Properties We own a 63,000 square foot building in Cleveland, Ohio. In addition, we lease an aggregate of approximately 280,000 square feet of office space in over 26 locations. See Item 13. “Certain Relationships and Related Transactions, and Director Independence.”
Selected Financial Data The following tables set forth our selected historical consolidated financial and operating information for the periods ended and as of the dates indicated. The selected consolidated income statement data for the years ended December 31, 2009, 2008 and 2007 and the balance sheet data as of December 31, 2009 and 2008 are derived from our audited financial statements included elsewhere in this report, which have been audited by BDO Seidman LLP, our independent auditors. These historical results are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information together with the other information contained in this report, including
Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This Form 10-K contains certain forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995, which are intended to be covered by the safe harbors created thereby. When we use words such as “anticipate,” “intend,” “plan,” “believe,” “estimate,” “expect,” or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of the Company’s business activities and availability of funds. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, regulatory framework, weather-related events and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. There can be no assurance that actual developments will be those anticipated by the Company. Actual results may differ materially from those projected as a result of significant risks and uncertainties, including non-receipt of the expected payments, changes in interest rates, effect of the performance of financial markets on investment income and fair values of investments, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the impact of competition and pricing environments, changes in the demand for the Company’s products, the effect of general economic conditions, adverse state and federal legislation, regulations and regulatory investigations into industry practices, developments relating to existing agreements, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected is contained in Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K for the period ended December 31, 2009 beginning on page 32. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
• Small Commercial Business insurance, which includes workers’ compensation, commercial package and other commercial lines produced by retail agents and brokers in the United States;
One of the key financial measures that we use to evaluate our operating performance is return on average equity. Our return on average equity was 21.5%, 21.2% and 24.7% for the years ended December 31, 2009, 2008 and 2007, respectively. Our overall financial objective is to produce a return on average equity of 15.0% or more over the long term. In addition, we target a net combined ratio of 95.0% or lower over the long term, while seeking to maintain optimal operating leverage in our Insurance Subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 79.8%, 74.4% and 83.2% for the years ended
Acquisitions Cybercomp In September 2009, the Company acquired from subsidiaries of Swiss Re America Holding Corp. (“Swiss Re”) access to the distribution network and renewal rights to CyberComp (“CyberComp”), a web-based platform providing workers’ compensation insurance to the small to medium-sized employer market. CyberComp operated in 26 states and distributes policies through a network of 13 regional wholesale agencies and over 600 retail agents. The purchase price was equal to a percentage of gross written premium through the third anniversary of the closing of the transaction. Upon closing, the Company made an initial payment to Swiss Re in the amount of $3 million which represented an advance on the purchase price and the minimum amount payable pursuant to the purchase agreement. In accordance with Financial Accounting Standards Board (“FASB”) ASC 805-10 (Prior authoritative literature: SFAS No 141(R) Business Combinations), the Company recorded a purchase price of $6.3 million which consisted of $2.8 million of renewal rights, $2.3 million of distribution networks, $0.7 million of trademarks and $0.5 million of goodwill as part of the Small Commercial Business segment. The intangible assets were determined to have useful lives of between two years and 15 years. The Company produced approximately $17.7 million of gross written premium in 2009 as a result of this transaction.
The aforementioned ACHL transactions allow the Company to obtain the benefit of the Captives’ capital and utilization of their existing and future loss reserves through a series of reinsurance arrangements with a subsidiary of the Company.
Ceding Commission Revenues. Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured.
Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. Net unrealized gains (losses) on those securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.
injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.
Other. Other expenses include those charges that are related to the amortization of tangible and intangible assets and non-insurance fee generating activities in which the Company engages, including salaries and benefits expenses and other charges directly attributable to non-insurance fee generating activities.
Net Expense Ratio. The net 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 the sum of acquisition costs and other underwriting expenses less ceding commission revenue to net premiums earned.
Premiums. Insurance premiums, other than Specialty Risk and Extended Warranty, are recognized as earned on the straight-line basis over the contract period. Insurance premiums on Specialty Risk and Extended Warranty are earned based on estimated program coverage periods. These estimates are based on the expected distribution of coverage periods by contract at inception, because a single contract may contain multiple coverage period options and these estimates are revised based on the actual coverage periods selected by the insured. Unearned premiums represent the portion of premiums written which is applicable to the unexpired term of the contract or policy in force. Premium adjustments on contracts and audit premiums are based on estimates made over the contract period. The Company also estimates an allowance for doubtful accounts based on a percentage of premium. The Company reviews its bad debt write-offs at least annually and adjusts its premium percentage as required. Allowance for doubtful accounts were approximately $9.4 million and $8.1 million at December 31, 2009 and 2008, respectively.
Earned But Unbilled Premium. Earned but unbilled premium (“EBUB”) estimates the amount of audit premium for those policies that have yet to be audited as of the date of the quarter or year end. Workers’ compensation policies are subject to audit and the final premium may increase or decrease materially from the original premium due to revisions to actual payroll and/or employee classification. Based on guidance in FASB ASC 944 (Prior authoritative literature: Statement of Financial Accounting Standards SFAS 60 “Accounting and Reporting by Insurance Enterprises”) as well as Statement of Statutory Accounting Principles (“SSAP”) 53, the Company determines EBUB using statistically supported aggregate calculations based on the Company’s historical premium audit results. The Company has not had a material adjustment as a result of actual premium audits materially differing from the estimates used in calculating EBUB.
As of December 31, 2009, if the actual results of the future premiums audits were 1% lower than the historical results used in calculating EBUB, the result would be a decrease in EBUB and net earned premium of $2.5 million or $1.6 million after tax. If the actual results of the future premiums audits were 1% higher than the historical results used in calculating EBUB, the result would be an increase in EBUB, and net earned premium of $2.5 million or $1.6 million after tax.
Investments. The Company accounts for its investments in accordance with ASC 320 Debt and Equity Securities, which requires that fixed-maturity and equity securities that have readily determined fair values be segregated into categories based upon the Company’s intention for those securities. In accordance with ASC 320, the Company has classified its fixed-maturity securities and equity securities as available-for-sale. The Company may sell its available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors.
Quarterly, the Company’s Investment Committee (“Committee”) evaluates each security which has an unrealized loss as of the end of the subject reporting period for other-than-temporary-impairment (“OTTI”). The Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. Some of the criteria the Company considers include:
Goodwill and Intangible Assets - The Company accounts for goodwill and intangible assets in accordance with ASC 820, Business Combinations and ASC 350 Intangibles - Goodwill and Other. A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset, and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statement of operations.
Deferred income taxes reflect the impact of “temporary differences” between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset primarily consists of book versus tax differences for premiums earned, loss and loss adjustment expense reserve discounting, policy acquisition costs, earned but unbilled premiums, and unrealized
of 2008, and the acquisition of the CyberComp distribution network and renewal rights in the third quarter 2009, partially offset by state mandated workers’ compensation rate reductions in the state of Florida and a decline in assigned risk business. The increase in Specialty Risk and Extended Warranty business resulted from the underwriting of new coverage plans primarily in Europe, partially offset by the strengthening of the U.S. dollar in the 2009 which negatively impacted the Company’s European business. The increase in our Specialty Middle Market Business was primarily from organic growth in workers’ compensation and other commercial package business.
Net Earned Premium. Net earned premium increased $134.9 million or 30.7% to $573.9 million from $439.0 million for the years ended December 31, 2009 and 2008, respectively. The increase by segment was: Small Commercial Business - $66.0 million; Specialty Risk and Extended Warranty - $36.3 million; and Specialty Middle Market Business - $32.6 million.
Service and Fee Income. Service and fee income increased $1.7 million or 5.9% to $30.7 million from $29.0 million for the years ended December 31, 2009 and 2008, respectively. The increase was attributable primarily to an increase in administration fees from new warranty business, servicing carrier contracts and consulting fees charged to ACAC partially offset by lower servicing carrier contract fees for state workers’ compensation assigned risk plans.
Net Realized Gains (Losses) on Investments. Net realized losses on investments for the year ended December 31, 2009 were $33.6 million, compared to net realized losses of $64.6 million for the same period in 2008. During the year ended December 31, 2009, realized losses related to certain sales of underperforming investments in the Company’s fixed income portfolio and non-cash write-downs of eleven equity securities and three fixed maturity securities of $24.8 million that were determined to be other-than-temporarily impaired. During the year ended December 31, 2008, realized losses related primarily to the non-cash write-down of $31.3 million related to two fixed income securities, Lehman Brothers Holdings and Washington Mutual, that were determined to be other than temporarily impaired and realized losses related to certain sales of underperforming investments in the Company’s fixed income portfolio.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $40.6 million or 19.9% to $244.3 million for the year ended December 31, 2009 from $203.7 million for the year ended December 31, 2008. The expense ratio increased to 22.7% from
Income Before Other Items, Income Taxes and Non-Controlling Interest. Income before other items, income taxes and non-controlling interest increased $28.9 million or 24.9% to $145.1 million from $116.2 million for the years ended December 31, 2009 and 2008, respectively. The change from 2008 to 2009 resulted primarily from a reduction in realized losses on the Company’s investment portfolio.
Consolidated Results of Operations 2008 Compared to 2007 Gross Written Premium. Gross written premium increased $271.2 million or 32.3% from $839.4 million for the year ended December 31, 2007 to $1,110.6 million for the year ended December 31, 2008. The increase was attributable to a $150.0 million increase in our Small Commercial Business, a $109.6 million increase in our Specialty Risk and Extended Warranty business and an $11.6 million increase in our specialty middle-market property and casualty business. The increase in the Small Commercial Business segment related primarily to $92.8 million of additional premiums resulting from the acquisition of UBI in the second quarter of 2008 and $63.0 million of additional premium from the managing general agency agreement entered into with Cardinal Comp. The increase in premiums for the Specialty Risk and Extended Warranty segment resulted, primarily, from the underwriting of new coverage plans and expansion of certain coverage plans in the United States and a full years’ results of operations for IGI, which the Company acquired in 2007. The increase in the Specialty Middle Market Business gross written premiums resulted from, primarily, from the underwriting of new programs and the growth of existing programs.
Net Written Premium. Net written premiums increased $135.0 million or 32.2% from $419.9 million to $554.9 million for the year ended December 31, 2007 and 2008, respectively. Net written premium reflected cessions of $247.3 million and $376.5 million to Maiden Insurance for the years ended 2007 and 2008, respectively, under the terms of the Maiden Quota Share, which was entered into during the third quarter of 2007. The increase before cessions by segment was: Small Commercial Business - $119.8 million; Specialty Risk and Extended Warranty - $102.1 million; and Specialty Middle Market Business - $42.3 million.
Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby AmTrust receives a 31% or 34.375% ceding commission, depending on the type of
Service and Fee Income. Service and fee income increased $8.6 million or 42.2% from $20.4 million to $29.0 million for the years ended December 31, 2007 and 2008, respectively. The increase resulted from the Company entering into the Maiden Quota Share, the reinsurance brokerage agreement and asset management agreement with Maiden Insurance during the third quarter of 2007, whereby the Company earned reinsurance brokerage fees and administration fees by which the Company receives a fee in the annual amount of 0.20% of assets under management, which is reduced to 0.15% per annum if assets under management exceed $1 billion. Additionally, the Company earned fees as a servicing carrier for workers’ compensation assigned risk plans in three additional states in 2008 as well as increased fees for warranty administration from Specialty Risk and Extended Warranty customers for which a subsidiary of the Company acts as warranty administrator.
Net Investment Income. Net investment income increased $8.6 million or 16.9% from $50.9 million to $59.5 million for the year ended December 31, 2007 and 2008, respectively. The increase resulted from an increase of average invested assets. Average invested assets (excluding equity securities) were approximately $1.3 billion for the year ended December 31, 2008 compared to approximately $1.0 billion for the year ended December 31, 2007, an increase of $0.3 billion or 30.0%. Yields on the Company’s fixed maturities have decreased from 5.3% in 2007 to 4.7% in 2008.
Income Before Other Items, Income Taxes and Non-Controlling Interest. Income before other items, income taxes and non-controlling interest decreased to $114.3 million for the year ended December 31, 2008, from $130.8 million for the year ended December 31, 2007, a decrease of $16.5 million or 12.6%. This decrease is primarily attributable to the net realized loss of $64.5 million in the Company’s investment portfolio offset by growth in revenue combined with improvement in the both the loss ratio and the net expense ratio.
Interest Expense. Interest expense for the year ended December 31, 2008 was $18.3 million, compared to $10.1 million for the same period in 2007. The increase was attributable primarily to interest expense on collateral loans made by Maiden Insurance pursuant to the Maiden Quota Share. Additionally, the Company incurred interest expense on its $40 million term loan and $30 million promissory note entered into during the second quarter of 2008.
Small Commercial Business Segment Results of Operation 2009 Compared to 2008 Gross Written Premium. Gross written premium increased $10.8 million or 2.4% to $469.6 million for the year ended December 31, 2009 from $458.8 million for the year ended December 31, 2008. The increase in Small Commercial Business resulted, primarily, from the acquisition from Swiss Re during the third quarter of 2009 of access to the distribution network and renewal rights of CyberComp, the UBI acquisition in the second quarter of 2008 and the managing general agency agreement with Cardinal Comp entered into in the third quarter of 2008. The increase was partially offset by state mandated workers’ compensation rate reductions in the state of Florida and a decline in assigned risk business.
Ceding Commission. Ceding commission represents commission earned, primarily, through the Maiden Quota Share, whereby AmTrust receives a 31% or 34.375% commission, depending on the type of business, on earned premium ceded to Maiden Insurance. The ceding commission earned during the years ended December 31, 2009 and 2008 was $59.4 million and $59.0 million, respectively. Ceding commission was consistent year over year as growth in premium ceded to Maiden Insurance in 2009 was offset, primarily, by
the allocation in 2008 to this segment of its proportionate share of ceding commission related to the 2008 cession to Maiden Insurance of $78.2 million of unearned premium assumed in connection with the acquisition of UBI during the second quarter of 2008.
Small Commercial Business Segment Results of Operation 2008 Compared to 2007 Gross Written Premium. Gross written premium increased $150.0 or 48.6% from $308.8 million to $458.8 million for the years ended December 31, 2007 and 2008, respectively. The increase in the Small Commercial Business segment related primarily to $92.8 million of additional premiums resulting from the acquisition of UBI during the second quarter of 2008 and $63.0 million of additional premium from our relationship with Cardinal Comp, offset by declines attributable to mandated rate reductions in New York and Florida.
Net Earned Premium. Net earned premium decreased $64.7 million or 27.2% from $237.7 million to $173.0 million for the years ended December 31, 2007 and 2008, respectively. Net earned premium for the years ended 2007 and 2008, respectively, reflected cessions of $47.4 million and $136.0 million to Maiden Insurance under the terms of the Maiden Quota share, which was entered into during the third quarter of 2007. Before cessions to Maiden Insurance, earned premium increased $23.9 million for 2008 compared to 2007. This increase resulted from an increase in gross written premium.
Ceding Commission Revenue. Ceding commission revenue increased $22.6 million or 62.2% from $36.4 million in 2007 to $59.0 million in 2008. The increase resulted from the impact of the Maiden Quota Share.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses decreased $49.1 million or 35.3% from $139.1 million to $90.0 million for the years ended December 31, 2007 and
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $6.4 million or 7.0% from $91.5 million to $97.9 million for the year ended December 31, 2007 and 2008, respectively. The increase relates primarily to higher salary expense related to the acquisitions of UBI and AIIC.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $8.0 million or 16.8% to $55.6 million for the year ended December 31, 2009 from $47.6 million for the year ended December 31, 2008. The expense ratio increased to 15.6% for the year ended December 31, 2009 from 13.4% for the year ended December 31, 2008. The increase in the expense ratio resulted, primarily, from the decrease in ceding commission received from Maiden Insurance during the period. In 2008, the ceding commission, which is based on earned premium ceded by the Company, included the segment’s proportionate share of ceding commission earned on the $78.2 million of unearned premium that the Company had assumed on June 1, 2008 in connection with the UBI acquisition. The ceding commission revenue is allocated to each segment based on that segment’s proportionate share of the Company’s overall acquisition costs. Therefore, the reduction in ceding commission had the effect of increasing acquisition costs compared to the corresponding period in 2008.
Specialty Risk and Extended Warranty Segment Results of Operation 2008 Compared to 2007 Gross Written Premium. Gross written premium increased $109.6 or 35.8% from $306.4 million to $415.9 million for the years ended December 31, 2007 and 2008, respectively. The increase in premium resulted, primarily, from the underwriting of new coverage plans, which included the benefit of an initial unearned premium assumption of $63 million on the underwriting of certain insurance programs and expansion of certain existing coverage plans, offset by the impact of the strengthening U.S. dollar on the Company’s European operations.
Net Earned Premium. Net earned premium increased $37.8 or 32.6% from $116.1 million to $153.9 million for the year ended December 31, 2007 and 2008, respectively. Net earned premium for the
Ceding Commission Revenue. Ceding commission revenue increased $15.5 million or 134.8% from $11.5 million in 2007 to $27.0 million in 2008. The increase resulted from the impact of the Maiden Quota Share being in effect for a full year in 2008.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses decreased $3.1 million or 3.9% from $81.9 million to $78.8 million for the years ended December 31, 2007 and 2008, respectively. The loss ratio for the segment decreased to 51.2% for 2008 from 70.5% for 2007. The improvement of the loss ratio resulted from the Company’s actual loss experience, which has continued to develop more favorably than the Company’s actuarially projected ultimate losses as well as a reduction in loss reserves of approximately $7 million related to the prior accident years, which was offset against 2008 loss and loss adjustment expenses.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition Costs and Other Underwriting Expenses increased $24.1 million or 103% from $23.5 million to $47.6 million for the years ended December 31, 2007 and 2008, respectively. The increase related, primarily, to higher policy acquisition costs and salaries and benefits in 2008 attributable to the acquisition of IGI during the second quarter of 2007.
Net Written Premium. Net written premium increased $23.2 million or 19.5% to $142.3 million for the year ended December 31, 2009 from $119.1 million for the year ended December 31, 2008. The increase in net written premium resulted from an increase of gross written premium for the years ended December 31, 2009 compared to gross written premium for the year ended December 31, 2008.
Specialty Middle Market Business Segment Result of Operations 2008 Compared to 2007 Gross Written Premium. Gross written premium increased $11.6 million or 5.2% from $224.2 million to $235.8 million for the years ended 2007 and 2008, respectively. The increase resulted primarily from the growth of existing workers’ compensation programs and commercial auto liability programs. The increase was offset by a decline in the credit business, which the Company wrote on behalf of HSBC Insurance Company of Delaware, pursuant to a 100% fronting arrangement entered into in connection with its acquisition of WIC in 2006. The gross written premium pursuant to the arrangement began winding down in 2008.
Net Written Premium. Net written premium increased $30.4 million or 34.3% from $88.7 million to $119.1 million for the years ended 2007 and 2008, respectively. Net written premium reflected cessions of $59.8 million and $71.7 million to Maiden Insurance for the years ended 2007 and 2008, respectively, under the terms of the Maiden Quota Share. Before cessions to Maiden Insurance, net written premium increased $42.3 million to 2008 compared 2007 and was the result of an increased writings over the last calendar year.
Net Earned Premium. Net earned premium increased $21.6 million or 23.9% from $90.5 million to $112.1 million for the years ended 2007 and 2008, respectively. Net earned premium for the years ended 2007 and 2008, respectively, reflected cessions of $29.1 million and $57.9 million to Maiden Insurance under the terms of the Maiden Quota Share. Before cessions to Maiden Insurance, earned premium increased $50.4 million for 2008 compared to 2007. The increase resulted from the change in net written premium.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting Expenses increased $17.9 million from $40.4 million for the year ended December 31, 2007 to $58.3 million for the year ended December 31, 2008. The increase related primarily to higher policy acquisition costs during 2008.
The tables below summarizes the average duration by type of fixed maturity as well as detailing the average yield as of December 31, 2009 and 2008:
• the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings; and
• the occurrence of a discrete credit event resulting in the issuer defaulting on material outstanding obligation or the issuer seeking protection under bankruptcy laws.
In addition to the other-than-temporary impairment of $24.8 million recorded during 2009, at December 31, 2009, the Company had $14.7 million of gross unrealized losses related to equity securities. The Company’s investment in equity securities consist of investments in preferred and common stocks across a wide range of sectors. The Company evaluated the near-term prospects for recovery of fair value in relation to the severity and duration of the impairment and has determined in each case that the probability of recovery is reasonable. Within the Company’s portfolio of common and preferred stocks, 19 equity securities comprised $12.9 million, or 88% of the unrealized loss. The Company holds six securities in both the consumer products sector and healthcare sector, respectively, which represents approximately 8% and 20%, respectively, of the total fair value of the Company’s equity portfolio and 25% and 36%, respectively, of the Company’s unrealized losses. The Company also holds seven equity securities in the technology, industrial and financial sectors which have fair values of approximately 7%, 5% and 7%, of the Company’s equity portfolio, respectively, and approximately 11%, 10% and 6%, respectively, of the Company’s unrealized losses. The duration of these impairments ranges from 1 to 27 months. The remaining securities in a loss position are not considered individually significant and accounted for 12% of the Company’s unrealized losses. The Company believes these securities will recover and that we have the ability and intent to hold them until recovery.
At December 31, 2009, the Company had $26.4 million of gross unrealized losses related to fixed income securities as of December 31, 2009. Corporate bonds represent approximately 36% of the fair value of our fixed maturities and approximately 94% of the total unrealized losses of our fixed maturities. The Company owns 151 corporate bonds in the industrial, financial and other sectors, which have a fair value of approximately 5%, 30% and 1%, of the Company’s fixed maturity portfolio, respectively, and 0.4%, 92% and 1% of total unrealized losses, respectively, of our fixed maturities. The Company believes that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and have the ability to meet their obligations. Therefore, the Company expects that the market price for these securities should recover within a reasonable time.
Our Insurance Subsidiaries principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund our anticipated growth, by providing capital to increase the surplus of our insurance company subsidiaries as well as for payment of claims and operating expenses,
payment of interest and principal on debt facilities and other holding company expenses until at least December 31, 2010. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth.
Net cash used in financing activities was $151.4 million for the year ended December 31, 2009 compared to net cash provided in 2008 of $162.2 million. In 2009 cash used in financing included primarily of $111.7 million paid from settling repurchase agreements, principal payments on debt of $20.8 million, dividend payments of $13.1 million and share repurchases of $6.1 million. In 2008 cash provided from financing included primarily of $138.1 million received from entering into repurchase agreements as well as the issuance of a $40 million note offset by dividend payments of $10.2 million.
Loss and loss expense reserves increased $77,885 and unearned premium increased $111,864 in 2009 due primarily to higher premium writings in 2009. Accrued expenses and other liabilities increased by $36,021 primarily as the result of investment securities which were purchased but not settled prior to year-end. Securities sold under arrangements to repurchase, at contract value, decreased by 111,718 in 2009 as the Company settled their positions on a large percentage of these investments.
Reinsurance The following table summarizes the top ten reinsurers that account for approximately 94% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2009:
(1) Amount recoverable from Trinity Universal is the result of the UBI acquisition. Prior to their acquisition by the Company, MCIC, SNIC, TUIC and TLIC ceded all of their net retention to Trinity Universal.
January 1, 2008 to January 1, 2010. From January 1, 2008 to January 1, 2010, we retain the first $1 million per occurrence on workers’ compensation claims other than those arising out of acts of terrorism. We cede losses greater than $1.0 million for such claims. Our reinsurance for such claims totals $129.0 million, structured as a five layer tower. The first two layers of this reinsurance exclude coverage for our participation in assigned risk plans.
• The first layer of this reinsurance provides $9.0 million of coverage per occurrence in excess of our $1.0 million retention. It has an annual aggregate deductible of $1.25 million and reinsures losses in excess of $1.0 million per occurrence up to $10.0 million. Pursuant to the deductible provisions, for each of the two years of the contract term, we must pay a total amount of $1.25 million in workers’ compensation losses incurred in excess of our $1.0 million per occurrence retention before we are entitled to any reinsurance recovery. Maiden Insurance reinsures 45% of this layer. We terminated the other 55% of this agreement at June 30, 2009 and Maiden’s 45% share terminated as of December 31, 2009. As a result, we retain 55% of this layer for losses occurring on or after July 1, 2009;
• The third layer provides $30.0 million of coverage per occurrence for claims in excess of $20.0 million. This layer provides coverage for losses in excess of $20.0 million per occurrence up to $50.0 million. A maximum of $10.0 million per individual claimant may be included as part of any loss. The third layer has an aggregate limit of $60.0 million for each 12-month contract period;
• The fourth layer provides $30.0 million of coverage per occurrence for claims in excess of $50.0 million per occurrence. It reinsures losses in excess of $50.0 million per occurrence up to $80.0 million. A maximum of $10.0 million per individual claimant may be included as part of any loss. The fourth layer has an aggregate limit of $60.0 million for each 12-month contract period; and
Effective for losses occurring on or after May 1, 2009, the top three layers were consolidated into two layers. The new third layer provides $40.0 million of coverage per occurrence excess of $20.0 million, subject to an annual aggregate limit of $80.0 million, and the new fourth layer provides $70.0 million of coverage per occurrence excess of $60.0 million, subject to an annual aggregate limit of $140.0 million.
• The first layer of this reinsurance, provides $9.0 million of coverage per occurrence in excess of our $1.0 million retention. It has an annual aggregate deductible of $1.25 million and reinsures losses in excess of $1.0 million per occurrence up to $10.0 million per occurrence. Pursuant to the aggregate deductible provisions, for each of the two years of the contract term, we must pay a total amount of $1.25 million in workers’ compensation losses incurred in excess of our $1.0 million per occurrence retention before we are entitled to any reinsurance recovery;
• The second layer provides $10.0 million of coverage per occurrence in excess of $10.0 million. This layer reinsures losses in excess of $10.0 million per occurrence up to $20.0 million and has an aggregate limit of $20 million for each annual period;
• The fifth layer provides $50.0 million of coverage per occurrence for claims in excess of $80.0 million. It reinsures losses greater than $80.0 million per occurrence up to $130.0 million. The fifth layer has limits of $10.0 million ($5.0 million for losses occurring before May 1, 2005) per individual and an aggregate limit of $100.0 million for each 12-month contract period.
January 1, 2005 to January 1, 2006. From January 1, 2005 to January 1, 2006, we retain the first $0.6 million per occurrence on workers’ compensation claims. We cede losses greater than $0.6 million for such claims. Our reinsurance for such claims totals $129.4 million, structured as a six layer tower. The first three layers of this reinsurance exclude coverage for our participation in assigned risk plans.
excess of $0.6 million up to $5.0 million. Pursuant to the deductible provisions, we must pay a total amount of $1.25 million in workers’ compensation losses incurred in 2005 in excess of our $0.6 million per occurrence retention before we are entitled to any reinsurance recovery;
• The third layer provides $10.0 million of coverage per occurrence excess of $10.0 million. The third layer reinsures losses in excess of $10.0 million up to $20.0 million. It has an aggregate limit of $20.0 million per 12-month contract period. This means that regardless of the number of occurrences in any 12-month contract period with insured losses in excess of $10.0 million, the aggregate amount paid under this layer would not exceed $20.0 million;
• The first layer of this reinsurance provides $40.0 million of coverage per occurrence for claims in excess of $20.0 million. It reinsures terrorism losses in excess of $20.0 million up to $50.0 million in the aggregate for the contract period; and
• The second layer of this reinsurance provides $70.0 million of coverage per contract year for claims in excess of $60.0 million. This layer provides coverage for losses in excess of $50.0 million up to $80.0 million in the aggregate for the contract period.
Terrorism recoveries are counted as part of the annual recoveries for the workers compensation layers. The annual aggregate limits referenced above for those layers are inclusive of any terrorism losses that may occur, and any such losses reduce the available annual limit accordingly.
Casualty Reinsurance From June 1, 2008 through May 31, 2009, we retain the first $2 million per occurrence on third party liability (casualty) losses. We cede the amounts in excess of $2 million on each such loss. Our reinsurance for such claims totals $30 million per occurrence, in a three layer tower.
• The first layer of this reinsurance provides $3 million of coverage per occurrence in excess of our $2 million per occurrence retention. This layer has an annual aggregate reinsured limit of $12 million;
• The second layer of this reinsurance provides $7 million of coverage per occurrence in excess of $5 million per occurrence. This layer has an annual aggregate reinsured limit of $21 million; and
• The second layer of this reinsurance provides $5.0 million of coverage per occurrence in excess of $5.0 million per occurrence. This layer has an annual aggregate reinsured limit of $15.0 million; and
• The third layer of this reinsurance provides $20.0 million of coverage per occurrence in excess of $10 million per occurrence. This layer has an annual aggregate reinsured limit of $40.0 million.
Property Per Risk Excess Coverage: From June 1, 2008 through May 31, 2009, we retain the first $2 million per risk on property losses. We cede the amounts in excess of $2 million on each such loss. Our reinsurance for such claims totals $13 million per risk, subject to the per occurrence and aggregate reinsured limits noted below, in a two layer tower.
• The first layer of this reinsurance provides $3 million of coverage per risk in excess of our $2 million per risk retention. Recovery under this layer is limited to $6 million reinsured per occurrence and is further subject to an annual aggregate reinsured limit of $9 million; and
• The second layer of this reinsurance provides $10 million of coverage per risk in excess of $5 million per risk. Recovery under this layer is limited to $10 million reinsured per occurrence and is further subject to an annual aggregate reinsured limit of $20 million.
From June 1, 2009 through May 31, 2010, we retain the first $2 million per risk on property losses. We cede the amounts in excess of $2 million on each such loss. Our reinsurance for such claims totals $18 million per risk, subject to the per occurrence and aggregate reinsured limits noted below, in a two layer tower.
• The second layer of this reinsurance provides $15 million of coverage per risk in excess of $5 million per risk. Recovery under this layer is limited to $15 million reinsured per occurrence and is further subject to an annual aggregate reinsured limit of $30 million.
Property Catastrophe Reinsurance From June 1, 2008 through May 31, 2009, we retain the first $4 million per occurrence on property losses per occurrence, net of recoveries under the property Per Risk Reinsurance referenced above. We cede the amounts in excess of $4 million on each such loss. Our reinsurance for such claims totals $61 million per occurrence, in a two layer tower.
• The first layer of this reinsurance provides $11 million of coverage per occurrence in excess of our $4 million retention. This layer has an annual aggregate reinsured limit of $22 million. We also purchase second reinstatement coverage that provides an additional $11 million of annual aggregate reinsured limit in the event that we incur more than $22 million in losses to the first layer during the contract period.
• The second layer of this reinsurance provides $50 million of coverage per occurrence in excess of $15 million per occurrence. This layer has an annual aggregate reinsured limit of $100 million.
From June 1, 2009 through May 31, 2010, we retain the first $5 million per occurrence on property losses per occurrence, net of recoveries under the Property Per Risk Reinsurance referenced above. We cede the amounts in excess of $5 million on each such loss. Our reinsurance for such claims totals $60 million per occurrence, in a two layer tower.
• The first layer of this reinsurance provides $10 million of coverage per occurrence in excess of our $5 million retention. This layer has an annual aggregate reinsured limit of $20 million; and
TRIA requires that commercial property and casualty insurance companies offer coverage (with certain exceptions, such as with respect to commercial auto insurance) for certain acts of terrorism and has established a federal assistance program through the end of 2014 to help such insurers cover claims for terrorism-related losses. TRIA covers certified acts of terrorism, and the U.S. Secretary of the Treasury must declare the act to be a “certified act of terrorism” for it to be covered under this federal program. In addition, no certified act of terrorism will be covered by the TRIA program unless the aggregate insurance industry losses from the act exceed $100 million for each year. Under the TRIA program, the federal government covers 85% of the losses from covered certified acts of terrorism on commercial risks in the United States only, in excess of a deductible amount. This deductible is calculated as a percentage of an affiliated insurance group’s prior year premiums on commercial lines policies (with certain exceptions, such as commercial auto insurance policies) covering risks in the United States. This deductible amount is 20% of such premiums.
Under the variable quota share reinsurance arrangements with Munich Re, we may elect to cede from 10% to 50% of each covered risk, but Munich Re shall not reinsure more than £0.5 million for each ceded risk which we at acceptance regard as one individual risk. This means that regardless of the amount of insured losses generated by any ceded risk, the maximum coverage for that ceded risk under this reinsurance arrangement is £0.5 million. For the majority of the business ceded under this reinsurance arrangement, we cede 10% of the risk to Munich Re, but for some newer or larger risks, we have the option to cede a larger share to Munich Re. This reinsurance is subject to a limit of £2.5 million per occurrence of certain natural perils such as windstorms, earthquakes, floods and storm surge. Coverage for losses arising out of acts of terrorism is excluded from the scope of this reinsurance.
In addition to the above outlined programs, the Company also purchases quota share and/or excess treaty and/or facultative reinsurance for specific programs, specialty lines of business, or individual policies to limit our loss exposure and/or allow our program managers to share the risks and rewards of the business they produce.
AmTrust’s U.K. insurance subsidiary IGI, net of commissions) and 40% of losses and (b) AII transferred to Maiden Insurance 40% of the AmTrust Ceding Insurer’s unearned premium reserves, effective as of July 1, 2007, with respect to then current lines of business, excluding risks for which the AmTrust Ceding Insurers’ net retention exceeded $5,000 (“Covered Business”). AmTrust also agreed to cause AII, subject to regulatory requirements, to reinsure any insurance company which writes Covered Business in which AmTrust acquires a majority interest to the extent required to enable AII to cede to Maiden Insurance 40% of the premiums and losses related to such Covered Business. The Maiden Quota Share further provides that the AII receives a ceding commission of 31% of ceded written premiums on original lines of business. The Maiden Quota Share had an initial term of three years which was renewed for a successive three year term, through June 30, 2013 and will automatically renew for successive three year terms thereafter, unless either AII or Maiden Insurance notifies the other of its election not to renew not less than nine months prior to the end of any such three year term. In addition, either party is entitled to terminate on thirty day’s notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Insurance, run-off, or a reduction of 50% or more of the shareholders’ equity of Maiden Insurance or the combined shareholders’ equity of AII and the AmTrust Ceding Insurers. Effective June 1, 2008 the Maiden Quota Share was amended such that AII agreed to cede and Maiden Insurance agreed to accept and reinsure retail commercial package business, which the Company, through Affiliates, commenced writing effective June 1, 2008, in connection with its acquisition of UBI. AII ceded to Maiden Insurance 100% of the unearned premium related to in-force retail commercial package business and losses related thereto at the acquisition date and 40% the Company’s net written premium and losses on retail commercial package business written or renewed on or after the effective date. AmTrust receives a ceding commission of 34.375% for retail commercial package business.
Other As part of the acquisition of Associated, the Company acquired a reinsurance recoverable as of the date of closing. The most significant reinsurance recoverable is from American Home Assurance Co. (“American Home”). AIIC’s reinsurance relationship with American Home incepted January 1, 1998 on a loss occurring basis. From January 1, 1998 through June 30, 1999 the American Home reinsurance covered losses in excess of $0.25 million per occurrence up to statutory coverage limits. Effective April 1, 1999, American Home provided coverage in the amount of $0.15 million in excess of $0.1 million. This additional coverage terminated on December 31, 2001 on a run-off basis. Therefore, for losses occurring in 2002 that attached to a policy that was in effect in 2001, the retention was $0.1 million per occurrence. Effective January 1, 2002, American Home increased its attachment to $0.25 million per occurrence. The excess of loss treaty that had an attachment of $0.25 million was terminated on a run-off basis on December 31, 2002. Therefore, losses occurring in 2003 that attached to a 2002 policy were ceded to American Home at an attachment point of $0.25 million per occurrence.
We reevaluate our reinsurance programs annually or more frequently, as needed, and consider a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms. Even if we maintain our existing retention levels, if the cost of reinsurance increases, our cash flow from
Securities Sold Under Agreements to Repurchase, at Contract Value The Company enters into repurchase agreements. The agreements are accounted for as collateralized borrowing transactions and are recorded at contract amounts. The Company receives cash or securities, that it invests in or holds in short term or fixed income securities. As of December 31, 2009, there were $172.8 million principal amount outstanding at interest rates between 0.25% and 0.30%. Interest expense associated with these repurchase agreements for 2009 was $1.6 million of which $0.002 million was accrued as of December 31, 2009. The Company has approximately $176.5 million of collateral pledged in support of these agreements.
Note Payable - Collateral for Proportionate Share of Reinsurance Obligation In conjunction with the Maiden Quota Share (See “Reinsurance”), AII entered into a loan agreement with Maiden Insurance during the fourth quarter of 2007, whereby, Maiden Insurance lends AII the amount of the obligations of the AmTrust Ceding Insurers that AII is obligated to secure, not to exceed the amount equal to the Maiden Insurance’s proportionate share of such obligations to such AmTrust Ceding Insurers in accordance with the Maiden Quota Share agreement. The loan agreement was amended in February 2008 to provide for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Each advance under the loan is secured by a promissory note. Advances totaled $168.0 million as of December 31, 2009.
Contractual Obligations and Commitments The following table sets forth certain of our contractual obligations as of December 31, 2009:
(1) The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2009 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense estimate process, see “Business - Loss Reserves.” Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors - Risks Related to Our Business - Our loss reserves are based on estimates and may be inadequate to cover our actual losses” for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
(3) We are required by the terms of certain purchase agreements to pay the seller an annual minimum override payment based on a contractually defined formula. The amount payable to the seller under these agreements could be materially higher if the premiums produced generate a higher payment than the calculated minimum payment.
Inflation Property and casualty insurance premiums are established before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates
where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings.