degree of judgment and estimates may vary, materially, from period to period. Estimated unpaid losses on reported claims are developed based on historical experience with similar claims by the Company. Development on reported claims, estimates of unpaid ultimate losses on claims incurred prior to December 31, 2014 but not yet reported, and estimates of unpaid loss adjustment expenses are developed based on the Company’s historical experience, using actuarial methods to assist in the analysis. The Company’s actuaries develop ranges of estimated development on reported and unreported claims as well as loss adjustment expenses using various methods, including the paid-loss development method, the reported-loss development method, the paid Bornhuetter-Ferguson method and the reported Bornhuetter-Ferguson method. Any single method used to estimate ultimate losses has inherent advantages and disadvantages due to the trends and changes affecting the business environment and the Company’s administrative policies. Further, external factors, such as legislative changes, medical cost inflation, and others may directly or indirectly impact the relative adequacy of liabilities for unpaid losses and loss adjustment expenses. The Company’s approach is to select an estimate of ultimate losses based on comparing results of a variety of reserving methods, as opposed to total reliance on any single method. Unpaid loss and loss adjustment expenses are reviewed periodically for significant lines of business, and when current results differ from the original assumptions used to develop such estimates, the amount of the Company’s recorded liability for unpaid loss and loss adjustment expenses is adjusted. In the event the Company’s actual reported losses in any period are materially in excess of the previously estimated amounts, such losses, to the extent reinsurance coverage does not exist, could have a material adverse effect on the Company’s results of operations.
Future policy benefits comprised 33% of the Company’s total liabilities at December 31, 2014. These liabilities relate primarily to life insurance products and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Deferred acquisition costs comprised 9% of the Company’s total assets at December 31, 2014. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to expense in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. Deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any previous calendar year.
volatility than the value of securities with publicly quoted market values. On occasion, the value of an investment may decline to a value below its amortized purchase price and remain at such value for an extended period of time. When an investment’s indicated fair value has declined below its cost basis for a period of time, the Company evaluates such investment for an other than temporary impairment. The evaluation for an other than temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. Potential risks and uncertainties include, among other things, changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. In evaluating a potential impairment, the Company considers, among other factors, management’s intent and ability to hold the securities until price recovery, the nature of the investment and the expectation of prospects for the issuer and its industry, the status of an issuer’s continued satisfaction of its obligations in accordance with their contractual terms, and management’s expectation as to the issuer’s ability and intent to continue to do so, as well as ratings actions that may affect the issuer’s credit status. If an other than temporary impairment is deemed to exist, then the Company will write down the amortized cost basis of the investment to its estimated fair value. While any such write down does not impact the reported value of the investment in the Company’s balance sheet, it is reflected as a realized investment loss in the Company’s consolidated statements of operations in the period incurred.
Management also considers and evaluates performance by analyzing the non-GAAP measure, operating income, and believes it is a useful metric for investors, potential investors, securities analysts and others because it isolates the “core” results of the Company before considering certain items that are either beyond the control of management (such as taxes, which are subject to timing, regulatory and rate changes depending on the timing of the associated revenues and expenses) or are not expected to regularly impact the Company’s operational results (such as any realized investment and other gains, which are not a part of the Company’s primary operations and are, to an extent, subject to discretion in terms of timing of realization).
(1) Gain from the purchase of $7.5 million of the Company’s junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”). See Note 6 of Notes to Consolidated Financial Statements.
A more detailed analysis of the operating companies and other corporate activities follows.
Gross written premiums at American Southern decreased $2.2 million, or 3.7%, during 2014 as compared to 2013. The decrease in gross written premiums was primarily attributable to a decrease of $11.0 million in commercial automobile written premiums resulting from the cancellation of an agency in 2014 due to unfavorable loss experience. Partially offsetting the decrease in gross written premiums in 2014 were increases in commercial automobile and property business from new and existing programs. In an effort to increase gross written premiums, diversify its business and offset the decrease in business writings from cancelled agencies, American Southern continually evaluates new underwriting programs. In both 2014 and 2013, American Southern’s five principal states in terms of written premiums were Alabama, Florida, Georgia, South Carolina, and Texas, which accounted for approximately 70% and 67% of total written premiums for 2014 and 2013, respectively.
Ceded premiums decreased $1.7 million, or 22.6%, during 2014 as compared to 2013. American Southern’s ceded premiums are determined as a percentage of earned premiums and generally increase or decrease as earned premiums increase or decrease. However, the change in ceded premiums was disproportionate to the increase in earned premiums due to the execution of a separate reinsurance agreement to specifically reinsure the commercial automobile business in a state contract awarded to American Southern in 2013. Otherwise, the decrease in ceded premiums during 2014 was primarily attributable to the decline in commercial automobile earned premiums from the agency cancellation discussed previously.
the state contract referenced previously. Also contributing were increases in general liability, property and surety earned premiums from both new and existing programs. Partially offsetting the increase in net earned premiums was the decrease in commercial automobile business from the agency cancellation discussed previously. Premiums are earned ratably over their respective policy terms, and therefore premiums earned in the current year are related to policies written during both the current year and immediately preceding year.
Net losses and loss adjustment expenses at American Southern increased $8.0 million, or 26.4%, during 2014 as compared to 2013. As a percentage of premiums, net losses and loss adjustment expenses were 72.5% in 2014 compared to 65.9% in 2013. The increase in the loss ratio was due to increased losses, which were anticipated, in the commercial automobile line of business primarily from the state contract referenced previously. Also contributing to the increase in the loss ratio were increased losses in all other primary lines of business during 2014 as compared to 2013.
Underwriting expenses decreased $1.7 million, or 10.3%, during 2014 as compared to 2013. As a percentage of premiums, underwriting expenses were 27.4% in 2014 compared to 35.1% in 2013. The decrease in the expense ratio was primarily due to American Southern’s variable commission structure, which compensates the company’s agents in relation to the loss ratios of the business they write. During periods in which the loss ratio increases, commissions and underwriting expenses will generally decrease, and conversely, during periods in which the loss ratio decreases, commissions and underwriting expenses will generally increase. In 2014, these commission accruals at American Southern decreased $1.6 million as compared to 2013 due to unfavorable loss experience. Also contributing to the decrease in the expense ratio was the increase in earned premiums coupled with a relatively consistent level of fixed general and administrative expenses.
Contingent commissions, if contractually applicable, are ultimately payable to agents based on the underlying profitability of a particular insurance contract or a group of insurance contracts, and are periodically evaluated and accrued as earned. Approximately 57% of American Southern’s earned premium provides for contractual commission arrangements which compensate the company’s agents in relation to the loss ratios of the business they write. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with American Southern. In periods in which loss reserves reflect
favorable development from prior years’ reserves, there is generally a highly correlated increase in commission expense also related to the prior year business. Accordingly, favorable loss development from prior years, while anticipated to continue in future periods, is not an indicator of significant additional profitability in the current year.
Benefits and losses decreased $2.2 million, or 3.1%, during 2014 as compared to 2013. As a percentage of premiums, benefits and losses were 67.5% in 2014 compared to 70.3% in 2013. The decrease in the loss ratio was primarily attributable to more favorable loss experience in the Medicare supplement line of business.
Underwriting expenses increased $3.2 million, or 10.6%, during 2014 as compared to 2013. As a percentage of earned premiums, these expenses were 33.6% in 2014 compared to 30.7% in 2013. The increase in the expense ratio was primarily attributable to increases in agency and underwriting related expenses, including increased hiring to support worksite product and distribution initiatives. Partially offsetting the increase in the expense ratio was a decrease in general advertising expenses as well as a decrease in actuarial consulting fees due to less utilization of consulting actuaries in the development of the company’s worksite products.
The Company had net realized investment gains of $1.6 million in 2014 compared to net realized investment gains of $8.7 million in 2013. The net realized investment gains in 2014 resulted from the disposition of several of the Company’s investments in fixed maturities. The net realized investment gains in 2013 were primarily due to the sale of a number of the Company’s investments in longer-term fixed maturities discussed previously. During 2014, the Company recorded investment impairments due to other than temporary declines in values of $0.2 million on certain of its investments in non-redeemable preferred stocks. While the impairments did not impact the carrying value of these investments, they resulted in realized losses which reduced reported realized gains. There were no impairments recorded in 2013. Management continually evaluates the Company’s investment portfolio and, as may be determined to be appropriate, makes adjustments for impairments and/or will divest investments. See Note 2 of Notes to Consolidated Financial Statements.
Other expenses (commissions, underwriting expenses, and other expenses) increased $1.7 million, or 3.3%, in 2014 as compared to 2013. The increase in other expenses was primarily attributable to increases in agency and underwriting related expenses in the life and health operations, amortization of deferred acquisition costs exceeding deferrals due to lower levels of new business as well as the increase of $0.4 million in amortization of unearned compensation from stock awards. Further, there was also an increase in severance expense of $0.1 million related to an increase in the number of employee separations in 2014 as compared to 2013. Partially offsetting the increase in other expenses was the $1.6 million decrease in commission accruals at American Southern due to recent increased loss experience. The majority of American Southern’s business is structured in a way that agents are compensated based upon the loss ratios of the business they place with the company. During periods in which the loss ratio increases, commissions and underwriting expenses will generally decrease, and conversely, during periods in which the loss ratio decreases, commissions and underwriting expenses will generally increase. As a percentage of earned premiums, other expenses were 34.9% in 2014 as compared with 35.6% in 2013. The decrease in the expense ratio was primarily due to the decrease in commission accruals at American Southern discussed previously.
The Company intends to pay its obligations under the Junior Subordinated Debentures using existing cash balances, dividend and tax sharing payments from the operating subsidiaries, or from potential future financing arrangements.
At December 31, 2014, the Company had 55,000 shares of Series D preferred stock (“Series D Preferred Stock”) outstanding. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s controlling shareholder. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,378,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. The Company redeemed 10,000 shares of the Series D Preferred Stock in 2014 and 5,000 shares of the Series D Preferred Stock in 2013 at the stated value of $100 per share, for aggregate payments of $1.0 million and $0.5 million, respectively. As of December 31, 2014 and 2013, the Company had accrued, but unpaid, dividends, on the Series D Preferred Stock of $17,722 and $20,945, respectively. In each of 2014 and 2013, the Company paid $0.5 million in Series D Preferred Stock dividends.
increased level of investing exceeding normal sales and maturities, additions to property and equipment of $4.1 million, the purchase of Junior Subordinated Debentures for treasury for $6.8 million, the redemption of 10,000 shares of the Series D Preferred Stock for $1.0 million, dividends paid on the Company’s common stock and Series D Preferred Stock of $0.8 million and $0.5 million, respectively, and the purchase of shares for treasury for $2.6 million. Partially offsetting the decrease was the net cash provided by operations of $4.5 million during 2014.
In the normal course of business, the Company has structured borrowings that, in accordance with accounting principles generally accepted in the United States of America, are recorded on the Company’s balance sheet at an amount that differs from the ultimate contractual obligation. See Note 6 of Notes to Consolidated Financial Statements.
We conducted our audits 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 audits 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 effectiveness of 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 financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
At December 31, 2014, the Parent owned four insurance subsidiaries, Bankers Fidelity Life Insurance Company and its wholly-owned subsidiary, Bankers Fidelity Assurance Company (“BFAC”) (together known as “Bankers Fidelity”), and American Southern Insurance Company and its wholly-owned subsidiary, American Safety Insurance Company (together known as “American Southern”), in addition to one non-insurance subsidiary, xCalibre Risk Services, Inc. BFAC was acquired on December 18, 2013. The results of operations of BFAC are included from the date of acquisition. The Parent has issued a guarantee of all liabilities of Bankers Fidelity.
Life insurance premiums are recognized as revenue when due; accident and health insurance premiums are recognized as revenue over the premium paying period and property and casualty insurance premiums are recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. Benefits and expenses are accrued as incurred and are associated with premiums as they are earned so as to result in recognition of profits over the lives of the contracts. For traditional life insurance and long-duration health insurance, this association is accomplished by the provision of a future policy benefits reserve and the deferral and subsequent amortization of the costs of acquiring business, “deferred policy acquisition costs” (principally commissions, premium taxes, and other incremental direct costs of issuing policies). Deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the policy benefits reserve. The Company provides for insurance benefits and losses on accident, health, and property-casualty claims based upon estimates of projected ultimate losses. Deferred policy acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Contingent commissions, if contractually applicable, are ultimately payable to agents based on the underlying profitability of a particular insurance contract or a group of insurance contracts, and are periodically evaluated and accrued as earned. In periods in which revisions are made to the estimated loss reserves related to the particular insurance contract or group of insurance contracts subject to such commissions, corresponding adjustments are also made to the related accruals. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance).
In January 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary
The following tables present the Company’s unrealized loss aging for securities by type and length of time the security was in a continuous unrealized loss position as of December 31, 2014 and 2013.
Level 2 Observable inputs, other than quoted prices included in Level 1, for an asset or liability or prices for similar assets or liabilities. The Company’s financial instruments valued using Level 2 criteria include significantly all of its fixed maturities, which consist of U.S. Treasury securities and U.S. Government securities, obligations of states and political subdivisions, and certain corporate fixed maturities, as well as its non-redeemable preferred stocks. In determining fair value measurements using Level 2 criteria, the Company utilizes various external pricing sources.
Level 3 Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Fair value is based on criteria that use assumptions or other data that are not readily observable from objective sources. The Company’s financial instruments valued using Level 3 criteria consist of a limited number of fixed maturities. As of December 31, 2014 and 2013, the value of the Company’s fixed maturities valued using Level 3 criteria was $2,214 and $1,991, respectively. The use of different criteria or assumptions regarding data may have yielded materially different valuations.
The following is a roll-forward of the Company’s financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2013 to December 31, 2014.
The amortized cost and carrying value of fixed maturities at December 31, 2014 and 2013 by contractual maturity were as follows. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Liabilities for life insurance future policy benefits are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of unexpected claim experience. The assumed mortality and withdrawal rates are based upon the Company’s experience. The interest rates assumed for
In accordance with general practice in the insurance industry, portions of the life, property and casualty insurance written by the Company are reinsured; however, the Company remains liable with respect to reinsurance ceded should any reinsurer be unable or unwilling to meet its obligations. Approximately 99% of the Company’s reinsurance receivables were due from two reinsurers as of December 31, 2014. Reinsurance receivables of $1,218 were due from Swiss Reinsurance Corporation, rated “AA-” by Standard & Poor’s and “A+” (Superior) by A.M. Best and $12,986 were due from General Reinsurance Corporation, rated “AA+” by Standard & Poor’s and “A++” (Superior) by A.M. Best. Allowances for uncollectible amounts are established against reinsurance receivables, if appropriate.
Deferred tax liabilities and assets at December 31, 2014 and 2013 were comprised of the following:
At December 31, 2013, a valuation allowance of $2,209 was established against deferred income tax benefits relating primarily to capital loss carryforwards that may not be realized. During 2014, the valuation allowance was decreased to zero. The decrease was primarily due to the write off of certain expired capital loss carryforward benefits that had been previously reserved for through an existing valuation allowance.
The Company has two unconsolidated Connecticut statutory business trusts, which exist for the exclusive purposes of: (i) issuing trust preferred securities (“Trust Preferred Securities”) representing undivided beneficial
interests in the assets of the trusts; (ii) investing the gross proceeds of the Trust Preferred Securities in junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”) of Atlantic American; and (iii) engaging in only those activities necessary or incidental thereto.
The financial structure of each of Atlantic American Statutory Trust I and II, as of December 31, 2014 and 2013, was as follows:
(3) On August 4, 2014, the Company acquired $7,500 of the Junior Subordinated Debentures. Consideration tendered, upon settlement, was $6,750 plus accrued interest resulting in a gain of $750 recognized in other income on the accompanying consolidated statements of operations in 2014.
The Company’s rental expense, including common area charges, for operating leases was $1,229 and $1,215 in 2014 and 2013, respectively. The Company’s future minimum base lease obligations under non-cancelable operating leases are as follows:
The Company initiated an employees’ savings plan (the “Plan”) qualified under Section 401(k) of the Internal Revenue Code in May 1995. The Plan covers substantially all of the Company’s employees. Effective January 1, 2009, the Company modified the Plan such that the Plan would operate on a safe harbor basis. Under the Plan, employees may defer up to 50% of their compensation, not to exceed the annual deferral limit. The Company’s total matching contribution for 2014 and 2013 was $186 and $173, respectively, and consisted of a contribution equal to 50% of up to the first 4% of each participant’s contributions. In addition to the matching contribution, the Company also provided a 3% safe harbor non-elective contribution in 2014 and 2013 of $391 and $369, respectively. The employer match and safe harbor contribution were made in cash.
The Company initiated a nonqualified stock purchase plan (the “Agent Stock Purchase Plan”) in May 2012. The purpose of the Agent Stock Purchase Plan is to promote and advance the interests of the Company and its stockholders by providing independent agents who qualify as participants with an opportunity to purchase the
The Company had 55,000 and 65,000 shares of Series D preferred stock (“Series D Preferred Stock”) outstanding at December 31, 2014 and 2013, respectively. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s controlling shareholder. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,378,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. The Company redeemed 10,000 shares of the Series D Preferred Stock in 2014 and 5,000 shares of the Series D Preferred Stock in 2013 at the stated value of $100 per share, for aggregate payments of $1,000 and $500, respectively. As of December 31, 2014 and 2013, the Company had accrued, but unpaid, dividends, on the Series D Preferred Stock of $18 and $21, respectively. During 2014 and 2013, the Company paid Series D Preferred Stock dividends of $471 and 483, respectively.
The assumed conversion of the Company’s Series D Preferred Stock was excluded from the earnings per common share calculation for 2014 since its impact would have been antidilutive.
The assets, liabilities and results of operations have been reported on the basis of GAAP, which varies in some respects from statutory accounting practices (“SAP”) prescribed or permitted by insurance regulatory authorities. The principal differences between SAP and GAAP are that under SAP: (i) certain assets that are non-admitted assets are eliminated from the balance sheet; (ii) acquisition costs for policies are expensed as
Under the insurance code of the state in which each insurance subsidiary is domiciled, dividend payments to the Parent by its insurance subsidiaries are subject to certain limitations without the prior approval of the applicable state’s Insurance Commissioner. The Parent received dividends of $6,468 and $6,646 in 2014 and 2013, respectively, from its subsidiaries. In 2015, dividend payments to the Parent by the insurance subsidiaries in excess of $7,640 would require prior approval.
In the normal course of business the Company has engaged in transactions with entities affiliated with the controlling shareholder of the Company. These transactions include the leasing of office space as well as certain investing and financing activities. At December 31, 2014, two members of the Company’s board of directors, including our chairman, president and chief executive officer, were considered to be affiliates of the majority shareholder, who is also a member of the Company’s board of directors.