The Company’s principal executive offices are approximately 69,000 square feet in size and are located at 919 Third Avenue, New York, New York 10022. The Company entered into a sublease for approximately 28,000 square feet of this space, which commenced on March 1, 2003 and expires on July 30, 2016. In April 2005, the Company signed an amendment to the sublease, for approximately 10,000 square feet of additional space. The amended sublease expires on July 30, 2016. The minimum monthly rental payments of $141,276 under the amended sublease include the rent paid by the Company for the original sublease. Rent payments under the amended sublease commenced in 2005 and end in 2016, with payments amounting to $20.8 million, collectively, over the term of the agreement. In June 2007, the Company leased an additional 30,615 square feet at the principal executive location in New York City. The lease provides for minimum monthly rental payments of $197,722 beginning in 2008 and $210,478 beginning in 2013. The lease expires on July 30, 2016. In 2008, the Company entered into a lease for 2,136 square feet for the office space for its newly formed MMO Agencies, an underwriting division of the Company. The office is located in Long Island, New York. Rent payments under the lease end in 2013, with payments amounting to approximately $370,000, collectively, over the term of the agreement. The lease expires in May 2013.
Ocean marine net premiums written and net premiums earned for the year ended December 31, 2008 each decreased by 13% and 10%, respectively, when compared to 2007. Larger net premium retention levels in 2008 resulted from lower excess of loss reinsurance costs and lower reinsurance reinstatement costs. Losses from hurricane Ike resulted in incurring reinsurance reinstatement costs of $1.6 million in 2008 as compared with $2.3 million of reinsurance reinstatement costs arising from a cargo loss in 2007. Net earned premiums in 2008 largely reflected the decline in gross premiums written, which was partially offset by lower reinsurance costs in 2008 when compared to 2007.
Effective January 1, 2009, the Company maintained its $5 million per risk net loss retention in the ocean marine line that was in existence during 2008. In addition, the Company’s net retention could be as low as $1 million for certain classes within ocean marine. The 80% quota share reinsurance protection for energy business, which commenced in 2006, also remains in effect for 2009 and the net retention from energy business is subject to inclusion within the ocean marine reinsurance program.
An analysis of gross premiums written for the other liability segment is presented below:
Aircraft premiums were nominal in 2008 and 2007 as a result of the Company having ceased writing new aircraft policies subsequent to March 31, 2002.
Net losses and loss adjustment expenses incurred as a percentage of net premiums earned (the loss ratio) were 65.8% for the year ended December 31, 2008 as compared to 54.1% for 2007. The larger loss ratios in 2008 were primarily attributable to losses incurred from hurricanes Gustav and Ike amounting to $6.6 million (including $1.6 million of reinstatement costs), which added 4.0% to the 2008 loss ratio and the resolution of a dispute in 2008 over reinsurance receivables with a reinsurer including a reevaluation of the provision for doubtful reinsurance receivables that resulted in additional losses of $12.4 million, and added 7.4% to the 2008 loss ratio. The decision to resolve the dispute regarding non-core reinsurance receivables and adjust our allowance for other potentially uncollectible non-core reinsurance receivables was related to reinsurance cessions made under a number of reinsurance contracts written from 1978 to 1986. The Company’s loss ratio in 2007 benefited from the novation of substantially all of the excess workers’ compensation policies written in conjunction with a prior producer. The novation reduced the overall loss ratio by 3.7% in 2007. Also contributing to a higher loss ratio in the other liability segment in 2008 was a change in premium mix in the other liability class. Excess workers’ compensation premiums have a higher loss ratio than other classes of other liability business and resulted in an overall increase in the other liability loss ratio. The inland marine/fire loss ratio decreased in 2008, reflecting lower severity losses and lower frequency of losses in the fire and the surety classes.
The Company increased net loss reserves by approximately $2.7 million in 2008 from the 2007 year-end net unpaid loss reserve amount of $306.4 million as a result of adverse loss reserve development. This is compared to $13.8 million of favorable loss reserve development recorded in 2007.
The Company reported favorable development of prior year loss reserves of $13.8 million in 2007. This favorable loss reserve development included $6.2 million recorded on the novation of excess workers’ compensation policies in the other liability line for accident years 2004-2006. Partially offsetting this benefit in the other liability line was adverse development of $3.0 million in the professional liability class as a result of two large claims in the 2006 accident year. The ocean marine line reported favorable development in the 2003-2005 accident years largely as a result of favorable loss trends. The inland marine/fire segment also reported favorable loss development partially due to lower emergence of severity losses. The favorable development in 2007 was partially offset by approximately $3.3 million in adverse development from the runoff aviation class.
Net investment loss for the year ended December 31, 2008 was $(63.5) million as compared to net investment income of $35.5 million in 2007. The decrease in 2008 primarily reflected trading portfolio losses and lower income from limited partnerships. Trading portfolio losses of $(42.3) million were recorded in 2008 and resulted primarily from the fair value changes in the underlying securities. This included municipal obligations of $(3.0) million, preferred stocks of $(31.5) million, economic hedged positions of $(1.1) million and exchange traded funds of $(6.7) million. Limited partnership income in 2008, excluding income from Altrion, decreased from the prior year’s comparable period as a result of lower returns amounting to (24.6)% as compared to 3.4% for the same period in 2007. Most of our hedge fund strategies reported lower returns in 2008 than the prior year’s comparable period. Income from Altrion was $1.2 million and $7.9 million for the year ended December 31, 2008 and 2007, respectively. Income from Altrion was greater in 2007 as a result of interest income received from the warehousing of CDO and CLO debt securities. There were no such activities in 2008. The reduction in investment income from fixed maturities available for sale and short-term investments resulted from maintaining lower average balances during 2008 in such investments.
Investment (loss) income, net of investment fees, from each major category of investments is as follows:
Net realized investment losses were $(47.7) million for the year ended December 31, 2008 as compared to $(6.9) million for the year ended December 31, 2007. These amounts result from the sale of fixed income investments as well as write-downs from other-than-temporary declines in the fair value of securities, which amounted to $46.2 million and $6.7 million for the years ended December 31, 2008 and 2007, respectively. The write-downs in 2008 and 2007 primarily relate to the Company’s investments in super senior residential mortgage-backed securities. The Company has collected all applicable interest and principal repayments on such securities to date. The Company collected $8.5 million in principal repayments on these securities in 2008, which resulted in $1.2 million in realized investment gains as a result of the recapture of previous write-downs of investment balances. The decision to write down such securities in 2008 was based upon the likelihood that the securities may not be held until the fair value decline is recovered. Contributing to management’s decision was the uncertainty of the duration of declines in the residential mortgage-backed market. However, on October 1, 2008, management reconsidered the classification of these securities as a result of our desire to hold such securities for their duration. Accordingly, the Company transferred these holdings to the held to maturity classification using the fair value of these securities on such date as its adjusted cost basis. The Company has both the intent and the ability to hold such securities until maturity.
Interest expense was $6.7 million for each of the years ended December 31, 2008 and 2007, respectively, and resulted primarily from the Company’s $100 million 6.5% senior notes.
Total income tax (benefit) expense amounted to $(33.4) million and $6.8 million, respectively, for the year ended December 31, 2008 and 2007. The Company’s effective tax rate was 24.3% and 33.7% for the year ended December 31, 2008 and 2007. The change in the effective tax rate is largely attributable to the deferred tax valuation allowance increase of $18.5 million resulting in large part from capital loss carryforwards.
Deferred income taxes at December 31, 2008 increased to $35.5 million from $14.4 million at December 31, 2007, primarily due to deferred tax benefits provided on declines in the fair value of investments. Management believes the Company’s total deferred tax assets, net of the recorded valuation allowance account, as of December 31, 2008 will more-likely-than-not be fully realized.
Unpaid losses and loss adjustment expenses decreased to $548.7 million at December 31, 2008 from $556.5 million at December 31, 2007. The decrease was largely the result of the payments of gross ocean marine losses and asbestos and environmental losses that were substantially reinsured.
Ceded reinsurance payable decreased to $23.8 million at December 31, 2008 from $27.1 million at December 31, 2007 mainly as a result of the payment of reinsurance reinstatement premiums on hurricane losses.
Property, improvements and equipments, net increased to $10.0 million at December 31, 2008 from $4.8 million at December 31, 2007, primarily due to as a result of capitalized expenditures relating to information technology infrastructure initiatives and capital improvements on leased office space.
Net income for the year ended December 31, 2007 was $13.4 million or $1.46 per diluted share, as compared to $29.9 million or $3.25 per diluted share, for the year ended December 31, 2006. Net income for 2007 was adversely affected by lower investment income, increases in realized investment losses and after-tax losses of $(3.4) million or $(.39) per share, resulting from the write-off of inefficient computer software and after tax losses of $(1.1) million or $(.13) per share resulting from expenses relating to an investment in an asset management company that was not consummated.
Net realized investment losses after taxes for the year ended December 31, 2007 were $(4.5) million, or $(.49) per diluted share, compared with $(262,000), or $(.03) per diluted share, for 2006. The realized investment losses in 2007 primarily related to write-downs to the Company’s investments in residential mortgage-backed securities.
Ocean marine net premiums written and net premiums earned for year ended December 31, 2007 each decreased by 9% when compared to 2006. Net written and earned premiums in 2007 reflected higher excess of loss reinsurance costs primarily as a result of $2.3 million in reinstatement reinsurance costs incurred on a cargo loss in 2007, and lower amounts of earned premium in the energy class due to additional ceded premiums earned.
As a result of the changes in gross underwriting and reinsurance structures, gross premiums written decreased in the excess worker’s compensation class, while net premiums written and net premiums earned increased in this class during 2007 when compared to 2006. Gross premiums written in the excess workers’ compensation class decreased to $32.5 million in 2007 from $41.7 million for the same period of 2006. Net premiums written, however, increased to $26.4 million in 2007 from $11.5 million in 2006 and net premiums earned increased to $23.4 million in 2007 from $11.6 million in 2006. Volume increases in the professional liability class were also achieved in 2007 when compared to 2006. Premium rates in these classes during in 2007 were flat to slightly declining when compared to 2006.
The Company decreased net loss reserves by approximately $13.8 million in 2007 from the 2006-year end net unpaid loss reserve amount of $293 million as a result of favorable loss reserve development. This compared to $7.7 million of favorable loss reserve development recorded in 2006.
The favorable development of $13.8 million in 2007 included $6.2 million recorded on the novation of excess workers’ compensation policies in the other liability line for accident years 2004-2006. Partially offsetting this benefit in the other liability line was adverse development of $3.0 million in the professional liability class as a result of two large claims in the 2006 accident year. The ocean marine line reported favorable development in the 2003-2005 accident years largely as a result of favorable loss trends. The inland marine/fire segment also reported favorable loss development partially due to lower emergence of severity losses. The favorable development in 2007 was partially offset by approximately $3.3 million in adverse development from the runoff aviation class.
Net realized investment losses were $(6.9) million for the year ended December 31, 2007 as compared to $(403,000) for the year ended December 31, 2006. These amounts result from the sale of fixed income investments as well as write-downs from other-than-temporary declines in the fair value of securities, which amounted to $6.7 million and $371,000 for the years ended December 31, 2007 and 2006, respectively. The write-downs in 2007 primarily relate to the Company’s investments in super senior residential mortgage-backed securities. The decision to write down such securities was based upon our belief that we would not hold such securities until the fair value decline was recovered.
Other assets increased to $10.2 million at December 31, 2007 from $6.9 million at December 31, 2006 primarily as a result of federal income taxes recoverable.
Reinsurance receivables on paid losses, net decreased to $38.8 million at December 31, 2007 from $47.5 million at December 31, 2006 primarily as a result of collections of hurricane losses in the ocean marine line.
In 2004, the Company issued $100,000,000 in 6.5% senior notes due March 15, 2014 and received proceeds of $98,763,000 net of underwriting discount, but before other transaction expenses. The senior notes provide for semi-annual interest payments and are to be repaid in full on March 15, 2014. On July 1, 2004 the Company completed the exchange of registered 6.5% senior notes for the unregistered senior notes issued on March 11, 2004, as required by the registration rights agreement with the purchasers of the senior notes. The indenture relating to the senior notes provides that the Company and its restricted subsidiaries may not incur indebtedness unless the total indebtedness of the Company and its restricted subsidiaries, calculated on a pro forma basis after such issuance, would not exceed 50% of our total consolidated capitalization (defined as the aggregate amount of our shareholders’ equity as shown on our most recent quarterly or annual consolidated balance sheet plus the aggregate amount of indebtedness of the Company and its restricted subsidiaries). The indenture also provides that the Company and its restricted subsidiaries will not pay dividends or make other payments or distributions on the Company’s stock or the stock of any restricted subsidiary (excluding payments by any restricted subsidiary to the Company), purchase or redeem the Company’s stock or make certain payments on subordinated indebtedness unless, after making any such payment, the total indebtedness of the Company and its restricted subsidiaries would not exceed 50% of our total consolidated capitalization (as defined above). In addition, the indenture contains certain other covenants that restrict our ability and our restricted subsidiaries’ ability to, among other things, incur liens on any shares of capital stock or evidences of indebtedness issued by any of our restricted subsidiaries or issue or dispose of voting stock of any of our restricted subsidiaries. The Company used part of the net proceeds from the sale of the senior notes to purchase from certain of its shareholders in 2005 a total of 1,092,735 shares of common stock at $24.80 per share. The Company used the remaining net proceeds for working capital and other general corporate purposes.
Cash flows provided by operating activities were $57.6 million for the year ended December 31, 2008. This compared to cash flows used in operating activities of $106.4 million for the year ended December 31, 2007 and cash flows provided by operating activities of $110.6 million for the year ended December 31, 2006. Cash flows from operating activities are significantly impacted by changes in the Company’s trading and commercial loan portfolios. Any securities purchased by the Company in its trading and commercial loan portfolios would be reflected as a use of cash from operating activities and any securities sold from its trading portfolio would be reflected as a source of cash from operating activities. Trading portfolio activities include the purchase and sale of preferred stocks, municipal bonds, CDO/CLO securities and exchange traded funds. Commercial loan activities include the purchase and sale of middle market loans made to commercial companies. Trading and commercial loan portfolio activities of $84.2 million and $109.8 million favorably affected cash flows for the years ended December 31, 2008 and December 31, 2006, respectively, while trading and commercial loan portfolio activities adversely affected cash flows for the year ended December 31, 2007 by $116.2 million. As the Company’s trading and commercial loan portfolio balances may fluctuate significantly from period to period, cash flows from operating activities may also be significantly impacted by such trading activities.
Cash flows used in financing activities were $10.0 million and $2.8 million for the years ended December 31, 2008 and 2007, respectively. The repurchase of treasury stock accounted for most of the use of cash flows in each of 2008 and 2007. Cash flows provided by financing activities were $1.2 million for the year ended December 31, 2006.
Under the Common Stock Repurchase Plan, as amended in 2008, the Company may purchase up to $75 million of the Company’s issued and outstanding shares of common stock on the open market. The Company paid $7.7 million, $7.1 million and $0 to repurchase its common stock during the years ended December 31, 2008, 2007 and 2006, respectively.
Effective August 1, 2008, the Company has subleased Space A for a term of 29 months, with an option to extend for an additional 19 months. The monthly rental income recognized under the sublease agreement is approximately $82,000 and has reduced overall general and administrative expenses by $410,000 for the year ended December 31, 2008.
Specific related party transactions and their impact on results of operations are disclosed in Note 18 of the Company’s financial statements. The Company adheres to investment guidelines set by management and approved by the Finance Committee of the Board of Directors. See “Investment Policy.”
Within this limitation, the maximum amount which could be paid to the Company out of the domestic insurance companies’ surplus was approximately $18.6 million as of December 31, 2008. There were no dividends declared by the insurance subsidiaries in 2008 and the Company might not receive dividends from its insurance subsidiaries in 2009.
At December 31, 2008, NYMAGIC’s investments consist of cash and short-term investments, residential mortgage-backed securities, limited partnership hedge funds and short-term premium and investment receivables as follows:
On March 7, 2008, the Company declared a dividend of eight cents per share to shareholders of record on March 31, 2008, payable on April 3, 2008. On May 22, 2008, the Company declared a dividend of eight cents per share to shareholders of record on June 30, 2008, payable on July 8, 2008. On September 9, 2008, the Company declared a dividend of eight cents per share to shareholders of record on September 30, 2008, payable on October 7, 2008. On December 4, 2008, the Company declared a dividend of eight cents per share to shareholders of record on December 31, 2008, payable on January 7, 2009. On March 5, 2007, the Company declared a dividend of eight cents per share to shareholders of record on March 30, 2007, payable on April 5, 2007. On May 23, 2007, the Company declared a dividend of eight cents per share to shareholders of record on June 29, 2007, payable on July 5, 2007. On September 14, 2007, the Company declared a dividend of eight cents per share to shareholders of record on September 28, 2007, payable on October 3, 2007. On December 7, 2007, the Company declared a dividend of eight cents per share to shareholders of record on December 31, 2007, payable on January 4, 2008. On February 23, 2006, the Company declared a dividend of six cents per share to shareholders of record on March 31, 2006, payable on April 5, 2006. On May 26, 2006, the Company declared a dividend of eight cents per share to shareholders of record on June 30, 2006, payable on July 6, 2006. On September 19, 2006, the Company declared a dividend of eight cents per share to shareholders of record on September 29, 2006, payable on October 4, 2006. On December 8, 2006, the Company declared a dividend of eight cents per share to shareholders of record on December 29, 2006, payable on January 4, 2007.
In 2003, the Company made an investment of $11.0 million in Altrion. Additional investments of $4.65 million, $2.7 million and $6.25 million were made in 2004, in 2005 and on April 27, 2007, respectively. The Company was previously committed to providing an additional $15.4 million, or a total of approximately $40 million, in capital to Altrion by August 1, 2008. Altrion, however, waived its right to require the Company to contribute its additional capital commitment of $15.4 million and accordingly, the Company’s obligation to make such capital contribution has expired. In addition, the Company withdrew $10 million of its capital from Altrion during July 2008. Withdrawals require one year’s prior written notice to the hedge fund manager. The Company has submitted a redemption notice to Altrion with an indicated redemption date of December 31, 2009. The Company is uncertain as to whether cash and/or securities will be received as payment of the redemption proceeds. See “Investment Management Arrangement” for a complete discussion of the Company’s investment in Altrion.
The following table presents the Company’s contractual obligations as of December 31, 2008:
Unpaid losses and loss adjustment expenses are based on individual case estimates for losses reported. A provision is also included, based on actuarial estimates utilizing historical trends in the frequency and severity of paid and reported claims, for losses incurred but not reported, salvage and subrogation recoveries and for loss adjustment expenses. Unpaid losses with respect to asbestos/environmental risks are difficult for management to estimate and require considerable judgment due to the uncertainty regarding the significant issues surrounding such claims. For a further discussion concerning asbestos/environmental reserves see “Reserves.” Unpaid losses and loss adjustment expenses amounted to $548.7 million and $556.5 million at December 31, 2008 and 2007, respectively. Unpaid losses and loss adjustment expenses, net of reinsurance amounted to $334.8 million and $306.4 million at December 31, 2008 and 2007, respectively. Management believes that both the gross and net unpaid loss reserve estimates as of December 31, 2008 have been reasonably estimated. Management continually reviews and updates the estimates for unpaid losses and any changes resulting therefrom are reflected in operating results currently. The potential for future adverse or favorable loss development is highly uncertain and subject to a variety of factors including, but not limited to, court decisions, legislative actions and inflation.
The allowance for doubtful accounts is based on management’s review of amounts due from insolvent or financially impaired companies. Allowances are estimated for both premium receivables and reinsurance receivables. Management continually reviews and updates such estimates for any changes in the financial status of companies. For a further discussion concerning reinsurance receivables see “Reinsurance Ceded.” The allowance for doubtful accounts on reinsurance receivables amounted to $21.4 million and $14.1 million at December 31, 2008 and 2007, respectively. The allowance for doubtful accounts on premiums and other receivables each amounted to $300,000 as of December 31, 2008 and 2007, respectively.
Impairment of investments, included in realized investment gains or losses, results from declines in the fair value of investments which are considered by management to be other-than-temporary. Management reviews investments for impairment based upon specific criteria that include the duration and extent of declines in fair value of the security below its cost or amortized cost. The Company performs a qualitative and quantitative review of all securities in a loss position in order to determine if any impairment is considered to be other-than-temporary. With respect to fixed income investments, declines in fair value of less than 10% are normally considered to be temporary, unless the fixed income security has been downgraded at least two levels by a major rating agency. Additionally, the Company reviews those securities held for six months or more, with fair value declines of greater than 10% at the end of each reporting period. The Company also reviews all securities with any rating agency declines during the reporting period. As a result of this review, the Company will record an impairment charge to earnings if the fair value decline is greater than 20%, if the fixed income security has been downgraded at least two levels by a major rating agency, or if the fair value decline is greater than 10% and the security has been downgraded one level by a major rating agency. This review includes considering the effect of rising interest rates and the Company’s intent and ability to hold impaired securities in the foreseeable future to recoup any losses. In addition to subjecting its securities to the objective tests of percent declines in fair value and downgrades by major rating agencies, when it determines whether declines in the fair value of its securities are other than temporary, the Company also considers the facts and circumstances that may have caused the declines in the value of such securities. As to any specific security, it may consider general market conditions, changes in interest rates, adverse changes in the regulatory environment of the issuer, the duration for which the Company has the intent and the ability to hold the security for the length of any forecasted recovery. Approximately $46.2 million and $6.7 million were charged to results from operations for 2008 and 2007, respectively, resulting from fair value declines considered to be other-than-temporary. The write-downs in 2008 primarily relate to the Company’s investments in residential mortgage-backed securities. Gross unrealized gains and losses on fixed maturity investments available for sale amounted to approximately $2.5 million and $6.9 million, respectively, at December 31, 2008. As of December 31, 2008, there were no unrealized losses consecutively for twelve months or longer on fixed income securities available for sale. The Company believes these unrealized losses to be temporary and result from changes in market conditions, including interest rates or sector spreads. The Company utilizes the equity method of accounting to account for its limited partnership hedge fund investments. Under the equity method, the Company records all changes in the underlying value of the limited partnership to net investment income in results of operations. Net investment loss before investment fees derived from investments in limited partnerships amounted to $(26.8) million for the year ended December 31, 2008. For the year ended December 31, 2007, $13.0 million of net investment income before investment fees was recognized from limited partnership investments. See