The Company’s corporate headquarters are located at 25 Race Avenue in Lancaster, Pennsylvania. The Company leases its home office building under a 15-year, non-cancelable lease through February 2017. The annual base rent is subject to an
The following table sets forth selected historical financial information for the Company for the years ended and as of the dates indicated. This information comes from the Company’s consolidated financial statements. The information presented for the year ended December 31, 2006 includes the results of ELH for the entire year and the results of EIHI and EHC and its subsidiaries for the period from June 17, 2006 to December 31, 2006. The information presented as of December 31, 2005, 2004 and 2003 and for the years then ended represents the financial condition and results of operations of ELH for the respective periods. You should read the following selected financial information along with the information contained in this annual report, including Part II,
The Company reported net income of $18.7 million for the year ended December 31, 2007, reflecting positive operating results in the workers’ compensation insurance and group benefits insurance segments. The workers’ compensation insurance segment reported net income of $17.1 million and the group benefits insurance segment reported net income of $4.8 million for the year ended December 31, 2007. The specialty reinsurance segment reported a net loss for the year ended December 31, 2007, primarily related to adverse development on prior year reserves for losses and LAE of $4.8 million. Purchase accounting adjustments increased consolidated net income by $1.5 million for the year ended December 31, 2007, compared to a decrease of $2.0 million for the year ended December 31, 2006.
The workers’ compensation insurance segment reported a combined ratio of 65.6% for the year ended December 31, 2007, compared to a combined ratio of 79.1% for the year ended December 31, 2006. The decrease in the combined ratio primarily reflects the impact of purchase accounting adjustments and a decrease in the loss ratio, before the effects of purchase accounting, from 2006 to 2007. Purchase accounting decreased the combined ratio by 0.4 points in 2007, compared to increasing the combined ratio by 8.7 points in 2006. The loss ratio, before the effects of purchase accounting, decreased from 53.6% in 2006 to 45.8% in 2007, which primarily reflects favorable development on prior year reserves for unpaid losses and LAE of $8.4 million during 2007.
Net premiums earned. Net premiums earned are the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2006, one-half of the premiums would be earned in 2006 and the other half would be earned in 2007. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices as a percentage to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date. The majority of the Company’s group benefits insurance policies are billed on a monthly basis with premiums being earned in the month in which coverage is provided. As a result, there is minimal unearned premium related to the group benefits insurance policies as of the balance sheet date.
Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and LAE) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets and the change in equity interest of limited partnerships included in other long-term investments. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in fair value of convertible bonds.
Policyholder dividend expense. Policyholder dividends represent the amount of dividends incurred during the period that are expected to be returned to policyholders. The dividend expense is based on the loss experience of the underlying workers’ compensation insurance policy.
Loss ratio. The loss ratio is the ratio (expressed as a percentage) of losses and LAE incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular year, regardless of when they are reported, as a percentage of net premiums earned during that year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.
Expense ratio. The expense ratio is the ratio (expressed as a percentage) of the sum of the acquisition and other underwriting expenses and other expenses to net premiums earned, and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.
When a claim is reported, the Company’s claims adjusters establish a case reserve, which consists of anticipated medical costs, indemnity costs and certain defense and cost containment expenses that the Company refers to as allocated loss adjustment expenses, or ALAE. At any point in time, the amount paid on a claim, plus the case reserve for future amounts to be paid, represents the claims adjuster’s estimate at that time of the total cost of the claim, or the case incurred amount. The case reserve for each reported claim is based upon various factors, including:
Incurred Loss Development Method. The incurred (case incurred) loss development method relies on the assumption that, at any given state of maturity, ultimate losses can be predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. “Age-to-age” loss development factors (“LDFs”) are calculated to measure the relative development of an accident year from one maturity point to the next.
As of December 31, 2007, the Company’s best estimate of its ultimate liability for losses and LAE, net of amounts recoverable from reinsurers and before purchase accounting adjustments, for its workers’ compensation insurance segment was $42.8 million. This amount was determined based on methods which were viewed to be better predictors than other methods.
The Company’s reserves for unpaid losses and LAE in its segregated portfolio cell reinsurance segment as of December 31, 2007 and 2006 are summarized below (in thousands):
data is aggregated into categories based on the dates on which the claims in question were incurred and paid. Data in the loss triangle is reviewed to evaluate historical claim payment patterns. A point estimate is then determined based on the historical claim payment patterns.
The dental reserves represent the Company’s estimate of future amounts due on in-process and IBNR dental claims. The Company estimates its dental reserves using a combination of the lag factor development method and the loss ratio method, which results in the development of a point estimate. The loss ratio method is generally applied to the last three months (or most recent quarter), based on recent loss ratio trends. Due to the small size of the Company’s dental block of business, the recorded dental reserve represents the point estimate plus an amount for adverse development equal to 10% of the point estimate.
The short-term disability reserves represent the Company’s estimate of future amounts due on in-process and IBNR short-term disability claims. The Company’s methodology for estimating its short-term disability reserves is consistent with the methodology for estimating dental reserves.
The term life premium waiver IBNR reserve represents the Company’s estimate of unreported premium waiver claims. The Company utilizes the lag factor development method to estimate the number of unreported premium waiver claims and then applies the number of estimated outstanding claims to an average reserve amount, resulting in the development of a point estimate.
With respect to the specialty reinsurance segment, numerous internal and external factors will affect the ultimate settlements of future claims including, but not necessarily limited to, changes in the cost of environmental remediation, impacts of relevant federal or state legislation, changes in technology and the resulting impact on costs, and reliance on ceding companies to handle claims and remit proper loss information in a timely manner. Reserving for assumed reinsurance requires evaluating loss information received from the ceding company. On a quarterly basis, Eastern Re receives a statement from the ceding company which includes premium and loss settlement activity for the period with corresponding reserves as established by the ceding company. Claims reported to the ceding company by insureds are entered into its claim system and ceded to Eastern Re on a quarterly basis. The claim information received from the ceding company is compiled into loss development triangles. Generally accepted actuarial methodologies, supplemented by judgment where appropriate, are used to develop the appropriate IBNR reserves for Eastern Re. Each quarter the Company compares its actual reported losses for the quarter, and cumulative reported losses since the most recently completed reserve study, to expected reported losses for the respective period, which may result in the Company increasing its losses and LAE, and its corresponding loss reserves in that quarter. This information is used as a tool in the judgmental process by which management assesses the overall adequacy of the reserves for unpaid losses and LAE at Eastern Re. The evaluation of the reserves for unpaid losses and LAE related to the Company’s specialty reinsurance programs requires that loss development be estimated over an extended period of time. Because the primary insurer under this program changed in 1999 and the claims management philosophy of the two primary insurers differed, historical loss data for years prior to 1999 is not very useful. Therefore, reliance has been placed on industry loss development patterns, adjusted to reflect considerations particular to the exposure. The reliance on external benchmarks, while necessary, creates an additional element of uncertainty.
Because the primary insurer under these programs changed in 1999, historical loss data is insufficiently developed. Therefore, reliance has been placed on industry loss development patterns adjusted, based on the management’s judgment, to reflect considerations particular to the exposure. The reliance on external benchmarks, while necessary, creates an additional element of uncertainty.
As of December 31, 2007, the Company’s best estimate of its ultimate liability for unpaid losses and LAE, before purchase accounting adjustments, for its specialty reinsurance segment was $25.0 million. This amount was determined based on methods which were viewed to be better predictors than other methods.
While management believes that the assumptions underlying the amounts recorded for the reserves for unpaid losses and LAE as of December 31, 2007 are reasonable, the ultimate net liability may differ materially from the amount period.
Equity securities. If an equity security has a market value below 80% of cost and remains below 80% of cost for more than three months, a review of the financial condition and prospects of the company is performed to determine if the decline in market value is other-than-temporary. A specific determination is made for any such security. Other equity securities in an unrealized loss position not meeting these quantitative thresholds are evaluated considering the magnitude and reasons for the decline and the prospects for the fair value of the securities to recover in the near term. If the decline in market value is determined to be other-than-temporary, then the cost basis of the security is written down to realizable value and the amount of the write down is accounted for as a realized loss.
Fixed income securities. A fixed income security generally is written down if the Company is unable to hold or otherwise intends to sell a security with an unrealized loss, or if it is probable that it will be unable to collect all amounts due according to the contractual terms of the security. A fixed income security is reviewed for collectibility if any of the following situations occur:
Certain direct policy acquisition costs consisting of commissions, premium taxes, fronting fees and certain other direct underwriting costs are deferred and amortized as the underlying policy premiums are earned. As of December 31, 2007 and 2006, deferred policy acquisition costs and the related unearned premium reserves in the Company’s workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, and specialty reinsurance segments were as follows (in thousands):
In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS No. 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS No. 141R retains the fundamental requirements of SFAS No. 141 in that the acquisition method of accounting is still
The following table represents the operations of the workers’ compensation insurance segment for the years ended December 31, 2007 and 2006 (in thousands):
The decrease in the calendar period loss ratio reflects an increase in favorable loss reserve development on prior accident years for the year ended December 31, 2007 compared to the same period in 2006, a decrease in the accident year loss ratio from 71.9% in 2006 to 60.3% in 2007 and a decrease in the impact of purchase accounting adjustments recorded in 2007 compared to 2006. Favorable loss reserve development on prior accident years of $8.4 million and $2.1 million was recorded for the years ended December 31, 2007 and 2006, respectively, which lowered the loss ratios for the years ended December 31, 2007 and 2006 by 14.9 points and 8.5 points, respectively. The favorable loss reserve development on prior accident years and the decrease in the accident year loss ratio relates primarily to a decrease in the current and prior accident year loss development factors used to estimate losses and LAE. The decrease in accident year loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of December 31, 2007. For the year ended December 31, 2007, the Company closed 281, or 56.8%, of the 495 open lost time claims as of December 31, 2006. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims. Management believes that the realization of the benefits of its return-to-work controls coupled with strong economies in its underwriting territories during 2005, 2006, and 2007 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements. The calendar period loss ratio for the year ended December 31, 2006 includes 9.2 points related to purchase accounting adjustments recorded to premiums earned and loss and loss adjustment expenses. Purchase accounting adjustments in 2007 had a negligible impact on the 2007 calendar year loss ratio. For the year ended December 31, 2007, there was one claim that exceeded the Company’s $500,000 reinsurance retention. There were no claims that exceeded the Company’s $500,000 reinsurance retention for the year ended December 31, 2006.
The increase in the expense ratio primarily reflects a reduction in fee based revenue from the segregated portfolio cell reinsurance segment from 2006 to 2007, and purchase accounting adjustments in 2006, which lowered the expense ratio by 4.0 points compared to negligible purchase accounting adjustments in 2007.
The increase in policyholder dividend expense reflects the acquisition of EHC on June 16, 2006. Policyholder dividends represent payments to customers who purchased participating policies that produced favorable loss ratios. For the years ended December 31, 2007 and 2006, 10.0% and 9.1%, respectively, of all workers’ compensation policies were written on a dividend policy basis.
(1) The workers’ compensation insurance, specialty reinsurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.
Net premiums written for the year ended December 31, 2007 include an increase of $330,000 related to the amortization of purchase accounting adjustments.
The increase in the calendar year loss ratio from 2006 to 2007 relates to favorable loss reserve development recorded on prior accident years of $3.0 million for the year ended December 31, 2007 compared to $2.0 million for the year ended December 31, 2006, which lowered loss ratios for the years ended December 31, 2007 and 2006 by 13.2 points and 17.7 points, respectively, partially offset by purchase accounting adjustments recorded in 2006 that increased the calendar period loss ratio by 4.6 points compared to negligible purchase accounting adjustments in 2007. The favorable loss reserve development on prior accident years relates primarily to a decrease in the prior year loss development factors used to estimate losses and loss adjustment expenses. The decrease in accident year loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of December 31, 2007.
The decrease in the short-term disability loss ratio primarily reflects a reduction in claim severity, which decreased 2.4% from 2006 to 2007. The accident period loss ratio decreased from 80.3% in 2006 to 71.5% in 2007. The decrease in the accident period loss ratio was partially offset by a decline in favorable loss reserve development from $337,000, or 5.2 percentage points, in 2006 to $148,000, or 2.2 percentage points, in 2007.
The following table represents the operations of the specialty reinsurance segment for the years ended December 31, 2007 and 2006 (in thousands):
The increase in net investment income is related to the acquisition of EHC on June 16, 2006. The average yield on the fixed income portfolio was 4.64% as of December 31, 2007 compared to an average yield of 4.52% as of December 31, 2006.
Consolidated net income for the year ended December 31, 2006 includes the impact of purchase accounting adjustments that reduced net income by $2.2 million, including reductions in the workers’ compensation insurance and specialty reinsurance segments of $2.4 million and $647,000, respectively, and a decrease in the net loss in the corporate/other segment of $801,000.
Net income reflects an after-tax charge of $2.4 million related to the amortization of purchase accounting adjustments, favorable loss reserve development on prior accident years of $1.4 million and a $567,000 reduction in the accrual for the Security Fund assessment.
Direct premiums written for traditional business and alternative markets were $27.1 million and $6.9 million for the period from June 17, 2006 to December 31, 2006, respectively. Direct written premiums include the impact of 2006 renewal rate decreases of 6.1%, a premium renewal retention rate of 85.4% and a reduction for purchase accounting adjustments of $5.1 million. Audit premiums of $1.6 million were also included in direct premiums written for the period from June 17, 2006 to December 31, 2006.
Net premiums written include traditional production, net of external reinsurance, because alternative markets business is ceded 100% to the segregated portfolio cell reinsurance segment.
Acquisition and other underwriting expenses for the period from June 17, 2006 to December 31, 2006 include a reduction for purchase accounting adjustments of $968,000 and a decrease of $872,000 related to management’s estimate that the Security Fund will not be making an assessment in 2007 based on 2006 direct written premium. Other expenses were $3.7 million for the period from June 17, 2006 to December 31, 2006. The expense ratio was 15.3% for the period from June 17, 2006 to December 31, 2006.
Net premiums written for the period from June 17, 2006 to December 31, 2006 include an increase of $1.0 million related to purchase accounting adjustments.
The increase in net realized investment gains primarily reflects the aforementioned change in the fair value of equity call options and the gain on the common stock sale, which totaled $716,000. The change in the fair value of equity call options increased $608,000 for the year ended December 31, 2006, compared to a decrease of $367,000 for the same period in 2005.
The improvement in the long-term disability loss ratio reflects lower claim frequency and severity and the termination of prior year claims. As a result of the decrease in the long-term disability claim retention, from a 50% coinsurance to a 20% coinsurance effective July 1, 2005, the termination of prior year claim reserves at a 50% coinsurance had a favorable impact on the 2006 calendar year loss ratio.
The decrease in acquisition and other underwriting expenses reflects the decline in net premiums earned and the elimination of sales and marketing fees paid to IBSi in Pennsylvania, Maryland and Delaware. Acquisition and other underwriting expenses totaled 14.1% and 16.2% of direct premiums written in 2006 and 2005, respectively. The decrease of 2.1% primarily reflects the reduction in sales and marketing fees.
The following table represents the operations of the specialty reinsurance segment for the period from June 17, 2006 to December 31, 2006 (in thousands):
Reinsurance premiums earned, by line of business, were as follows for the period from June 17, 2006 to December 31, 2006 (in thousands):
Net investment income was $1.0 million for the period from June 17, 2006 to December 31, 2006.
The corporate/other segment results for the year ended December 31, 2006 include the results of operations of Employers Alliance, EIHI, Eastern Holding Company, Ltd., Eastern Services, and Global Alliance for the period from June 17, 2006 to December 31, 2006, and ELH’s group medical insurance run-off operations and corporate activities for the year ended December 31, 2006. This segment also includes certain eliminations necessary to reconcile the segment information to the consolidated statements of operations. For the year ended December 31, 2005, the corporate/other segment consists of the results of operations of ELH’s former general agency operations, group medical insurance run-off operations, and certain corporate activities of ELH.
Total liabilities were $207.7 million as of December 31, 2007, compared to $194.5 million as of December 31, 2006. The increase in total liabilities primarily reflects an increase in reserves for unpaid losses and LAE, unearned premiums and the segregated portfolio cell dividend payable. The increase in reserves primarily reflects the adverse development on prior year reserves in the specialty reinsurance segment. The increase in unearned premiums primarily reflects the amortization of purchase accounting adjustments of $2.8 million and the increase in net premiums written from 2006 to 2007. The increase in the segregated portfolio cell dividend payable primarily reflects the segregated portfolio cell reinsurance segment’s 2007 results of operations.
As of December 31, 2007, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
We have audited the accompanying consolidated statements of operations and comprehensive income (loss), changes in shareholders’ equity, and cash flows of Eastern Insurance Holdings, Inc. and subsidiaries (formerly Educators Mutual Life Insurance Company) (the Company) for the year ended December 31, 2005. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
Immediately after the common stock offering and conversion, EIHI purchased all of the outstanding common stock of Eastern Holding Company, Ltd. (“EHC”) for a purchase price of $78,929 (See Note 3).
EIHI is an insurance holding company offering workers’ compensation and group benefits insurance products through its wholly-owned subsidiaries. The accompanying consolidated financial statements include the accounts of EIHI and its wholly-owned subsidiaries (collectively, the “Company”), EHC and ELH, and EHC’s wholly-owned subsidiaries, Eastern Services Corporation (“Eastern Services”), Global Alliance Holdings, Ltd. (“Global Alliance”), Global Alliance Statutory Trust I (“Trust I”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Eastern Re Ltd., S.P.C. (“Eastern Re”), and Employers Alliance, Inc. (“Employers Alliance”).
The Company operates in five segments: workers’ compensation insurance, group benefits insurance, specialty reinsurance, segregated portfolio cell reinsurance, and corporate/other. See Note 15 for a description of each segment.
significant estimates in the consolidated financial statements include reserves for unpaid losses and loss adjustment expenses, earned but unbilled premium, deferred acquisition costs, return premiums under reinsurance contracts, and current and deferred income taxes. Actual results could differ from these estimates.
The Company adopted Statement of Financial Accounting Standards No. 155 (SFAS 155), “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”, on January 1, 2007. Prior to January 1, 2007, the Company accounted for its convertible bond securities in accordance with SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” and bifurcated the equity call option, or embedded derivative, from the convertible bond security, or host contract. Under SFAS 133, the change in the fair value of the equity call option was reported as a realized gain or loss in the Company’s consolidated statement of operations and comprehensive income (loss) and the change in the fair value of the convertible bond security was reported as an unrealized gain or loss in accumulated other comprehensive income, net of tax. Upon adoption of SFAS 155, the equity call option is no longer bifurcated from the convertible bond security and the change in the fair value of the Company’s convertible bond securities, which meet the definition of a hybrid financial instrument under SFAS 155, is reported as a realized gain or loss in the consolidated statement of operations and comprehensive income (loss). The adoption of SFAS 155, which did not change the carrying value of Company’s convertible bond securities, was reported as a cumulative effect adjustment to beginning shareholders’ equity and resulted in a reclassification between retained earnings and accumulated other comprehensive income of $405.
SFAS 155 prohibits restatement of prior years’ financial statements. As a result, the Company’s consolidated balance sheet as of December 31, 2006 has not been adjusted to reflect the adoption of SFAS 155. The following table provides the impact to the Company’s consolidated balance sheet as of December 31, 2006 under SFAS 155 (in thousands).
Realized gains or losses are based on cost and are computed using the specific identification method. The Company monitors its equity securities for unrealized losses that appear to be other-than-temporary. The Company performs a detailed review of these securities to determine the underlying cause of the unrealized loss and whether the security is impaired. At the time a security is determined to be other-than-temporarily impaired, the Company reduces the cost of the security to the estimated fair value and records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent increase in the security’s estimated fair value would be reported as an unrealized gain.
Other long-term investments consist primarily of investments in limited partnerships. Investments in limited partnerships are reported in the consolidated financial statements using the equity method. Changes in the value of the Company’s proportionate share of its limited partnership investments are included in net investment income in the consolidated statements of operations and comprehensive income (loss).
Premiums generated by the Company’s workers’ compensation insurance segment, including estimates of additional premiums resulting from audits of insureds’ records, are generally recognized as written upon inception of the policy. Premiums written are primarily earned on a daily pro rata basis over the terms of the policies to which they relate. Accordingly, unearned premiums represent the portion of premiums written which is applicable to the unexpired portion of the policies in force. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration to make a final determination of applicable premiums. Included in net premiums earned is an estimate for earned but unbilled final audit premiums. The Company estimates earned but unbilled premiums by tracking, by policy, how much additional premium is billed in final audit invoices as a percentage of payroll exposure to estimate the probable additional amount that it has earned, but not yet billed, as of the balance sheet date. Earned but unbilled premiums accrued as of December 31, 2007 and 2006, and included in net premiums earned, totaled $1,500.
Reinsurance premiums assumed by the Company’s specialty reinsurance segment are estimated based on information provided by the ceding companies. The information used in establishing these estimates is reviewed and subsequent adjustments are recorded in the period in which they are reported. These premiums are earned over the terms of the related reinsurance contracts.
The liability for reported but unpaid long-term disability claims is calculated using the 1987 Commissioners Group Disability Table. The long-term disability reserves are discounted based on the expected rate of return of ELH’s fixed income portfolio in the year that the claim was incurred. The discount rate for claims incurred in 2007 and 2006 was 5.25% and 4.75%, respectively. The liability for incurred but not reported claims is estimated on a policy-by-policy basis, taking into consideration average monthly premium, policy elimination periods, and an expected loss ratio.
The liability for reported but unpaid and incurred but not reported dental and short-term disability claims is estimated using statistical claim development models, taking into consideration historical claim severity and frequency patterns and changes in benefit structures that may impact the amount at which claims are ultimately settled. For the most recent incurral months, which usually consist of the last three months, the liability is estimated by applying an expected loss ratio to net premiums earned, less claim payments through the balance sheet date.
The liability for reported but unpaid term life claims represent those claims reported to the Company as of the balance sheet date for which payment has not yet been made. Term life incurred but not reported claims are estimated based on historical patterns of claims incurred as a percent of in-force premium as of the balance sheet date.
The Company issues certain workers’ compensation insurance policies with dividend payment features. These policyholders share in the operating results of their respective policies in the form of dividends. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies. As of December 31, 2007 and 2006, the Company recorded accrued dividends payable of $989 and $598, respectively, which are included in accounts payable and accrued expenses on the consolidated balance sheets.
assessments are established on an actuarial basis to provide an amount sufficient to pay the outstanding and anticipated claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department to administer the fund and to maintain a minimum balance in the fund of $500 million. If the Security Fund determines that the balance in the Security Fund is less than $500 million based on the actuarial study, then an assessment up to one percent of direct written premium is made to all companies licensed to write workers’ compensation in Pennsylvania. Eastern Alliance and Allied Eastern recognize a liability and the related expense for the assessments when premiums covered under the Security Fund are written; when an assessment from the Security Fund has been imposed or it is probable that an assessment will be imposed; and the amount of the assessment is reasonably estimable. No assessments were recorded in 2007 or 2006.
Comprehensive income (loss) includes all changes in shareholders’ equity during the reporting period, net of tax. The components of accumulated other comprehensive income, net of tax, as of December 31, 2007 and 2006 were as follows (in thousands):
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements.-an amendment of ARB No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for the non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires that the ownership interests and the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS No. 160 also provides consistent accounting principles for changes in a parent controlling ownership interest in a subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured initially at fair value. SFAS No. 160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively, except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. The Company is currently in the process of evaluating the impact of SFAS No. 160.
On June 16, 2006, the Company acquired all of the outstanding common stock of EHC for a purchase price of $78,929, which consisted of the Company issuing 3,876,048 shares of its $10.00 common stock and paying cash of $40,175 to EHC’s
On October 31, 2005, ELH entered into a Membership Purchase Agreement (the “Agreement”) for the sale of its interest in IBSi, LLC (“IBSi”), a general agent, for cash of $300. As a result of the sale, the Company recognized a net gain totaling $210, which was included in net realized investment gains on the 2005 consolidated statement of operations and comprehensive loss. Under the terms of the Agreement, the Company is prohibited from marketing its group benefits insurance products through IBSi’s top twenty producers through December 31, 2008, without the prior approval of IBSi.
For the years ended December 31, 2007 and 2006, the Company contributed $1,100 and $550 to the ESOP, which the ESOP used to make principal and interest payments to the Company related to the outstanding loan balance. The Company’s contributions and the related principal and interest payments are considered non-cash transactions for purposes of the consolidated statements of cash flows.
For the year ended December 31, 2006, the net proceeds received as a result of the Company’s stock offering of 69,622 is reflected net of the proceeds from the shares purchased by the ESOP of $7,500 in the statement of cash flows for year ended December 31, 2006.
The acquisition of EHC resulted in the identification of certain intangible assets. The allocation of the purchase price in excess of the fair value of the Company’s net assets acquired to intangible assets totaled $9,197. As of December 31, 2007 and 2006, intangible assets consisted of the following (in thousands):
Basic earnings per share are computed by dividing net income for the years ended December 31, 2007 and 2006 by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income for the years ended December 31, 2007 and 2006 by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. Dilutive potential common shares outstanding include 306,099 stock warrants for the years ended December 31, 2007 and 2006 and restricted stock awards of 33,881 and 0 for the years ended December 31, 2007 and 2006, respectively. For the year ended December 31, 2007, stock options and restricted stock awards totaling 843,058 were excluded from the Company’s earnings per share calculation because to include them would have been anti-dilutive. There were no stock options or restricted stock outstanding as of December 31, 2006. Consolidated net income, basic shares outstanding, diluted shares outstanding, basic earnings per share and diluted earnings per share for the years ended December 31, 2007 and 2006 were as follows (in thousands, except share and per share data):
On February 15, 2007, the Company’s Board of Directors authorized the repurchase of up to 5 percent, or 567,552 shares, of the Company’s issued and outstanding shares of common stock. On August 2, 2007, the Company’s Board of Directors authorized the repurchase of additional shares of the Company’s outstanding common stock up to an aggregate of 1,046,500 shares, which represents the total number of shares of common stock for which awards may be granted under the Company’s Stock Incentive Plan. On September 27, 2007, the Company’s Board of Directors increased the share repurchase authorization to 2,046,500 shares. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan. As of December 31, 2007, the Company repurchased 1,016,865 shares at a cost of $15,589, representing a weighted average cost of $15.33 per share. The Company repurchased an additional 701,400 shares at a cost of $11,550 through March 12, 2008.
Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. The reserves for unpaid losses and loss adjustment expenses of Eastern Alliance and Allied Eastern are discounted on both a tabular and non-tabular basis. The discounting of workers’ compensation indemnity reserves on a tabular basis is a prescribed practice by the NAIC. The discounting of other workers’ compensation reserves on a non-tabular basis is a permitted practice by the Insurance Department. The non-tabular discounting of other workers’ compensation reserves increased Eastern Alliance’s and Allied Eastern’s statutory surplus by $1,346 and $198, respectively, as of December 31, 2007 and by $1,239 and $180, respectively, as of December 31, 2006. The non-tabular discounting of other workers’ compensation reserves increased (decreased) Eastern Alliance’s statutory net income by $107, $176, and $(32) and increased (decreased) Allied Eastern’s statutory net income by $18, $34, and $(11) for the years ended December 31, 2007, 2006, and 2005, respectively. ELH did not have any permitted practices for the years ended December 31, 2007, 2006, or 2005.
The statutory surplus and statutory net income (loss) of Eastern Alliance, Allied Eastern, and ELH as of December 31, 2007 and 2006 and for the years ended December 31, 2007, 2006, and 2005 was as follows (in thousands):
The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of December 31, 2007 and 2006 (in thousands):
The amortized cost and estimated fair value of fixed income securities and convertible bonds as of December 31, 2007, by contractual maturity, are shown below (in thousands). Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of December 31, 2007 and 2006 are as follows (in thousands):
The gross realized gains and gross realized losses recognized by the Company as a result of the sale of investments were as follows for the years ended December 31, 2007, 2006, and 2005 (in thousands):
For the year ended December 31, 2007, the change in the estimated fair value of convertible bonds included in net realized investment gains in the consolidated statement of operations and comprehensive income totaled $(457). For the years ended December 31, 2006 and 2005, the change in the estimated fair value of equity call options included in net realized investment gains in the consolidated statements of operations and comprehensive income (loss) totaled $837 and $(367), respectively.
The change in the Company’s net unrealized gains and losses for the years ended December 31, 2007, 2006, and 2005 was as follows (in thousands):
Net investment income for the years ended December 31, 2007, 2006, and 2005 was as follows (in thousands):
Workers’ Compensation Insurance. The Company’s results of operations include a decrease in estimated incurred losses and LAE on its workers’ compensation line of business primarily related to accident years 2006, 2005, and 2004 of $8,398 for the year ended December 31, 2007. The favorable development on prior accident years relates primarily to significant claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves.
Group Benefits Insurance. The Company’s results of operations for the year ended December 31, 2007 include favorable development on prior year reserves of $961 in the group benefits insurance segment. The favorable development reflects better claim experience than anticipated in the dental, short-term disability and term life lines at the time the liability was established and the termination of prior year long-term disability claims as a result of claimants returning to work, claimant death, or the termination of benefits in accordance with policy provisions.
Specialty Reinsurance. The Company’s results of operations included an increase in estimated incurred losses and LAE on its specialty reinsurance line of business related to prior accident years of $4,844 for the year ended December 31, 2007. The unfavorable prior year development was the result of changes in estimates as losses emerged at a higher rate than had been originally anticipated when the reserves were estimated with respect to accident years 2006, 2005, 2004, and 2003. The evaluation of the reserve or unpaid losses and LAE related to the specialty reinsurance segment requires that loss development be estimated over an extended period of time. Because the primary insurer under these programs changed in 1999, historical loss data is insufficiently developed. Therefore, reliance has been placed on industry loss development patterns, adjusted based on the Company’s judgment, to reflect considerations particular to the exposure. The reliance on external benchmarks, while necessary, creates an additional element of uncertainty.
The following table provides a summary of the Company’s losses and loss adjustment expenses incurred on a direct, assumed, ceded and net basis for the years ended December 31, 2007, 2006, and 2005 (in thousands):
The components of the income tax provision for the years ended December 31, 2007, 2006, and 2005 are as follows (in thousands):
In addition to the income tax provision, the net deferred tax asset (decreased) increased by $(696), $132, and $803 in 2007, 2006, and 2005, respectively, as a result of changes in the unrealized gains and losses on the Company’s fixed income and equity securities. The net deferred tax asset was also decreased by $58 and $228 in 2007 and 2006, respectively, related to unrecognized benefit plan gains. The tax effect of these items is recorded directly to accumulated other comprehensive income, which is a component of equity.
The provision for income taxes for the years ended December 31, 2007, 2006, and 2005 is as follows (in thousands):
The components of the net deferred tax asset as of December 31, 2007 and 2006 are as follows (in thousands):
The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”) effective January 1, 2007. The adoption of FIN 48 had no effect on the Company’s consolidated financial statements. As of December 31, 2007, the Company has no tax positions for which management believes a provision for uncertainty is necessary. The Company’s federal income tax returns for tax years subsequent to December 31, 2003 are subject to examination by the Internal Revenue Service.
ELH sponsors a non-contributory defined benefit pension plan (the “pension plan”) covering substantially all of its employees. On May 17, 2005, ELH’s Board of Directors approved the freezing of the pension plan effective December 31, 2005. ELH also sponsors a defined benefit postretirement plan (the “postretirement plan”), which provides certain health care and life insurance benefits for retired employees. Current employees of ELH may become eligible for these benefits if they reach retirement age while working for ELH and meet certain years of service levels prior to January 1, 2015. Life insurance benefits are set at 100% of an employee’s annual salary at the time of retirement, up to a maximum of $175, and are reduced to $10 by age 70.
A reconciliation of changes in the benefit obligation, fair value of plan assets and funded status of the pension plan and the postretirement plan as of December 31, 2007 and 2006 is as follows (in thousands):
As of December 31, 2007 and 2006, the following amounts related to the pension plan and postretirement plan have been included in accumulated other comprehensive income (“AOCI”) (in thousands):
The amounts included in AOCI that are expected to be recognized in 2008 are as follows (in thousands):
The pension plan’s assets were comprised of the following at December 31, 2007 and 2006 (in thousands):
The following table provides the components of net periodic benefit cost for the pension plan and the postretirement plan for the years ending December 31, 2007, 2006, and 2005 (in thousands):
During 2007, the Company recognized a settlement gain of $384 related to the purchase of the annuity to satisfy the future obligations of the pension plan related to participants receiving benefits as of December 31, 2007
As of December 31, 2007, the assumed healthcare cost trend rate used in the estimate of the postretirement benefit plan obligation was 7.00% , with the rate decreasing to 4.00% in 2011 and thereafter. An increase or decrease in the assumed healthcare cost trend of one percentage point does not have a material impact on the Company’s benefit obligation or net periodic benefit cost as of December 31, 2007.
The Company offers workers’ compensation insurance coverage to employers, primarily in Pennsylvania, Maryland and Delaware. The Company offers a complete line of workers’ compensation products, including guaranteed cost and loss sensitive products.
The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, investment and segregated portfolio management services. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation, specialty reinsurance, and corporate/other segments totaling approximately $3,900 and $4,000 for the years ended December 31, 2007 and 2006, respectively.
The corporate/other segment includes the holding company and third party administration activities of the Company, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The corporate/other segment also includes the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors.
The following table represents the segment results for the year ended December 31, 2005, which reflects the results of operations of ELH (in thousands):
The Company’s corporate headquarters are located at 25 Race Avenue in Lancaster, Pennsylvania. The Company leases its home office building under a 15-year, non-cancelable lease through February 2017. The annual base rent is subject to an annual increase based upon the consumer price index at the end of each preceding calendar year. In addition to the base rent, the Company is responsible for its proportionate share of expenses related to the building including, but not limited to, utilities, maintenance, real estate taxes, and insurance. The Company has a 5% interest in the limited partnership that owns the building. Minimum monthly lease commitments for the remainder of the lease term are as follows (in thousands):
On May 15, 2003, Trust I, a business trust subsidiary formed by Global Alliance, issued $8,000 of fixed/floating rate trust preferred securities. The securities mature on May 15, 2033, with a provision allowing the Company to call the securities at par on May 15, 2008. Cash distributions are currently being paid quarterly in arrears at a fixed rate of 7.35% through May 15, 2008. Subsequent to May 15, 2008 cash distributions will be based on a floating rate equal to the three-month LIBOR plus 410 basis points. The Company guarantees all obligations of Trust I with respect to distributions and payments of these securities. Proceeds from the sale of these securities by the Trust I were used to acquire $8,000 of fixed/floating rate junior subordinated deferrable interest rate debentures issued by Global Alliance. These debentures have the same terms with respect to maturity, payments, and distributions, as the fixed/floating rate trust preferred securities issued by Trust I.
On March 10, 2008, the Company announced its Board of Directors authorized a quarterly cash dividend of $0.07/share on its issued and outstanding shares of common stock, payable March 28, 2008 to shareholders of record at the close of business on March 14, 2008.
19. Quarterly Financial Data (Unaudited, in thousands, except per share data)