The Company’s corporate headquarters are located in Buffalo, New York in a building owned by a subsidiary of Mutual that contains approximately 113,000 square feet of office space. Mutual also has regional underwriting and/or claims office facilities in Buffalo, Albany and Hauppauge, New York; Manchester, New Hampshire; Moorestown, New Jersey and Columbus, Ohio. All of the offices except the Buffalo office are leased.
On March 20, 2006, the Chairman of the Board of the Company received a letter from the Chairman of Mutual that indicated that Mutual was interested in acquiring the Company and was prepared to negotiate an all cash acquisition (by way of a tender offer and/or merger) for all the outstanding common stock of the Company at $29.00 per share. The letter noted that the per share price of the proposed offer is less than both the GAAP and STAT book values per share of the Company’s stock as well as recent closing prices of the Company’s common stock on the American Stock Exchange, but it stated that the proposed offer would be within the range of values that Mutual believed the Company’s shareholders would find acceptable for an all cash offer for all shares under the circumstances. The letter indicated that the only conditions that Mutual could foresee to a closing would be any approvals required from the State Insurance Departments (which Mutual stated that it was highly confident could be obtained in a relatively short time) and assurances from A.M. Best Company and Fitch Ratings that the respective ratings of Mutual and the Company would not be reduced as a result of the acquisition. The letter indicated that Mutual’s offer to negotiate the proposed offer would remain outstanding until the close of business on April 4, 2006, provided, however, that Mutual would consider extending the period of the offer to negotiate through April 21, 2006 if the Company advises Mutual by April 4, 2006 that its Board of Directors requires additional time to evaluate the proposal.
Results of operations for 2005 and 2004 reflect the effects of the Services Agreement and the Reinsurance Pooling Agreement among the Company, its wholly-owned insurance subsidiary, MNH, and Mutual, effective January 1, 2003. The Services Agreement calls for Mutual to provide underwriting, administrative, claims and investment services to the Company and MNH. The Reinsurance Pooling Agreement provides for the pooling, or sharing, of insurance business traditionally written by Mutual and MNH on or after the effective date. MNH’s share of pooled (combined Mutual and MNH) premiums earned and losses and loss adjustment expenses (LAE) for 2005 and 2004 in accordance with the Reinsurance Pooling Agreement was 30% and 35%, respectively. The Reinsurance Pooling Agreement pertains to premiums earned and incurred losses and LAE. Direct premiums written by MNH or Mutual are not pooled. MNH’s share of pooled premiums will be reduced to 25% in 2006 and 2007, though not to exceed $42,500,000 and $37,500,000 in net written premiums, respectively. MNH’s limit on net written premiums in 2005 in accordance with the pooling Agreement was $50,000,000.
The 20% (or $10,037,000) decrease in group-wide voluntary personal direct premiums written resulted from a 30% decrease in private passenger automobile (PPA) direct premiums written and a 1% decrease in homeowners direct premiums written. The decrease in PPA direct premiums written is the result of the companies’ decision, implemented in 2001, not to write new policies in certain jurisdictions and from the approval of the companies’ plan to withdraw from the New Jersey PPA market by the New Jersey Department of Banking and Insurance, which was effective in June 2003 and was completed in May 2005. As a result, voluntary PPA policies in force at December 31, 2005 were 14,640, a decrease of 5,291 or 27%, from 19,931 at December 31, 2004.
Group-wide voluntary commercial direct premiums written were $131,789,000, an increase of $12,676,000, or 11%, from $119,113,000 in 2004. This increase resulted from period to period increases in every significant group-wide commercial product. The average premium per group-wide, non-Umbrella Program commercial policy increased 2% from the year earlier period. Total non-Umbrella Program commercial policies in force at December 31, 2005 were 36,050, an increase of 8% from 33,415 at December 31, 2004.
The 19% decrease in group-wide involuntary direct premiums written resulted primarily from a decrease in assignments from the New York Automobile Insurance Plan (NYAIP). Direct premiums written related to policies assigned from the NYAIP decreased 16% to $2,329,000 from $2,783,000 for 2004. The NYAIP provides coverage for individuals who are unable to obtain auto insurance in the voluntary market. Assignments from the NYAIP vary depending upon a company’s PPA market share and the size of the NYAIP. The Company is unable to predict the volume of future assignments from the NYAIP.
In order to minimize the adverse impact of assignments from the NYAIP, the Company purchased territorial credits from an unaffiliated company pursuant to Section 6.A.7. of the NYAIP Manual. The credits against NYAIP assignments were generated by the other insurance company for writing PPA business in certain localities in New York with PPA market availability problems. The other insurance company, by nature of its concentration in PPA business in “credit” territories, generated more credits than it required to offset its NYAIP assignments. The purchased credits reduced the Company’s share of the NYAIP. The purchased credits decreased direct premiums written related to NYAIP assignments during 2005 and 2004 by approximately $1,200,000 and $2,351,000, respectively.
An improvement in the accident year direct loss and ALAE ratio for each of the Company’s primary products, the most significant of which was an improvement from 64.4% to 54.1% in the accident year direct loss and LAE ratio in the Company’s PPA product. This improvement was due to increased fraud prevention, detection and prosecution efforts resulting from certain legislative changes in New York State. PPA liability is one of the Company’s larger products and represents approximately 23% of the Company’s net earned premiums. The decrease in the PPA loss and LAE ratio decreased the Company’s overall loss and LAE ratio by approximately 1.6 percentage points.
During 2004 the Company recorded $1,543,000 of retrospective commission expense related to the Reinsurance Pooling Agreement, which increased the 2004 ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned by 2.7 percentage points. Other underwriting
The 20% (or $12,669,000) decrease in group-wide voluntary personal DWP resulted from a 27% decrease in PPA DWP and a 1% decrease in homeowners DWP. The decrease in PPA DWP is the result of the companies’ decision, implemented in 2001, not to write new policies in certain jurisdictions and from the approval of the companies’ plan to withdraw from the New Jersey PPA market by the New Jersey Department of Banking and Insurance, which was effective in June 2003. As a result, voluntary PPA policies in force at December 31, 2004 were 19,931, a decrease of 8,492 or 30%, from 28,423 at December 31, 2003.
Total revenues for 2004 were $65,505,000, a decrease of $11,467,000 or 15%, from $76,972,000 in 2003.
The Company’s share of pooled net premiums earned in accordance with the Reinsurance Pooling Agreement for 2004 was $57,123,000. The Company’s share of net premiums earned in 2003 were $65,097,000. This $7,974,000, or 12%, decrease in net premiums earned primarily resulted from the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
Net losses and LAE were $37,681,000 for 2004, a decrease of $11,931,000 or 24% from $49,612,000 for 2003. The decrease in net losses and LAE was due to the 12% decrease in net premiums earned and a 10.2 percentage point decrease in the loss and LAE ratio to 66.0% in 2004 from 76.2% in 2003. This 10.2 percentage point decrease in the loss and LAE ratio was due to an 9.0 percentage point decrease in
the loss and LAE ratio for the current accident year to 67.4% in 2004 from 76.4% in 2003 and a $753,000 decrease in the change in the Company’s estimates of losses incurred related to prior accident years.
An improvement in the PPA liability loss and LAE ratio to 86.6% in 2004 from 111.6% in 2003, which accounted for 4.2 percentage points of the decrease. This improvement was due to improved involuntary loss experience, primarily from the NYAIP.
An improvement in the commercial package loss and LAE ratio to 69.0% in 2004 from 81.8% in 2003 which accounted for 3.5 percentage points of the decrease. This improvement was the result of a reduction in loss frequency.
The Company made no significant changes to its procedures for processing or reserving for workers’ compensation claims during 2004. In addition to the comments above related to the 2001 accident year, the $2,042,000 of favorable loss development on the workers’ compensation product stems from inherent uncertainty in estimating ultimate costs in circumstances that involve the complex and changing medical condition of claimants. However, the Company believes that the decrease in loss estimates for workers compensation business is consistent with changes initiated by the Company in 2002 to reduce the concentration in its workers’ compensation policy portfolio of classes of risk that are subject to high severity losses, which became evident in the loss development activity in 2004. The underwriting changes have continued through 2004. The Company believes that it took several years for the absence of severe losses to become apparent, as the severity of such losses, if it were to develop, typically does not become apparent for several years.
The ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned increased to 40.5% for 2004 from 33.7% for 2003. A $2,073,000 or 12% decrease in the amortization of deferred acquisition costs was more than offset by a $3,260,000 or 65% increase in other underwriting expenses. Other underwriting expenses included $1,543,000 (2.7 percentage points of the expense ratio) of retrospective commission expense related to the Reinsurance Pooling Agreement, which is owed to Mutual based on a decrease during 2004 in the estimated cumulative loss and LAE ratio on the “pooled” business since the inception of the Reinsurance Pooling Agreement. During 2003 the Company recorded $305,000 of retrospective commission income related to the Reinsurance Pooling Agreement. This amount reduced the 2003 ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned by .5 percentage points.
The Reserve for Losses and LAE is an estimate of the ultimate cost of settling all losses incurred and unpaid, including those losses not yet reported to the Company, and is stated net of reinsurance. The amount of loss reserves for reported claims is based upon a case-by-case evaluation of the circumstances and policy provisions pertaining to the claim (case reserves) relating to the loss. Reserves for claims that have occurred but have not been reported (IBNR) to the Company and for the costs of settling or adjusting claims are determined using commonly accepted actuarial techniques based on historical information for each of the Company’s products, adjusted for current conditions.
The Company’s primary assumption when determining its reserves is that past experience, adjusted for the effect of current developments and trends, is relevant in predicting future events. When establishing its loss reserves, the Company analyzes historical data and estimates the impact of various loss development factors such as the historical loss experience of the Company and of the industry, the mix of products sold, trends in claim frequency and severity, the Company’s claim processing procedures, changes in legislation, judicial decisions, legal developments, including the prevalence of litigation in the areas served by the Company, and changes in general economic conditions including inflation.
Management determines the amount of reserves for losses and LAE to be recorded based upon analyses prepared by the Company’s internal and external actuaries and management’s assessment of a reasonable amount of reserves. The reasonable estimate is determined after considering the estimates produced using a variety of actuarial techniques for each of the Company’s products. The following is a summary of the methods used:
The Bornhuetter-Ferguson (BF) with premium and paid loss method is a combination of the paid loss development method and an expected loss ratio assumption. The expected loss ratios are modified to the extent actual loss payments differ from payments expected based on the selected paid loss development pattern. This method avoids possible distortions resulting from a large development factor being applied to a small base of paid losses in order to estimate ultimate losses. This method will react slowly if actual ultimate losses differ substantially from losses inherent in the expected loss ratio.
The Bornhuetter-Ferguson (BF) with premium and incurred loss method is a combination of the incurred loss development method and an expected loss ratio assumption. The expected loss ratios are modified to the extent actual incurred losses differ from expected incurred losses based on the selected incurred loss development pattern. This method avoids possible distortions resulting from a large development factor being applied to a small base of incurred losses in order to estimate ultimate losses. This method will react slowly if actual ultimate losses differ substantially from losses inherent in the expected loss ratio.
This method is analogous to the paid loss development method except paid ALAE is developed instead of paid losses. Paid ALAE patterns often are more stable than paid loss patterns. However, paid ALAE typically develop more slowly than paid losses, resulting in a large leveraging impact on less mature accident years.
How results of methods based on paid losses compare to methods based on incurred losses.
To the extent these considerations result in changes to the Company’s estimates of reserves for losses and LAE related to prior accident years, the Company recognizes such changes in the accounting period in which the change becomes known.
As stated previously, the above methods assume that past experience adjusted for the effects of current developments and trends is an appropriate basis for predicting future events. A range of reasonably likely reserves by product as of December 31, 2005, net of reinsurance, developed by the Company’s actuaries are shown in the table below. Generally the low and the high values in the range represent
reasonable minimum and maximum amounts of these actuarial indications using the methods described above.
The following table presents the liability for the reserve for unpaid losses and loss adjustment expenses separated into case reserves, reserves for IBNR losses and reserves for LAE by major product:
Fixed maturity investments are classified as available for sale and are carried at fair value. Net unrealized holding gains or losses, net of taxes, are shown as “accumulated other comprehensive income.” Investment income is recognized when earned, and gains and losses are recognized when investments are sold and in instances when a decline in the fair value of a security is determined to be other-than-temporary.
At December 31, 2005, the Company owned 127 investment securities, of which 108 were in an unrealized loss position. As of December 31, 2005 all of the Company’s fixed maturity investments were exchange traded or are readily marketable and are supported by the broker/dealer community. The total potential impact on the Company’s future earnings if the unrealized losses associated with its investment portfolio at December 31, 2005 were to become other-than-temporary would be $3,128,000, or $2,064,000 after taxes.
At December 31, 2005, $6,123,000 or 3% of the Company’s investment portfolio was invested in non-investment grade securities, compared to $2,150,000 or 1% at December 31, 2004.
At December 31, 2005 the Company’s portfolio of fixed maturity investments represented 91.4% of invested assets. Management believes that this level of fixed maturity investments is consistent with the Company’s liquidity needs because it anticipates that cash receipts from net premiums written, investment income and maturing securities will enable the Company to satisfy its cash obligations. Furthermore, a portion of the Company’s fixed maturity investments are invested in mortgage-backed and other asset-backed securities which, in addition to interest income, provide monthly paydowns of bond principal.
The Company did not repurchase any shares of its common stock during 2005. At December 31, 2005 the Company was holding 1,139,700 shares in treasury.
The Company has arranged for a $2,000,000 unsecured credit facility from a bank. Any borrowings under this facility are payable on demand and carry an interest rate which can be fixed or variable and is negotiated at the time of each advance. This facility is available for general working capital purposes and for repurchases of the Company’s common stock. No amounts were outstanding related to this facility at December 31, 2005.
Regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to its statutory surplus should not exceed 3 to 1. The Company has consistently followed a business strategy that would allow MNH to meet this 3 to 1 regulatory guideline. MNH’s ratio of net premiums written to statutory surplus for 2005 was .7 to 1.
At December 31, 2005, the Company had no contractual obligations related to long-term debt, capital leases, operating leases, purchase obligations or other long-term liabilities reflected on its balance sheet.
Unlike most other contractual obligations, reserves for losses and LAE do not have specified due dates. The amounts shown in the preceding table are the Company’s estimates of these amounts.
The following accounting pronouncements were issued by the Financial Accounting Standards Board during 2005 and 2006 and are effective for fiscal years ending subsequent to December 31, 2005:
The Company does not expect these pronouncements to have any impact on its financial statements.
The Terrorism Risk Insurance Act of 2002 (“TRIA”), signed into law on November 26, 2002, provides a federal backstop for losses related to the writing of the terrorism peril in property and casualty insurance policies. In December 2005, TRIA was extended through December 31, 2007. The Company has complied with TRIA requirements to notify commercial policyholders about requirements of the law, that the Company was required to offer terrorism coverage and how the coverage would be priced. Currently, the Company is issuing terrorism exclusions on its commercial lines policies in states other than New York, where terrorism exclusions have not been approved by the New York Insurance Department. These exclusions will be effective if TRIA expires at December 31, 2007.
the terms of MNH’s insurance policies because of either specific or general coverage exclusions contained in the policies. However, there is no assurance that the courts will agree with MNH’s position in every case, nor can there be assurance that material claims will not be asserted under policies which a court will find do not explicitly or implicitly exclude claims for environmental damages. Management, however, is not aware of any pending claim or group of claims which would result in a liability that would have a material adverse effect on the financial condition of the Company or MNH.