The following table sets forth selected financial data for the Company. The financial data for 2002 through 2003 reflects the results of operations and financial position of the Insurance Company. The financial data for 2006, 2005 and 2004 reflects the consolidated results of operations and financial position of the Holding Company and the Insurance Company including the effects of the Conversion which occurred on October 15, 2004. You should read this data in conjunction with the Company’s consolidated financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this report.
(3) The net loss and loss adjustment expense (LAE) ratio is the net loss and LAE in relation to net premium earned.
(7) Earnings per share data for 2004 reflects only net income for the period from October 16, 2004 through December 31, 2004, the period after the Conversion. Net income during this period was $902,711.
(8) In 2005, the Company recorded a federal income tax benefit of $1,152,000 despite having pre-tax income of $7,930,000. The federal income tax benefit was due to the Company recognizing a $3,855,000 reduction in its deferred tax valuation allowance in 2005. See Note 5 to the consolidated financial statements, included elsewhere in this report, for further information regarding federal income taxes.
Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on a quarterly basis, we review, existing reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior accident years. We use historical paid and incurred losses and accident year data to derive expected ultimate loss and loss adjustment expense ratios by line of business. We then apply these expected loss and loss adjustment expense ratios to earned premium to derive a reserve level for each line of business. In connection with the determination of the reserves, we also consider other specific factors such as recent weather-related losses, trends in historical paid losses, and legal and judicial trends with respect to theories of liability. Some of our business relates to coverage for short-term risks, and for these risks loss development is comparatively rapid and historical paid losses, adjusted for known variables, have been a reliable predictive measure of future losses for purposes of our reserving. Some of our business relates to longer-term risks, where the claims are slower to emerge and the estimate of damage is more difficult to predict. For these lines of business, more sophisticated actuarial methods, such as the Bornhuetter-Ferguson loss development methods (see “Methods” below) must be employed to project an ultimate loss expectation, and then the related loss history must be regularly evaluated and loss expectations updated, with the possibility of variability from the initial estimate of ultimate losses.
When a claim is reported to us, our claims representatives establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by our claims staff as more information becomes available. It is our policy to settle each claim as expeditiously as possible.
Description of Ultimate Loss Estimation Methods. The 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. Historical “age-to-age” loss development factors were calculated to measure the relative development of an accident year from one maturity point to the next. We then selected appropriate age-to-age loss development factors based on these historical factors and used the selected factors to project the ultimate losses.
In estimating our loss reserves for the multi-peril lines of business including homeowners, farmowners and commercial and the general liability line of business we relied on the incurred Bornhuetter-Ferguson method for accident years 2003 to 2006 and the incurred loss development for accident years prior to 2003.
For the workers’ compensation line of business we relied on the incurred Bornhuetter-Ferguson method for accident years 2001 to 2006 and the incurred loss development method for the remaining years. Given the longer tail development of workers’ compensation claims and the fact that the Company’s workers’ compensation book of business is relatively small we placed more reliance on the incurred Bornhuetter-Ferguson method.
Each quarter, we review our loss reviews to ascertain whether new developments have occurred which would require adjustment to our ultimate loss estimates. The quarterly review involves roundtable discussion involving the claims and accounting departments. Discussion is generally focused on claims involving liability and those claims that involve significant judgement. Because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on the Company’s results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.
Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss adjustment expenses will likely differ from the amount recorded at December 31, 2006.
The following table shows the activity in the loss and LAE reserve balances of the Company for the years ended December 31, 2006, 2005 and 2004, prepared in accordance with accounting principles generally accepted in the United States of America.
personal auto-$1,329,000, commercial multi-peril-$1,247,000, workers compensation-$715,000, farm- $379,000 while the remaining product lines had redundant development of $214,000. There were no significant changes in the key assumptions utilized in the analysis and calculations of the Company’s reserves during 2006. The favorable development was concentrated in accident years 2003 through 2005 and is a result of downward development on both case and incurred but not reported reserves and loss adjusting expense reserves.
In 2004, the Company experienced favorable development on losses and LAE for prior accident years of $666,000 which represents 10.9% of net loss and LAE reserves as of the beginning of the year. The favorable development was concentrated in the commercial segment’s product lines of commercial multiple peril and workers compensation which experienced favorable development of $1,076,000 primarily in accident years 2000, 2002 and 2003. During 2003, the Company strengthened its reserves in the commercial segment because the Company’s actuarial projections indicated higher ultimate losses on prior accident years driven primarily by the volatility in claim development within the newer product lines within the commercial segment. Throughout 2004 the development on commercial losses was less than what was expected as the settlement of reported cases was favorable. The homeowner and farm product lines experienced adverse development of $344,000 resulting from the normal claims review process, and not from changes in key assumptions or reserving methods.
The following table shows the development of our reserves for unpaid losses and LAE on a GAAP basis for each of the years ended December 31, from 1996 to 2006. The line in the table titled “Net liability for loss and LAE,” shows the initial reserves at the balance sheet date, including losses incurred but not reported. The portion of the table titled “Cumulative net paid as of,” shows the cumulative amounts subsequently paid as of successive years with respect to the reserve shown at the top of the table. The portion of the table titled “Re-estimated net liability as of:” shows the re-estimated amount of the previously reported liability for loss and LAE based on experience as of the end of each succeeding year. The estimates of liability for loss and LAE change as more information becomes available about the frequency and severity of claims for individual years. A redundancy (or deficiency) exists when the re-estimated amount of liability at each December 31 is less (or greater) than the prior liability estimate. The “Net cumulative redundancy (deficiency)” depicted in the table, for any particular
Other Income, Net. Other income, net which includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income and expense items increased 5.0% to $417,000 in 2006 compared to $398,000 in 2005.
Federal Income Tax. During the year ended December 31, 2006 the Company recorded income tax expense of $3,466,000 resulting in an effective tax rate of 32.4%. Federal income taxes do not bear the usual relationship to pre-tax income primarily as a result of the effects of non-taxable investment income and other provision to return variances as well as the change to the deferred tax asset valuation allowance. During the year ended December 31, 2005 the Company recorded an income tax benefit of approximately $1,152,000 resulting in an effective tax rate of 14.5%. For 2005, federal income taxes did not bear the usual relationship to pre-tax income primarily as a result of the effects of the reduction of the deferred tax asset valuation allowance, non-taxable investment income and other provision to return variances. During the quarter ended September 30, 2005 the Company’s management reassessed the need for a full valuation allowance, and based on all available evidence, including the Company’s cumulative net income for recent fiscal years, estimates of current and future profitability and the overall prospects of our business, concluded that a full valuation allowance was no longer necessary. As a result, the valuation allowance was reduced by approximately $3,855,000 which is reflected in the 2005 income tax benefit. The Company’s federal income tax expense excluding the effect of the change in the valuation allowance was $2,704,000 resulting in an effective tax rate of 34.1% for the year ended December 31, 2005.
Amortization of deferred policy acquisition costs increased $2,391,000 during 2005 due to the reduction in the quota share reinsurance ceding commission income component of deferred policy acquisition costs. The
remaining increase of $705,000 is due to the increase in premium volume as compared to the prior year. Items affecting the decline in other underwriting expenses include a decrease of $490,000 in the net periodic benefit cost related to the post-retirement benefit plan as a result of the plan amendment made at the end of 2004 coupled with a decrease of $128,000 in assessments from state mandated associations and guaranty funds. These decreases were offset by an increase in agent marketing incentives and profit sharing commissions of $219,000 and an increase in salaries and wages of $227,000 as a result of annual merit increases and the accrual of employee profit sharing which is directly tied to the performance and profitability of the Company. The expense ratio, defined as the ratio of policy acquisition and other underwriting expenses to net premiums earned, decreased to 32.3% from 35.4%. The decline in the ratio is due to the previously mentioned decrease in other underwriting expenses coupled with the increase in net premiums earned which is primarily attributable to the effects of the quota share runoff.
Liquidity is a measure of the ability to generate sufficient cash to meet cash obligations as they come due. In addition to the need for cash flow to meet operating expenses, our liquidity requirements relate primarily to the
payment of losses and loss adjustment expenses. Our short and long term liquidity requirements vary because of the uncertainties regarding the settlement dates for liabilities for unpaid claims and because of the potential for large losses, either individually or in the aggregate.
Cash flow used in investing activities was $8,875,000 and $15,266,000 during the years ended December 31, 2005 and 2004, respectively, a decrease of $6,391,000. Net cash proceeds received from the issuance of common stock in the Conversion on October 15, 2004 amounted to $5,007,000. The majority of the net cash proceeds were placed into the Company’s fixed maturity investment portfolio during 2004 which caused the net cash used for investing activities to be higher in 2004.
Our debt structure consists of surplus notes which carry a 7 percent interest rate and mature on September 30, 2007. At December 31, 2006 and December 31, 2005, the Company had approximately $2,890,000 of Series B Surplus Notes outstanding. The Company expects to payoff the surplus notes in September 2007 from its existing cash and cash equivalents.
The Holding Company has not paid and does not intend to pay dividends in the foreseeable future and cannot assure our stockholders that dividends will be paid in the future. The Holding Company’s principal source of cash available for payment of dividends is dividends from the Insurance Company. The annual future cash requirements of the Holding Company are not foreseen to be significant. They will include director fees and other administrative expenses related to annual filings such as income tax returns and other compliance type filings. As of December 31, 2006 the Holding Company had a cash balance of $132,000.
The payment of dividends by the Insurance Company is subject to limitations imposed by the Michigan Insurance Code. The Insurance Company may not pay an extraordinary dividend unless it notifies the Insurance Commissioner and she does not disapprove the payment. An extraordinary dividend includes any dividend which, when taken together with other dividends paid within the preceding 12 months, exceeds the greater of 10% of the Insurance Company’s statutory policyholders’ surplus as of December 31 of the immediately preceding year or its statutory net income, excluding realized capital gains, for the 12-month period ending December 31 of the immediately preceding year. During the year ending December 31, 2007, the Insurance Company can pay a non-extraordinary dividend of up to $6,725,000 without prior approval from the Insurance Commissioner. In order to pay any dividends, the Insurance Company must be in a position to satisfy the requirement that the company continue to be safe, reliable and entitled to public confidence. Also, in the absence of approval of the Insurance Commissioner, dividends may only be paid from statutory earned surplus. Also, dividends may not exceed the amount of the Insurance Company’s statutory capital stock account in any one-year unless it meets certain other requirements.
In accordance with FASB Statement No. 109, Accounting for Income Taxes, we may recognize certain tax assets whose realization depends upon generating future taxable income. These tax assets can only be realized through the generation of future taxable income and thereby utilizing the net operating loss (NOL) and Alternative Minimum Tax (AMT) credit carry-forwards we have available. At December 31, 2006, the Company has NOL carryforwards of approximately $7,748,000 and an AMT credit carryforward of approximately $358,000. The AMT credit carryforward can be carried forward indefinitely. The NOL carryforward expires as follows:
The Company has a contractual obligation with respect to its outstanding surplus notes and loss and LAE reserves which are recorded as liabilities in our financial statements. In addition, the Company is contractually committed to make certain minimum lease payments for the use of equipment under operating lease agreements. The following table summarizes our significant contractual obligations and commitments as of December 31,
We have audited the accompanying consolidated balance sheets of Fremont Michigan InsuraCorp, Inc. and subsidiary (the Company) as of December 31, 2006 and 2005 and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated statements of operations, of stockholders’ equity and comprehensive income and of cash flows for the year ended December 31, 2004 present fairly, in all material respects, the results of operations and cash flows of Fremont Michigan InsuraCorp, Inc. and its subsidiary (the “Company”) for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules for the year ended December 31, 2004 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audit of these statements 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. 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
On October 12, 2004, FIC, formerly Fremont Mutual Insurance Company, converted from a mutual to a stock form of insurance company and subsequently on October 15, 2004, all of its outstanding capital stock was transferred to FMIC thereby becoming a wholly owned subsidiary of FMIC. Prior to the conversion and since 1876, Fremont Mutual Insurance Company conducted business as a Michigan domiciled mutual property and casualty insurer. FMIC was formed on November 18, 2003 for the purpose of acquiring all of the stock of FIC. On October 15, 2004 FMIC issued and sold 1,724,236 shares of its Common Stock at $5 per share (the “Conversion”). As part of the Conversion, surplus note holders converted approximately $2,498,000 of principal and accrued interest on surplus notes into common stock of FMIC. The following table presents (in thousands) the net value of the common stock issued as well as the net cash proceeds received as a result of the Conversion:
At December 31, 2006 and 2005, all of the Company’s investments are classified as available-for-sale and are those investments that would be available to be sold in response to the Company’s liquidity needs, changes in market interest rates and asset-liability management strategies, among others. Available-for-sale investments are
recorded at fair value, with the corresponding unrealized appreciation or depreciation, net of deferred income taxes and any corresponding deferred tax asset valuation allowance, reported as a component of accumulated other comprehensive income or loss until realized.
The Company reviews the status and market value changes of its investment portfolio on at least a quarterly basis during the year, and any provisions for other-than-temporary impairments in the portfolio’s value are evaluated and established at each quarterly balance sheet date. In reviewing investments for other than temporary impairment, the Company, in addition to an investment’s market price history and its intent and ability to hold fixed maturity investments until maturity, considers the issuer’s operating results, financial condition and liquidity, its ability to access capital markets, credit rating trends, most current audit opinion, industry and securities markets conditions, and analyst expectations, in their totality to reach its conclusions. When a security in the Company’s investment portfolio has an unrealized loss in value that is deemed to be other than temporary, the Company reduces the book value of such security to its current market value, recognizing the decline as a realized loss in the statement of operations. Any future increases in the market value of investments written down are reflected as changes in unrealized gains as part of accumulated other comprehensive income within stockholders’ equity.
Other income consists of premium installment charges which are recognized when earned and other miscellaneous income.
Changes, net of tax, in accumulated other comprehensive income (loss) are presented in the table below:
Reinsurance recoverables include balances due from reinsurance companies for paid and unpaid losses and LAE that will be recovered from reinsurers, based on contracts in force. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve the Company from its primary obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk with respect to the individual reinsurer that participates in its ceded programs to minimize its exposure to significant losses from reinsurer insolvencies. When necessary the Company holds collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not considered authorized insurers by the State of Michigan Office of Financial and Insurance Services.
Property and equipment is recorded at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method. Estimated useful lives are: building-35 years, computer equipment including software-3 to 5 years and furniture, fixtures and equipment-5 to 7 years. Software is capitalized in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” and amortized on a straight-line method over the estimated useful life of the software, generally not exceeding 3 years. Maintenance, repairs and minor renewals are charged to expense as incurred. Depreciation expense was $602,687, $141,665 and $120,529 for the years ended December 31, 2006, 2005, and 2004, respectively. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Upon sale or retirement, the cost and related accumulated depreciation of assets disposed of are removed from the accounts; any resulting gain or loss is reflected in income.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The adoption of the provisions of SAB 108 on December 31, 2006 had no impact on the consolidated financial statements.
Net investment income for the years ended December 31, 2006, 2005 and 2004 is summarized as follows:
Sales of available-for-sale fixed maturities resulted in the following during the years ended December 31, 2006, 2005 and 2004:
The Company engages an investment management consultant for the fixed maturity portfolio. Under the guidelines provided to the investment management consultant the fixed maturity portfolio has experienced a rebalancing during 2006, 2005 and 2004. The focus of the Company’s rebalancing is to improve credit quality, liquidity and diversification within the portfolio, to create a more stable income stream and to enhance long-term total return. During 2006, 2005 and 2004, special attention was given to portfolio duration in order to reduce market value fluctuations in a rising interest rate environment. Despite the Company’s intent and ability to hold fixed maturity investments until maturity, proceeds from the sale of fixed maturity investments increased during 2005 as a result of rebalancing the portfolio.
As of December 31, 2005, the portfolio included 49 fixed maturity investments and 5 equity investments in an unrealized loss position for less than 12 months and 37 fixed maturity investments in an unrealized loss position for more than 12 months, none of which were trading below 90% of cost or amortized cost. All of the fixed maturity investments in an unrealized loss position and assigned a rating by commercial credit rating companies are rated investment grade investments. While all of these investments are monitored for potential impairment, the Company’s experience indicates that they generally do not present as great a risk of impairment, as fair value often recovers over time. These investments have generally been adversely affected by the downturn in the financial markets and overall economic conditions. Management believes that the analysis of each of these investments support the view that these investments were not other-than-temporarily impaired.
During 2006 and 2005 the property excess of loss coverage provided up to $2,850,000 over the $150,000 retention. During 2004 the property excess of loss coverage provided up to $2,375,000 over the $125,000 retention.
There is an annual aggregate deductible feature in the amount of $400,000 that applied to the multi-line contract in 2004.
The Company had 3 layers of catastrophic excess of loss reinsurance providing coverage for up to $22,000,000 in 2006 and 2005 and $20,000,000 in 2004 above a $1,000,000 retention. The Company had an automatic reinstatement provision after the first loss for each layer to provide coverage in the event of subsequent catastrophes during the year. Coverage would have lapsed after the second event, in which case the Company would have evaluated the need for a new contract for the remainder of a particular year. During 2006, 2005 and 2004 the coverage could be reinstated for a fee of 100% of the original premium.
During 2003, the Company utilized a multi line quota share agreement which provided coverage for virtually all of the Company’s business. The Company ceded 45% of its premiums and losses on all business except boiler and machinery to the reinsurers. The agreement contained a “loss corridor” provision. Reimbursement stops on losses when the loss and LAE ratio on the premium ceded is between 60% and 74% and resumes when the ratio is between 74% and 82.5%. A loss and LAE ratio that exceeds 82.5% will trigger a “drop down coverage” feature that will reimburse the Company for 100% of the losses between the loss ratios of 60% to 65%. Reimbursement stops between the loss ratios of 65% to 74%. Payment resumes again when the loss ratios are 74% to 85%. Losses in excess of 85% are 100% retained by the Company. The Company received a 36% commission on the ceded premium. The agreement is structured on a funds withheld basis and requires the Company to accrue interest at an annual rate of approximately 2.5%. During 2006, 2005 and 2004 the Company recorded interest expense of approximately $26,000, $106,000 and $150,000, respectively, on the funds withheld balance. The agreement provides that a profit commission will be retained by the Company upon commutation equal to the positive balance in the funds withheld account. During 2005 and 2004 the Company accrued profit commission based on the experience of the underlying business ceded under this agreement of $1,400,000 and $945,000, respectively. The profit commission reduced ceded written and earned premiums.
Actual federal income taxes vary from amounts computed by applying the current federal income tax rate of 34 percent to income before federal income taxes. For the years ended December 31, 2006, 2005 and 2004 the reasons for these differences and the tax effects thereof, are as follows:
Deferred federal income tax assets and liabilities are recognized for the estimated future tax consequences attributable to the difference between financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, the Company’s management reviews both positive and negative evidence, including current and historical results of operations, the annual limitation on utilization of net operating loss carryforwards pursuant to Internal Revenue Code Section 382 (“Section 382”), future income projections and the overall prospects of our business. As of December 31, 2006, the Company has net operating loss carryforwards of approximately $7,748,000, which begin to expire in 2010 and fully expire in 2021, and alternative minimum tax credits of approximately $358,000, which may be carried forward indefinitely. As a result of the Conversion and demutualization discussed in Note 1 the aforementioned net operating losses are subject to certain “change in control” limitations under Section 382. The annual limitation on the utilization of the net operating losses is approximately $400,000. In addition to the net operating loss carryforwards, the Company’s alternative minimum tax credit carryforwards are also subject to the Section 382 limitation however these credit carryforwards have no expiration and can be carried forward indefinitely. Based on the annual Section 382 limitation of the utilization of net operating loss carryforwards management has determined that approximately $2,971,000 of net operating loss carryforwards will not be realized and therefore a full valuation allowance of approximately $1,010,000 will be maintained for the deferred tax asset associated with these amounts.
The tax effects of temporary differences that give rise to deferred federal income tax assets and deferred federal income tax liabilities are as follows:
The Company assesses the recoverability of deferred policy acquisition costs against future expected underwriting income and reduces deferred policy acquisition costs if it appears that a premium deficiency may exist. There were no premium deficiencies at December 31, 2006, 2005 and 2004. During 2004, the Company received a 36% ceding commission on the ceded premiums under the multi line quota share reinsurance agreement which reduced the deferred commission costs.
In 2006, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $5,224,000 which represents 40.4% of the net loss and LAE reserves as of the beginning of the year. There were no significant changes in the key assumptions utilized in the analysis and calculations of the Company’s reserves during 2006. The redundant development included $1,340,000 related to homeowners, $1,329,000 related to personal auto, $1,247,000 related to commercial multi-peril, $715,000 related to workers compensation, $379,000 related to farm while the remaining lines of business had redundant development of $214,000. There were no significant changes in the key assumptions utilized in the analysis and calculations of the Company’s reserves during 2006. The favorable development was concentrated in accident years 2003 through 2005 and is a result of downward development on both case and incurred but not reported reserves and loss adjusting expense reserves.
During 2005, the commercial segment experienced adverse development of approximately $253,000 driven by the workers compensation product line which had adverse development of $234,000. The Company strengthened its workers compensation reserves for accident years 2001 through 2004 as a result of adjusting the ultimate loss estimates so they are more in line with industry averages. Given the fact that workers’ compensation claims take a much longer time to be reported and settled coupled with the fact that the Company began writing workers’ compensation policies in 1997 the Company deemed industry loss ratios to be a more prudent estimate than loss ratios based on the Company’s historical development patterns since 1997. The remaining redundant development of $278,000 came from the marine segment’s 2004 and 2003 accident years.
In December 2002, approximately $2,673,000 million of Series A notes were converted into Series B notes at the request of the holders. Also in December 2002, additional notes, aggregating approximately $1,020,000, were purchased by agents and other private investors. During 2003, approximately $641,000 of Series B Surplus Notes were issued. In addition, holders of $930,000 of the Series A Surplus Notes converted their notes into Series B Surplus Notes. The balance of the Series A Surplus Notes, which approximated $804,000, was repaid on June 30, 2003. In conjunction with the Conversion which was completed on October 15, 2004 approximately $2,374,000 of Series B Surplus Notes were converted into stock of the Company.
The estimated prior service credit and net actuarial loss that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $85,682 and $20,293, respectively.
As of December 31, 2006 and 2005, approximately $85,660,000 and $75,715,000, respectively, of consolidated assets represent assets of FIC that are subject to regulation and may not be transferred to FMIC in the form of dividends, loans or advances without the prior approval of the Michigan Office of Financial and Insurance Services (“OFIS”). Dividends paid by FIC are subject to limitations imposed by the Michigan Insurance Code (“Code”). Under the Code, FIC may pay dividends only from statutory earnings and capital and surplus. In addition, FIC may not declare an “extraordinary” dividend to its shareholders without the prior approval of OFIS. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of statutory capital and surplus as of December 31, of the preceding year or the statutory net income, excluding net realized investment gains, for the immediately preceding calendar year. Accordingly, FIC may pay dividends of approximately $6,725,000 in 2007 without prior approval. However, the OFIS has the authority to prohibit payment of any dividend.
note includes a 5 year balloon payment, which becomes due June 2010. During 2006 and 2005 the agent earned $55,117 and $52,300, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.
Three nonemployee directors of the Company are also owners of independent insurance agencies. These individuals are currently appointed as agents with and write insurance for the Company. The terms and conditions of the agency agreements between these agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays all agencies commissions on business produced. All agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. Total regular and profit sharing commissions earned by these agencies approximated $484,000, $487,000 and $458,000 in 2006, 2005 and 2004, respectively. The commission rates, including profit sharing commission opportunity, are the same as other agents of the Company. The agencies are independent agents and also write with regional and national insurers that may be competitors of the Company.
A nonemployee director of the Company is a partner in a law firm. The Company has retained this law firm for certain legal matters in the past and plans to continue to do so in the future. Legal fees paid by the Company to the law firm were approximately $35,000 in 2006, $55,000 in 2005 and $261,000 in 2004.
Non-employee directors of the Company also participated in the surplus note offerings and held surplus notes at December 31, 2006 and 2005, as disclosed in Note 9-Surplus Notes. For the years ending December 31, 2006, 2005 and 2004, non-employee directors holding surplus notes received directors’ fees of $68,400, $54,900 and $47,100, respectively.
The Company also paid investment commissions to a firm controlled by an individual who held surplus notes at December 31, 2006 and 2005. Total investment commissions paid during the years ending December 31, 2006, 2005 and 2004 were approximately $30,000, $20,000 and $13,000, respectively.
revenues are generated from external customers and the Company does not have a significant reliance on any single major customer or agent.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2006, 2005 and 2004. The expected
A summary of option activity under the plans as of December 31, 2006 and changes during the year then ended is presented below:
As of December 31, 2006, there was $327,802 of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under both plans. That cost is expected to be recognized over a weighted average period of 4.1 years.