Bancinsurance Corporation (“Bancinsurance”) is a specialty property/casualty insurance holding company incorporated in the State of Ohio in 1970. Bancinsurance Corporation and its subsidiaries (collectively, the “Company”) have three reportable business segments: (1) property/casualty insurance; (2) municipal code publishing; and (3) insurance agency. These segments are described in more detail below.
Our unemployment compensation (“UC”) products are utilized by qualified entities that elect not to pay the unemployment compensation taxes and instead reimburse state unemployment agencies for benefits paid by the agencies to the entities’ former employees. Through our UCassure® and excess of loss products, we indemnify the qualified entity for liability associated with their reimbursing obligations. In addition, we underwrite surety bonds that certain states require employers to post in order to obtain reimbursing status for their unemployment compensation obligations.
Other specialty products consist primarily of our waste surety bond program (“WSB”). In the second quarter of 2004, the Company entered into a 50% quota share reinsurance arrangement whereby the Company assumed waste surety bond coverage with certain insurance carriers. Effective January 1, 2005, the reinsurance arrangement was amended whereby the Company’s assumed participation was reduced from 50% to 25%. In addition to assuming business, the Company also writes surety bonds on a direct basis and then cedes 50% of that business under the reinsurance arrangement. All surety bonds written directly and assumed under this program are produced and administered by a general insurance agent that is affiliated with one of the insurance carriers. The majority of the surety bonds under the program satisfy the closure/post-closure financial responsibility imposed on hazardous and solid waste treatment, storage and disposal facilities pursuant to Subtitles C and D of the Federal Resource Conservation and Recovery Act (“RCRA”). Closure/post-closure bonds cover future costs to close and monitor a regulated site such as a landfill. All of the surety bonds are indemnified by the principal and collateral is maintained on the majority of the bonds. The indemnifications and collateralization of this program reduces the risk of loss.
Municipal Code Publishing. Our wholly-owned subsidiary, American Legal Publishing Corporation (“ALPC”), codifies, publishes, supplements and distributes ordinances for approximately 1,900 local governmental units in 40 states. Ordinance codification is the process of collecting, organizing and publishing legislation for state and local governments. ALPC also provides information management services which includes electronic publishing, document imaging and internet hosting services.
Insurance Agency. In July 2002, we formed Ultimate Services Agency, LLC (“USA”), a wholly-owned subsidiary. We formed USA to act as an agency for placing property/casualty insurance policies offered and underwritten by Ohio Indemnity and potentially by other property/casualty insurance companies.
Harco Arbitration. On November 3, 2004, Rosemont Reinsurance Ltd., one of the reinsurers participating in the discontinued bond program, instituted arbitration against Harco National Insurance Company (“Harco”), one of the insurance carriers. On December 2, 2004, Harco made a request that the Company and Contributionship join in this arbitration. On December 22, 2004, the Company agreed to consolidate arbitrations with Rosemont Reinsurance Ltd. and Harco. The Contributionship also agreed to participate in the consolidated arbitration. Through this arbitration, the Company is seeking rescission of the reinsurance agreement and other appropriate relief. Harco is seeking to recover certain of its losses from the Company under the reinsurance agreement. This arbitration is proceeding and a hearing is currently scheduled to begin in June 2006.
2005 Reserve Developments. The Company recorded discontinued bond program losses and LAE of $0.4 million and $20.2 million during 2005 and 2004, respectively. The $20.2 million of losses and LAE recorded in 2004 consisted of $1.4 million of net paid losses and an $18.8 million increase in loss and LAE reserves. The $0.4 million of losses and LAE recorded in 2005 consisted of the following: 1) a $2.8 million net increase in loss and LAE reserves during 2005 based on revised estimates of potential future liabilities as provided by the insurance carriers; 2) a $2.8 million increase in loss and LAE reserves during 2005 related to the Highlands’ Receiver global settlement with the New Jersey Attorney General (“NJAG”) for its bail bond obligations; 3) a $1.6 million net decrease in loss and LAE reserves during 2005 due primarily to a favorable ruling by the Aegis Arbitration Panel (the “Panel”) whereby the Panel limited the Company’s immigration bond obligations to Aegis; and 4) a $3.6 million decrease in loss and LAE reserves during 2005 based on management’s estimated settlement values with certain insurance carriers as of December 31, 2005. The following provides a more detailed description of these developments:
It should be noted that there is potential for the Company to mitigate its ultimate liability on the program through the arbitrations with the insurance carriers; however, because of the subjective nature inherent in assessing the final outcome of the arbitrations, management can not estimate the probability of an adverse or favorable outcome as of December 31, 2005. In addition, while outside counsel believes we have legal defenses under the reinsurance agreements, they are unable to assess whether an adverse outcome is probable or remote in the arbitrations as of December 31, 2005. In accordance with SFAS No. 5 “Accounting for Contingencies,” the Company is reserving to its best estimate of the ultimate liability on the program at December 31, 2005 taking into account the estimated settlement values with certain insurance carriers (as described above) but not taking into account the final outcome of the arbitrations. If the Company obtains information to revise its estimate of potential settlement values or determine an estimate of final arbitration values, the Company will record such reserve changes, if any, in the period that the revised estimate is made in accordance with SFAS No. 60, “Accounting and Reporting by Insurance Enterprises.” The Company does not intend to pay for any of the losses on the discontinued bond program unless and until the arbitrations are settled on a mutually agreeable basis and/or a final binding judgment is made as to the Company’s ultimate liability.
See Notes 16 and 25 to the Consolidated Financial Statements for additional discussion of the discontinued bond program.
During 2003, we selectively began to respond to growth opportunities through producer-owned reinsurance. This involves an insurance producer forming a sister reinsurance company, commonly referred to as a producer-owned reinsurance company (“PORC”). The primary reason for an insurance producer to form a reinsurance company is to realize the underwriting profits and investment income from the insurance premiums generated by that producer. In return, the Company receives a ceding commission, which is based on a percentage of the premiums ceded.
During the second quarter of 2004, the Company entered into a 50% quota share reinsurance arrangement whereby the Company cedes and assumes waste surety bond coverage with another insurance carrier. Effective January 1, 2005, this reinsurance arrangement was amended whereby the Company’s assumed participation was reduced from 50% to 25%.
See Note 16 to the Consolidated Financial Statements for additional information regarding the Company’s reinsurance.
Net income (loss) for 2004 was $(8,500,620), or $(1.72) per diluted share, compared to $3,909,817, or $0.77 per diluted share, in 2003. The most significant factor contributing to the decrease in net income (loss) was an increase in losses and LAE of approximately $20.2 million for the discontinued bond program. See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for additional information concerning the discontinued bond program. This decrease was partially offset by a federal income tax benefit of $6.7 million related to the discontinued bond program loss.
Net premiums earned for WSB increased 129.2%, or $2,727,705, to $4,839,248 in 2005 from $2,111,543 in 2004, as we participated in this program for a full year in 2005 compared to a partial year in 2004.
ULI net premiums earned decreased 15.6%, or $5,373,145, to $29,074,557 in 2005 from $34,447,702 in 2004. The decline was due to decreased lending volume for certain of our financial institution customers, one of our managing general agents moving a portion of its premium in an effort to evenly distribute its business with existing insurance carriers and an increase in experience rating adjustments. The experience rating adjustment is primarily influenced by ULI policy experience-to-date and premium growth. A decrease in experience rating adjustments results in a positive impact to net premiums earned whereas an increase in experience rating adjustments results in a decrease to net premiums earned. Experience rating adjustments increased for the year when compared to last year primarily due to favorable loss experience for the ULI product line. Management anticipates that experience rating adjustments will fluctuate in future periods based upon loss experience and premium growth. These decreases in ULI net premiums earned were partially offset by an increase in lending volume by several of our other financial institution customers.
Discontinued bond program net premiums earned declined $672,897 in 2005 compared to a year ago due to the discontinuation of this program in the second quarter of 2004. See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for additional information concerning the discontinued bond program.
Net realized gains on investments increased 17.1%, or $187,581, to $1,281,755 in 2005 from $1,094,174 a year ago. This increase was a combination of the timing of sales of individual securities and other-than-temporary impairments on investments. We generally decide whether to sell securities based upon investment opportunities and tax consequences. We regularly evaluate the quality of our investment portfolio. When we believe that a specific security has suffered an other-than-temporary decline in value, the difference between cost and estimated fair value is charged to income as a realized loss on investments. There were no impairment charges included in net realized gains on investments in 2005 compared to $535,487 a year ago. Included in impairment charges for 2004 is a write down of $334,136 related to a private equity investment due to its financial uncertainty. For more information concerning impairment charges, see “Critical Accounting Policies-Other-Than-Temporary Impairment of Investments” below.
development of benefit charges. Our management fees increased to $713,697 in 2005 from $33,710 a year ago as a result of pricing actions, favorable unemployment experience during 2005 and cancellation of a poor performing account at the end of 2004. We expect management fees to vary from period to period depending on unemployment levels and benefit charges.
ULI losses and LAE decreased 27.3%, or $5,883,795, to $15,685,102 in 2005 from $21,568,897 a year ago. The decrease was due primarily to favorable loss development during 2005 as a result of fewer loan defaults, bankruptcies and automobile repossessions among our ULI customers combined with a decrease in business.
CPI losses and LAE increased 14.0%, or $98,070, to $798,465 in 2005 from $700,395 a year ago which is consistent with the growth in the business.
GAP losses and LAE increased 22.7%, or $941,850, to $5,088,477 in 2005 from $4,146,627 a year ago principally due to growth in the business.
WSB losses and LAE increased 129.2%, or $272,771, to $483,925 in 2005 from $211,154 a year ago. This increase is consistent with the growth in WSB net premiums earned as the Company records loss and LAE reserves for WSB using an expected loss ratio reserving method, which is based on a certain percentage of net premiums earned.
Codification and Subscription Expenses. Codification and subscription expenses incurred by ALPC decreased 20.9%, or $741,844, to $2,809,700 in 2005 from $3,551,544 a year ago. This decrease was consistent with the decline in codification and subscription revenues and was primarily attributable to the completion of a one-time project during 2004 that generated additional expenses for last year as well as the impairment write-down of a database in the second quarter of 2004.
Interest Expense. Interest expense increased 28.8%, or $257,900, to $1,152,363 in 2005 from $894,463 a year ago as a result of rising interest rates. See “Liquidity and Capital Resources” for discussion of the Company’s trust preferred debt issued to affiliates, which makes up the majority of the Company’s interest expense.
GAAP Combined Ratio. For 2005, the combined ratio decreased to 93.6% from 129.7% a year ago. The loss ratio improved to 45.8% in 2005 from 95.1% a year ago due principally to the decrease in losses and LAE for the discontinued bond program. Excluding the discontinued bond program losses and LAE, the Company’s loss ratio was 45.0% in 2005 compared to 54.8% a year ago. The improvement in the loss ratio (excluding the discontinued bond program) was attributable to the performance of our ULI, CPI, GAP and
WSB product lines. The expense ratio increased to 47.8% in 2005 from 34.6% a year ago primarily due to an increase in commission expense and other insurance operating expenses as described above.
Net premiums earned for the discontinued bond program were $588,801 for 2004 compared to $525,089 for 2003. This increase was primarily the result of additional premiums being reported to the Company by the insurance carriers during 2004 compared to 2003.
During 2004, we recorded a net realized gains on investments of $1,094,174 compared to $822,161 in 2003. This increase was a combination of the timing of the sale of individual securities and other-than-temporary impairment write downs on investments. There were $535,487 in impairment charges included in net realized gain on investments in 2004 compared to $129,729 in 2003. Included in impairment charges for 2004 is a write down of $334,136 related to a private equity investment due to its financial uncertainty. For more information concerning impairment charges, see “Other-Than-Temporary Impairment of Investments” below.
Losses and Loss Adjustment Expenses. Total losses and LAE increased 42.8% to $47,237,315 in 2004 from $33,083,172 in 2003 principally due to losses and LAE of $20.2 million on the discontinued bond program. Excluding the discontinued bond program, losses and LAE declined 17.1% to $27,076,212 in 2004 from $32,650,827 in 2003 primarily due to decreases in losses and LAE for our ULI, CPI and UC products which were partially offset by an increase in losses and LAE for our GAP product.
UC losses and LAE declined 81.5% to $428,191 in 2004 from $2,318,940 in 2003 primarily due to the cancellation of an excess of loss policy at the end of 2003. This decrease was partially offset by an increase in losses and LAE due to reserve strengthening during 2004 associated with rising unemployment compensation obligations.
Commissions, Other Insurance Expenses and General and Administrative Expenses. Commission expense rose 43.0% to $11,285,050 in 2004 from $7,891,016 in 2003 principally due to commissions associated with the growth in GAP and WSB combined with a decrease in ceding commissions associated with a lender/dealer reinsurance agreement that was cancelled at the end of 2003. Other insurance operating expenses and general and administrative expenses combined increased 12.1% to $6,950,665 in 2004 from $6,199,027 in 2003 as a result of an increase salaries and benefits combined with an increase in administrative fees associated with the UCassure® product. These increases were partially offset by a decrease in premium taxes which resulted from the cancellation of the lender/dealer reinsurance agreement at the end of 2003.
Codification and Subscription Expenses. Codification and subscription expenses incurred by ALPC increased 8.6% to $3,551,544 in 2004 from $3,269,714 in 2003 principally due to higher salaries and an impairment write-down of a database which resulted from cancellation of a state customer during 2004.
Federal Income Taxes. The Company had an income tax (benefit) of $(4,767,432) in 2004 compared to income tax expense of $1,614,165 in 2003. The benefit in 2004 was primarily caused by losses from the discontinued bond program.
Increased incentives being offered on new cars by dealers and manufacturers have depressed the value of the used car market. In addition, the increasing cost of fuel could lower the fair value of less fuel efficient vehicles. If used car prices continue to decline, the “gap” between the value of the vehicle and the outstanding loan balance would increase and thus the severity of our GAP losses would increase. The Company has taken pricing actions to help mitigate the effect of these trends.
Automobile sale volumes are projected to be lower in 2006 which could result in fewer automobile financings among our lender/dealer customers. As a result, premium volume could decline if our lender/dealer customers are impacted by such trend. In addition, during the third quarter of 2005, one of our managing general agents moved a portion of its ULI and GAP premium in an effort to evenly distribute its business with existing insurance carriers. As a result, the Company expects a decline in premiums earned and losses and commissions incurred of approximately $3.0 million and $2.5 million, respectively, for this managing general agent in 2006 when compared to 2005.
If interest rates continue to rise during 2006, it would increase the level of interest expense on the Company’s trust preferred debt and any borrowings under its revolving line of credit. In addition, a rise in interest rates could decrease the fair value of the Company’s fixed income investment portfolio.
short-term investment position. We maintain a level of cash and liquid short-term investments which we believe will be adequate to meet our anticipated cash needs without being required to liquidate intermediate-term and long-term investments. At December 31, 2005, total cash and short-term investments were approximately $13.5 million and gross loss and LAE reserves, excluding the discontinued bond program, were approximately $7.7 million.
As discussed in “Overview-Discontinued Bond Program” above and in Note 16 to the Consolidated Financial Statements, the Company recorded $19.6 million in loss and LAE reserves for the discontinued bond program at December 31, 2005. As of December 31, 2005, the Company was disputing these losses in ongoing arbitration proceedings. The Company does not intend to pay for any of the losses on the discontinued bond program unless and until the arbitrations are settled on a mutually agreeable basis and/or a final binding judgment is made as to the Company’s liability. Given the uncertainties of the outcome of the arbitrations, settlements with the insurance carriers or other potential recoveries, uncertainties as to the prospective settlement amount between Highlands and DHS for Highlands’ immigration bond obligations, uncertainties in the future loss information provided by the insurance carriers, and the inherent volatility in assumed reinsurance, actual losses incurred for the discontinued bond program could be materially different from our estimated reserves. Ultimate payment on the discontinued bond program may result in an increase in cash outflows from operations when compared to trends of prior periods and may impact our financial condition by reducing our invested assets. We consider the discontinued bond program liabilities and related arbitrations as we manage our assets and liabilities. In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed-income investments with the expected payout of our liabilities for the discontinued bond program. There are no significant variations between the maturity of our investments and the expected payout of our loss and LAE reserves for the discontinued bond program.
ALPC derives its funds principally from codification and subscription fees which are currently sufficient to meet its operating expenses. USA derives its funds principally from commissions and fees which are currently sufficient to meet its operating expenses.
Ohio Indemnity is restricted by the insurance laws of the State of Ohio as to amounts that can be transferred to Bancinsurance in the form of dividends without the approval of the Department. During 2006, the maximum amount of dividends that may be paid to Bancinsurance by Ohio Indemnity without prior approval is limited to $3,478,274.
Ohio Indemnity is subject to a risk-based capital test applicable to property/casualty insurers. The risk-based capital test serves as a benchmark of an insurance enterprise’s solvency by state insurance regulators by establishing statutory surplus targets which will require certain company level or regulatory level actions. Ohio Indemnity’s total adjusted capital is in excess of all required action levels as of December 31, 2005.
Given the Company’s historic cash flows and current financial condition, management believes that cash flows from operating and investing activities over the next year will provide sufficient liquidity for the operations of the Company. Our line of credit provides us with additional liquidity that could be used for short-term cash requirements if cash from operations and investments is not sufficient.
Our loss and LAE reserves do not have contractual maturity dates; however, based on historical payment patterns, we have included an estimate of when we expect our loss and LAE reserves to be paid in the above table. The exact timing of the payment of claims cannot be predicted with certainty. The actual payment amounts and the related timing of those payments could differ significantly from these estimates.
The following discussion summarizes our process of reviewing our investments for possible impairment.
relevant rating history, analysis and guidance provided by rating agencies and analysts; and
our ability and intent to hold the security for a period of time sufficient to allow for recovery in the market value.
The Company utilizes its internal staff, reports from ceding insurers under assumed reinsurance and an independent consulting actuary in establishing its loss and LAE reserves. The Company’s independent consulting actuary reviews the Company’s reserve for losses and LAE at the end of each fiscal year and prepares a report that includes a recommended level of reserves. The Company considers this recommendation in establishing the amount of its reserves for losses and LAE.
that are not presently quantifiable. Thus, while we believe our reserve estimates are reasonable given the information currently available, actual emergence of losses could deviate materially from our estimates and from amounts recorded by us.
We record reserves on an undiscounted basis. Our reserves reflect anticipated salvage and subrogation included as a reduction to loss and LAE reserves. We do not provide coverage that could reasonably be expected to produce asbestos and/or environmental liability claims activity or material levels of exposure to claims-made extended reporting options.
Loss and LAE Reserves at Year End. As of December 31, 2005 and 2004, gross loss and LAE reserves by product line were split between incurred but not reported (“IBNR”) and case reserves as follows:
ratio for the 2004 accident year was 69.4% and 73.2%, respectively. Changes in this key assumption occurred primarily during the first half of 2005 as the majority of our ULIL losses are settled within four months from the date of loss. When estimating the ultimate loss ratio at December 31, 2004, the Company selected an ultimate loss ratio for the 2004 accident year that was comparable to previous accident years’ ultimate loss ratios. During the first half of 2005, our 2004 accident year loss experience was more favorable than previously estimated at December 31, 2004. In accordance with SFAS No. 60, the Company recorded this change in reserves as a change in estimate during 2005. It should be noted that the ULIL product is subject to premium adjustments based on loss experience (i.e., experience-rated policies and retrospective-rated policies), and therefore, this prior year loss development had no impact on net income.
Certain statements made in this Annual Report on Form 10-K are forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written or oral communications from time to time that contain forward-looking statements. Forward-looking statements convey our current expectations or forecast future events. All statements contained in this Annual Report on Form 10-K, other than statements of historical fact, are forward-looking statements. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations. The words “may,” “continue,” “estimate,” “intend,” “plan,” “will,” “believe,” “project,” “expect,” “anticipate” and similar expressions generally identify forward-looking statements but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that may cause actual results to differ materially from those statements. Risk factors that might cause actual results to differ from those statements include, without limitation, changes in underwriting results affected by adverse economic conditions, fluctuations in the investment markets, changes in the retail marketplace, changes in the laws or regulations affecting the operations of the Company, changes in the business tactics or strategies of the Company, the financial condition of the Company’s business partners, changes in market forces, litigation, developments in the discontinued bond program and related arbitrations, the ongoing SEC private investigation and the concentrations of ownership of the Company’s common shares by members of the Sokol family, and other risk factors identified in our filings with the SEC, any one of which might materially affect our financial condition and/or results of operations. Any forward-looking statements speak only as of the date made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
We have audited the accompanying consolidated balance sheets of Bancinsurance Corporation and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for the three years then ended. Our audits also included the financial statement schedules listed in the index at Item 15(a). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bancinsurance Corporation and subsidiaries at December 31, 2005 and 2004 and the results of their operations and their cash flows for the three years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 123R, “Share-Based Payment,” that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on fair value of the equity instrument issued on the grant date. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” the principles that the Company employed through 2005 to account and report its employee stock option awards. SFAS No. 123R is effective at the beginning of the entity’s first fiscal year that begins after December 15, 2005. The Company will implement this standard in the first quarter of 2006. The Company believes the impact of implementing this standard will result in higher compensation expense and the standard would have reduced 2005 net income by approximately $0.02 per diluted share (see Note 1(r) to the Consolidated Financial Statements).
Ohio Indemnity’s insurance premiums and ceded commissions are earned over the terms of the related insurance policies and reinsurance contracts. For our ULI and GAP products, premiums are earned over the contract period in proportion to the amount of insurance protection provided as the amount of insurance protection declines according to a predetermined schedule. For all other products, premiums are earned pro rata over the contract period. The portion of premiums written applicable to the unexpired portion of insurance policies is recorded in the balance sheet as unearned premiums.
Revenue from ALPC municipal code contracts is recognized on the percentage-of-completion method. Completion is measured based on the percentage of direct labor costs incurred-to-date compared to estimated direct labor costs for each contract. While we use available information to estimate total direct labor costs on each contract, actual experience may vary from estimated amounts. Revenue from code supplements is recognized on the completed-contract method because the typical supplement is completed in a few months.
In the ordinary course of business, we cede and assume reinsurance with other insurers and reinsurers. We report balances pertaining to reinsurance transactions “gross” on the balance sheet, meaning that reinsurance recoverables on unpaid losses and LAE and ceded unearned premiums are not deducted from insurance reserves but are recorded as assets. Ceded reinsurance transactions for the Company represent quota share arrangements for certain lender/dealer producers. In addition, the Company participates in a waste surety bond program under a quota share arrangement in which the Company assumes and cedes business. As discussed in Note 16 to the Consolidated Financial Statements, the Company assumed bail and immigration bond business through the second quarter of 2004 after which the program was discontinued.
Certain ULI policies are eligible for premium adjustments based on loss experience. For certain policies, return premiums are
Pursuant to the terms of certain surety bonds issued by the Company that guarantee the payment of reimbursable unemployment compensation benefits, certain monies are held by the Company in contract funds on deposit and are used for the payment of benefit charges. The Company has agreements with a cost containment service firm designed to control the unemployment compensation costs of the employers enrolled in the program. Any remaining funds after the payment of all benefit charges are shared between the Company and the cost containment firm as management fees. Management fees are recognized when earned based on the development of benefit charges. Management fees of $713,697, $33,710 and $114,094 were recognized in 2005, 2004 and 2003, respectively, as a result of this arrangement.
Cash and cash equivalents include all cash balances and highly liquid investments with an initial maturity of three months or less. Cash equivalents are stated at cost, which approximates fair value. The Company places its cash investments with high credit quality financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $100,000. At December 31, 2005 the Company had uninsured cash of $3,834,056.
The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. Additional awards in future years are anticipated.
The amortized cost and estimated fair value of fixed maturity investments in held to maturity and available for sale securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The proceeds from sales of available for sale securities were $47,636,072, $28,255,910 and $38,118,613 for the years ended December 31, 2005, 2004 and 2003, respectively.
The Company continually monitors developments affecting our invested assets, paying particular attention to events that might give rise to impairment write-downs, including but not limited to: (1) the length of time and extent to which the estimated fair value has been less than book value; (2) whether the decline appears to be related to general market or industry conditions or is issuer-specific; and (3) our ability and intent to hold the security for a period of time sufficient to allow for recovery in the estimated fair value. There were $0, $535,487 and $129,729 in impairment charges included in net realized gains on investments for the years ended December 31, 2005, 2004 and 2003, respectively. Included in impairment charges for 2004 is a write down of $334,136 related to a private equity investment due to its financial uncertainty. As part of the Company’s normal assessment of other-than-temporary impairments of investments, the securities listed above were evaluated and no further impairments were deemed necessary as of December 31, 2005.
Changes in deferred policy acquisition costs for the year ended December 31 are summarized as follows:
The future minimum lease payments required under these operating leases for the next five fiscal years are as follows:
dividend obligations with respect to such trust preferred securities. BIC Trust I’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred basis points (8.44% and 6.44% at December 31, 2005 and 2004, respectively), are redeemable at par on or after December 4, 2007 and mature on December 4, 2032. BIC Trust II’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred and five basis points (8.58% and 6.61% at December 31, 2005 and 2004, respectively), are redeemable at par on or after September 30, 2008 and mature on September 30, 2033. Interest on the junior subordinated debentures is charged to income as it accrues. Interest expense related to the junior subordinated debentures for the period ended December 31, 2005, 2004 and 2003 was $1,148,431, $862,256 and $538,056, respectively. The Company was in compliance with all provisions of our debt covenants at December 31, 2005.
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which requires the consolidation of certain entities considered to be variable interest entities (“VIEs”). An entity is considered to be a VIE when it has equity investors who lack the characteristics of having a controlling financial interest, or its capital is insufficient to permit it to finance its activities without additional subordinated financial support. Consolidation of a VIE by an investor is required when it is determined that the investor will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the VIE’s expected residual returns if they occur, or both. The Company adopted FIN 46 on July 1, 2003. Upon adoption, BIC Trust I was deconsolidated effective July 1, 2003 with prior periods reclassified in the consolidated financial statements. The deconsolidation did not have any impact on net income. In accordance with FIN 46, BIC Trust II was not consolidated upon formation in September 2003.
The Ohio Indemnity Company Employee 401(k) and Profit Sharing Plan (the “401(k) Plan”) is available to full-time employees who meet the 401(k) Plan’s eligibility requirements. Under the 401(k) Plan, we match 100% of the qualified employee’s contribution up to 3% of salary and 50% of the qualified employee’s contribution between 3% and 5% of salary. The total cost of the matching contribution was $126,640, $224,548 and $164,057 for the years ended December 31, 2005, 2004 and 2003, respectively.
There were no options granted during 2005. The fair value of each option granted during 2004 and 2003 is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: (1) expected volatility of 27.10% for 2004 and 27.44% for 2003; (2) risk-free interest rate of 4.26% for options granted May 17, 2004, 3.88% for options granted December 21, 2004, 3.09% for options granted March 14, 2003, 2.82% for options granted May 16, 2003, 2.74% for options granted June 2, 2003, and 2.64% for options granted June 3, 2003; (3) expected life of six years for all years; and (4) 0% dividend yield for all years.
The following table summarizes weighted-average information by range of exercise prices for stock options outstanding and exercisable at December 31, 2005:
Ohio Indemnity is subject to a risk-based capital test applicable to property/casualty insurers. The risk-based capital test serves as a benchmark of an insurance enterprise’s solvency by state insurance regulators by establishing statutory surplus targets which will require certain company level or regulatory level actions. Ohio Indemnity’s total adjusted capital was in excess of all required action levels at December 31, 2005.
Activity in the reserve for unpaid losses and LAE is summarized as follows (dollars in thousands):
As a result of changes in estimates of insured events in prior years, the provision for unpaid loss and LAE decreased by approximately $3,697,000, $5,383,000 and $2,805,000 in 2005, 2004 and 2003, respectively, due to favorable loss development, primarily attributable to the Company’s ULI product line.
Company’s capacity to write business, provide greater diversification, align business partners with the Company’s interests, and/or limit the Company’s maximum loss arising from certain risks. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer. The primary insurer would reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreement. The ability to collect reinsurance is subject to the solvency of the reinsurers and/or collateral provided under the contract.
Effective October 1, 2003, the Company entered into a producer-owned reinsurance arrangement with an existing lender/dealer customer whereby 100% of that customer’s premiums (along with the associated risk) was ceded to its PORC. For this reinsurance arrangement, the Company has obtained collateral in the form of a trust from the reinsurer to secure its obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and the Company has immediate access to such collateral if necessary. Under this arrangement, the Company ceded premiums earned of $1,727,303, $894,717 and $8,124,672 during 2005, 2004 and 2003, respectively.
Beginning in the second quarter of 2004, the Company entered into a quota share reinsurance arrangement with certain insurance carriers whereby the Company assumed and ceded 50% of the applicable business. Effective January 1, 2005, the reinsurance arrangement was amended whereby the assumed participation was reduced from 50% to 25%. Under this program, the Company assumed premiums earned of 4,302,509 and $1,980,492 during 2005 and 2004, respectively. Also, the Company ceded premiums earned of $679,563 and $131,051 during 2005 and 2004, respectively.
Effective January 1, 2005, the Company entered into a producer-owned reinsurance arrangement with a GAP agent whereby 100% of that agent’s premiums (along with the associated risk) were ceded to its PORC. For this reinsurance arrangement, the Company has obtained collateral in the form of a letter of credit to secure its obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and the Company has immediate access to such collateral if necessary. Under this arrangement, the Company ceded premiums earned of $734,435 during 2005.
Based on the design of the program, the bail bond agency was to obtain and maintain collateral and other security and to provide funding for bond losses. The bail bond agency and its principals were responsible for all losses as part of their program
administration. The insurance carriers and, in turn, the reinsurers were not required to pay losses unless there was a failure of the bail bond agency. As the bonds were to be 100% collateralized, any losses paid by the reinsurers were to be recoverable through liquidation of the collateral and collections from third party indemnitors.
Arbitrations. The Company has entered into arbitrations with all four insurance carriers that participated in the discontinued bond program. The arbitration proceedings as of December 31, 2005 are described in more detail below:
Highlands Arbitration. Highlands Insurance Company (“Highlands”), one of the insurance carriers, was placed in receivership during 2003. On August 31, 2005, Highlands’ Receiver demanded arbitration against the Company and other reinsurers, including the Contributionship, AHIC and various Lloyds Syndicates. In November 2005, the Company responded to this demand seeking rescission of the reinsurance agreement, monetary damages for claims that were paid by the Company under the agreement and other appropriate relief. Highlands is seeking to recover certain of its losses from the Company under the reinsurance agreement. No arbitration panel has yet been constituted.
as provided by the insurance carriers; 2) a $2.8 million increase in loss and LAE reserves during 2005 related to the Highlands’ Receiver global settlement with the New Jersey Attorney General (“NJAG”) for its bail bond obligations; 3) a $1.6 million net decrease in loss and LAE reserves during 2005 due primarily to a favorable ruling by the Aegis Arbitration Panel (the “Panel”) whereby the Panel limited the Company’s immigration bond obligations to Aegis; and 4) a $3.6 million decrease in loss and LAE reserves during 2005 based on management’s estimated settlement values with certain insurance carriers as of December 31, 2005. The following provides a more detailed description of these developments:
Loss and LAE Reserves. The following compares our loss and LAE reserves for the discontinued bond program at December 31, 2005 and December 31, 2004 (dollars in millions):
At December 31, 2005, the Company believed Highlands was in negotiations with DHS for global settlement of its immigration bond obligations. The Company believes negotiated settlements are not uncommon for this type of program. The Company’s immigration bond loss and LAE reserves at December 31, 2005 take into consideration estimated global settlement values between DHS and Highlands.
In 1994, we entered into a Split-Dollar Insurance Agreement with a bank, as trustee, for the benefit of an officer and his spouse wife. The bank has acquired a second-to-die policy on the lives of the insureds, in the aggregate face amount of $2,700,000. At December 31, 2005 and 2004, we had loaned the trustee $860,934 and $789,215, respectively, under this agreement for payment of insurance premiums, which is included in loans to affiliates in the accompanying balance sheet. Amounts loaned by the Company to the trustee are to be repaid, in full, without interest, from any of the following sources: (1) cash surrender value of the underlying insurance policies; (2) death benefits; and/or (3) the sale of 15,750 common shares of the Company contributed by the officer to the trust.
In February 2000, we entered into a Split-Dollar Insurance Agreement for the benefit of another officer in the face amount of $1,000,000. All premiums paid by the Company in accordance with this agreement are to be repaid, in full, without interest, upon the death, retirement or termination of the officer. The Company paid premiums of $30,000 relating to this agreement; however, the Company is no longer paying premiums under the agreement. At December 31, 2005 and 2004, $30,000 was included in loans to affiliates in the accompanying balance sheet for payment of insurance premiums in accordance with this agreement.
Short-term investments: The carrying amounts are reasonable estimates of fair value.
Fixed maturities and equity securities: Fair values are based upon quoted market prices or dealer quotes for comparable securities.
Our results of operations have varied, and in the future may vary, from quarter to quarter, principally because of fluctuations in our underwriting results. Consequently, quarterly results are not necessarily indicative of full year results, nor are they comparable to the results of other quarters. The following table sets forth certain unaudited quarterly consolidated financial and operating data: