with respect to premiums receivable are limited due to the large number of entities comprising the Company's customer base.
The following table illustrates the pro forma effect on net earnings and earnings per share for the years ended December 31, 2005 and 2004 (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):
o Compensation cost for all share-based awards (expected to vest) granted during the year ended December 31, 2006 based upon the grant-date fair value estimated in accordance with the provisions of SFAS 123R.
See Note 15 for additional information regarding the Company's stock-based compensation plans and the assumptions used to calculate the fair value of stock-based awards.
SEGMENT REPORTING--The Company operates in a single industry segment, property and casualty insurance specializing in workers' compensation insurance.
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 attribute 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 is effective January 1, 2007. The Company is currently evaluating the impact of this standard.
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 generally accepted accounting principles, 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.
Statement of Position ("SOP") 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts, issued September 2005, became effective January 1, 2007. SOP 05-1 provides guidance on accounting for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverage that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The Company does not anticipate a significant impact upon adoption of this pronouncement.
Additionally, AmCOMP Preferred and AmCOMP Assurance are required to comply with NAIC risk-based capital ("RBC") requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating conditions.
Statutory-basis net income (loss) for AmCOMP Preferred and AmCOMP Assurance for the years ended December 31, 2006, 2005 and 2004 is as follows (in thousands):
2006 2005 2004 ------- ------- -------- AmComp Preferred .............. $ 8,596 $ 5,922 $(5,686) AmComp Assurance .............. 5,317 6,078 (1,467)
Statutory-basis capital and surplus for AmCOMP Preferred and AmCOMP Assurance as of December 31, 2006 and 2005 is as follows (in thousands):
Stock insurance companies are subject to Florida statutes related to excess profits for workers' compensation insurance companies. Excessive profits are calculated based upon a complex statutory formula which is applied over rolling three year periods. Companies are required to file annual excess profits forms, and they are required to return so-called "excessive profits" to policyholders in the form of a cash refund or credit toward the future purchase of insurance. To date, we have not been required to return excess profits and no amounts have been provided for returns of excess profits in our financial statements. See Note 17.
GUARANTY FUND ASSESSMENTS-- Most states have guaranty fund laws under which insurers doing business in the state are required to fund policyholder liabilities of insolvent insurance companies. Generally, assessments are levied by guaranty associations within the state, up to prescribed limits, on all insurers doing business in that state on the basis of the proportionate share of the premiums written by insurers doing business in that state in the lines of business in which the impaired, insolvent or failed insurer is engaged. The Company accrues a liability for estimated assessments as direct premiums are written and defers these costs and recognizes them as an expense as the related premiums are earned. The Company is continually notified of assessments from various states relating to insolvencies in that particular state; however, the Company estimates the potential future assessment in the absence of an actual assessment. Guaranty Fund assessment expenses were $1.5 million, $4.0 million and $3.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company has deferred approximately $1.2 million and $1.7 million as of December 31, 2006 and 2005, respectively, related to guaranty fund assessments, which is included in deferred policy acquisition costs. Maximum contributions required by law in any one state in which we offer insurance vary between 0.3% and 2.0% of direct premiums written.
SECOND INJURY FUND ASSESSMENTS AND RECOVERIES -- Many states have laws that established second injury funds to reimburse employers and insurance carriers for workers' compensation benefits paid to employees who are injured and whose disability is increased by a prior work-related injury. The source of these funds is an assessment charged to workers' compensation insurance carriers doing business in such states. Assessments are based on paid losses or premium surcharge mechanisms. Several of the states in which we operate maintain second injury funds with material assessments. The Company accrues a liability for second injury fund assessments as net premiums are written or as losses are incurred based on individual state guidelines, and for premium based assessments, we defer these costs and recognize them as an expense as the related premiums are earned. Second Injury Fund Assessment expenses were $4.6 million, $11.9 million, and $5.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company has deferred approximately $1.8 million and $2.0 million as of December 31, 2006 and 2005, respectively, related to second injury fund assessments, which is included in deferred policy acquisition costs.
The Florida SDTF currently has significant unfunded liabilities. It is not possible to predict how the Florida SDTF will operate, if at all, in the future after further legislative review. Changes in the Florida SDTF's operations could decrease the availability of recoveries from the Florida SDTF, increase Florida SDTF assessments payable by AmCOMP Preferred and/or result in the discontinuation of the Florida SDTF and thus could have an adverse effect on AmCOMP Preferred's business, financial condition, and its operations. Under current law, future assessments are capped at 4.52% of net written premiums, and no recoveries can be made for losses incurred by the Florida SDTF after January 1, 1998.
Gross Gross Amortized Unrealize Unrealized Fair Cost Gains Losses Value -------- -------- -------- -------- Available-for-sale securities at December 31, 2006: U.S. Treasury securities ........................ $ 34,020 $ 848 $ 706 $ 34,162 Agency .......................................... 42,276 17 447 41,846 Municipalities .................................. 74,737 137 819 74,055 Corporate debt securities ....................... 190,638 196 3,196 187,638 Mortgage-backed securities ...................... 7,816 3 202 7,617 -------- -------- -------- -------- Total fixed maturity securities ................ $349,487 $ 1,201 $ 5,370 $345,318 ======== ======== ======== ======== Held-to-maturity securities at December 31, 2006:
Mortgage-backed securities ...................... $ 76,198 $ 255 $ 520 $ 75,933 ======== ======== ======== ========
The amortized cost and estimated fair values of investments in fixed maturity securities, segregated by available-for-sale and held-to-maturity, at December 31, 2006 are summarized by maturity as follows (in thousands):
Available-for-sale Held-to-maturity ------------------- ------------------- Amortized Fair Amortized Fair Cost Value Cost Value -------- -------- -------- -------- Years to maturity: One or less ...................... $ 54,066 $ 53,708 -- -- After one through five ........... 172,036 168,968 -- -- After five through ten ........... 102,968 101,636 -- -- After ten ........................ 12,601 13,389 -- -- Mortgage-backed securities ....... $ 7,816 7,617 76,198 75,933 -------- -------- -------- -------- Total .............................. $349,487 $345,318 $ 76,198 $ 75,933 ======== ======== ======== ========
Proceeds from the sale of available-for-sale fixed maturity securities during the years ended December 31, 2006, 2005 and 2004 were $5.3 million, $33.4 million and $49.2 million, respectively. Gross gains of $9,000, $0.2 million and $1.2 million and gross losses of $0.2 million, $0.6 million and $0.2 million were realized in the years ended December 31, 2006, 2005 and 2004, respectively, on those sales.
The Company continuously monitors its 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 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.
The following table summarizes, for all fixed maturity securities in an unrealized loss position at December 31, 2006, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position (in thousands):
At December 31, 2006, there were no investments in fixed maturity securities with individual material unrealized losses. Three other-than-temporary impairments totaling approximately $0.2 million were recorded on our investments during the year ended December 31, 2006. All the unrealized losses on the fixed maturity securities are interest rate related.
2006 2005 --------- --------- Direct billed premiums receivable ................ $ 20,722 $ 18,197 Estimated future audit premiums .................. 11,318 11,759 Collateralized premiums receivable ............... 31 132 Premiums receivable deferred installments ........ 78,305 79,321 --------- --------- 110,376 109,409 Less allowance for doubtful accounts ............. (4,106) (4,887) --------- --------- Net premiums receivable .......................... $ 106,270 $ 104,522 ========= =========
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):
1989 and 1990 $ 500 Unlimited Unlimited 1991 through 1993 500 Unlimited Unlimited 1994 400 Unlimited Unlimited 1995 400 $ 28,000 Unlimited 1996 500 Unlimited Unlimited 1997 500 Unlimited Unlimited 1998 500 Unlimited Unlimited 1999 250 Unlimited Unlimited 2000 250 Unlimited Unlimited 2001 250 Unlimited Unlimited 2002 (a) 500 Unlimited $ 50,000 2003 1,000 Unlimited 20,000 2004 (b) 1,000 Unlimited 20,000 2005 2,000 Unlimited 20,000 2006 2,000 Unlimited 30,000 ------------------ (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.
2006 2005 2004 -------------------- -------------------- -------------------- Written Earned Written Earned Written Earned --------- --------- --------- --------- --------- --------- Direct ................. $ 266,827 $ 269,752 $ 270,331 $ 267,809 $ 260,173 $ 249,526 Assumed ................ 6,886 7,266 6,764 8,308 10,808 9,919 Ceded .................. (8,925) (10,562) (9,442) (19,514) (53,509) (78,259) --------- --------- --------- --------- --------- --------- Net .................... $ 264,788 $ 266,456 $ 267,652 $ 256,603 $ 217,472 $ 181,186 ========= ========= ========= ========= ========= =========
Incurred losses and loss adjustment expenses for the years ended December 31, 2006, 2005 and 2004 are summarized as follows (in thousands):
2006 2005 2004 --------- --------- --------- Direct losses and loss adjustment expenses incurred ........ $ 157,005 $ 144,832 $ 162,250 Assumed losses and loss adjustment expenses incurred ....... 6,376 8,164 8,750 Ceded losses and loss adjustment expenses incurred .......... 289 (9,333) (51,879) --------- --------- --------- Net losses and loss adjustment expenses incurred ............ $ 163,670 $ 143,663 $ 119,121
Significant components of income tax expense for the years ended December 31, 2006, 2005 and 2004 are as follows (in thousands):
2006 2005 2004 -------- -------- -------- Current expense (benefit) Federal .................................. $ 8,690 $ 9,555 $ 1,891 State .................................... 425 1,205 (277) -------- -------- -------- Total current tax expense ............... $ 9,115 $ 10,760 $ 1,614 -------- -------- -------- Deferred expense (benefit) Federal .................................. $ (827) $ (1,123) $ 1,461 State .................................... (32) (311) 1,200 -------- -------- -------- Total deferred tax expense (benefit) .... (859) (1,434) 2,661 -------- -------- -------- Income tax expense ...................... $ 8,256 $ 9,326 $ 4,275 ======== ======== ========
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and tax liabilities as of December 31, 2006 and 2005 are presented below (in thousands):
2006 2005 -------- -------- Deferred tax assets: Loss reserve adjustments ..................... $ 13,551 $ 13,432 Unearned and advance premiums ................ 8,112 8,043 Allowance for bad debt ....................... 1,531 1,774 Policyholder dividends ....................... 3,170 2,409 FAS 115 unrealized losses .................... 1,553 1,674 Deferred compensation ........................ 650 470 Disallowed capital losses .................... 326 -- Other ........................................ 689 477 -------- -------- Total deferred tax assets ................... 29,582 28,279 Deferred tax liabilities: Deferred policy acquisition expenses ......... (7,734) (7,049) Other ........................................ (235) (359) -------- -------- Total deferred tax liabilities .............. (7,969) (7,408) -------- -------- Total net deferred tax assets ............... $ 21,613 $ 20,871 ======== ========
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 26%, 25% and 22% of the total business was subject to dividend participation during the years ended December 31, 2006, 2005 and 2004, 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 2006, 2005 and 2004 policies reflect the full potential amount allowed under the respective policies.
LITIGATION--AmCOMP along with AmCOMP Preferred and AmCOMP Assurance are collectively defendants in identical actions commenced in Pennsylvania and Florida courts by the Insurance Commissioner of Pennsylvania, acting in the capacity as liquidator of Reliance Insurance Company. The complaints in those actions allege that preferential payments were made by Reliance Insurance Company under the formerly existing reinsurance agreement with AmCOMP Preferred and AmCOMP Assurance and seek damages in the amount of approximately $2.3 million. AmCOMP, along with AmCOMP Preferred and AmCOMP Assurance, has made various motions addressed to these complaints. The Company, based on the advice of counsel, believes that it has a variety of factual and legal defenses, including a right of offset related to the statement of claim filed by the Company and Preferred in the Reliance Insurance Company liquidation proceeding for the recovery of approximately $9.9 million under the reinsurance agreement. Although the ultimate results of these legal actions and related claims cannot presently be determined, the Company had accrued a liability of $1.2 million and $1.3 million as of December 31, 2006 and 2005, respectively, related to those matters.
The Company is named as a defendant in various legal actions arising principally from claims made under insurance policies and contracts. Those actions are considered by the Company in estimating the losses and LAE reserves.
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, $2.6 million and $2.6 million for 2006, 2005 and 2004, respectively. Future minimum payments under noncancelable operating leases with initial terms of one year or more as of December 31, 2006 are as follows (in thousands):
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 $619,000, $570,000 and $525,000 for the years ended December 31, 2006, 2005 and 2004, 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.
The Loan contains various restrictive covenants and certain financial covenants. At December 31, 2006, the Company was in compliance with all restrictive and financial covenants.
On May 26, 2004, AmCOMP Preferred issued a $12 million surplus note, in return for $12 million in cash, to ICONS, Inc., as part of a pooled transaction. The note matures in 30 years and is callable by the Company after five years. The terms of the note provide for quarterly interest payments at a rate 425 basis points in excess of the 90-day LIBOR. Interest paid through December 31, 2006 and 2005 totaled $1.1 million and $0.9, million respectively. Interest unpaid as of December 31, 2006 and 2005 was $115,000 and $104,000, respectively. This interest was paid subsequent to year end.
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.
Prior to 1999, the Company granted two executives options to purchase shares under nonqualified stock option agreements. Of the options granted, options to purchase 272,877 common shares are still outstanding as of December 31, 2006. 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.
A summary of the Company's stock option activity through December 31, 2006 is as follows:
Options Outstanding ------------------------------------------------------------------- Weighted Number Average Outstanding at Remaining Weighted December 31, Contractual Average Aggregate Range of Exercise Prices 2006 Life Exercise Price Intrinsic Value ---------------------------------------------------------------------------------------------- $ 0.00 - $ 8.99 84,501 1.03 $ 8.83 $ 84,409 9.00 - 9.99 782,943 4.03 9.02 637,114 10.00 - 14.00 291,877 0.55 13.52 -- --------- ---- --------- --------- 1,159,321 2.93 $ 10.14 $ 721,523 ========= ==== ========= =========
Options Outstanding Options Exercisable --------------------------------------------------------------------------------- Weighted Number Average Number Outstanding at Remaining Weighted Exercisable at Weighted December 31, Contractual Average December 31, Average Range of Exercise Prices 2006 Life Exercise Price 2006 Exercise Price --------------------------------------------------------------------------------------------------------------- $ 0.00 - $ 8.99 86,579 1.03 $ 8.83 65,798 $8.83 9.00 - 9.99 842,102 4.03 9.02 21,830 9.30 10.00 - 14.00 292,877 0.56 13.51 272,877 13.74 --------- ---- ------- ------- ------ 1,221,558 2.99 $ 10.08 360,505 $12.58 ========= ==== ======= ======= ======
In the event that currently outstanding options are exercised, the Company intends to first issue treasury shares to the extent available, followed by new shares as necessary.
AMCOMP INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
On March 19, 2007, the Company received a Notice of Intent to Issue Order to Return Excessive Profit signed March 14, 2007 (the "Notice") from the Florida OIR. The Notice indicates on a preliminary basis that Florida OIR proposes to make a finding, following its review of data submitted by the Company on July 1, 2006 for accident years 2002, 2003 and 2004, that "Florida excessive profits" (as defined in Florida Statute Section 627.215) ("excessive profits") in the amount of $5,663,805 have been realized by the Company. Excessive profits under the statute are required to be returned to policyholders under methods defined in the statute. Upon receipt of the Notice, and upon further review by the Company of the data previously submitted, the Company amended its filings to the Florida OIR responding to the Notice and amending the deductible expense items that are utilized in the calculation of excessive profits. These filings amend and increase the expenses the Company believes are permitted by the statute in calculating excessive profits.