Total shareholders’ equity of $164.1 million, or $19.11 per diluted share
Adverse net loss reserve development reported on prior year loss reserves of $2.7 million
Total cash and invested assets of $547.0 million at year end 2008
The Company’s results of operations are derived from participation in pools of insurance covering ocean marine, inland marine, aircraft and other liability insurance managed by MMO and affiliates. Since January 1, 1997, the Company’s participation in the pools has been increased to 100%. The Company formerly wrote aircraft business, but has ceased writing any new policies covering aircraft insurance for periods subsequent to March 31, 2002.
The Company reported a net loss for the year ended December 31, 2008 of $(104.3) million, or $(12.23) per diluted share, as compared to net income of $13.4 million or $1.46 per diluted share, for the year ended December 31, 2007. The decrease in results of operations for the year ended December 31, 2008 when compared to the same period in 2007 was primarily attributable to pre-tax losses from other-than-temporary write-downs of $46.0 million resulting substantially from “super senior” residential mortgage-backed securities, losses of $42.3 million from the trading portfolio, losses of $26.3 million from the limited partnership portfolio, hurricane losses from hurricanes Gustav and Ike of $6.6 million, deferred tax valuation allowance increase of $17.6 million for capital loss carryforwards and $12.4 million in reevaluations of the provision for reinsurance receivable balances.
Net realized investment losses for the year ended December 31, 2008 were $47.7 million compared with $6.9 million for 2007. The realized investment losses in 2008 primarily relate to write-downs in the Company’s investments in residential mortgage-backed securities that consist of “Alt A” mortgages.
Gross premiums written of $217.3 million and net premiums written of $165.4 million decreased by 5% and 1% for the year ended December 31, 2008, respectively, compared to the same period of 2007. However, net premiums earned increased by 1% for the year ended December 31, 2008 over the same period of 2007.
An analysis of gross premiums written for the ocean marine segment is presented below:
Ocean marine gross premiums written in 2008 decreased by 16%, primarily reflecting decreases in volume in the cargo and hull classes. The decrease in cargo production resulted primarily from the termination of a relationship with Southern Marine and Aviation, one of the Company’s agents writing cargo business. The decrease in hull premiums reflected the non-renewal of certain unprofitable accounts resulting from a continued effort to improve profitability in this class. Rates in the various classes of marine business declined slightly when compared to the prior year’s comparable period.
An analysis of gross premiums written for the inland marine/fire segment is presented below:
The Company writes excess workers’ compensation insurance on behalf of certain self-insured workers’ compensation trusts. Gross and net premiums written in the excess workers’ compensation class increased to $36.0 million and $31.9 million, respectively, in 2008 from $32.5 million and $26.4 million, respectively, in the same period of 2007. The increase in gross premiums in 2008 largely reflected production increases. Increases in net premiums written and net premiums earned in 2008 reflected the increased gross premium production. Net premiums written in 2007 reflected larger reinsurance cessions primarily as a result of quota share reinsurance, which was not renewed at the end of 2006.
The adverse loss reserve development of $2.7 million in 2008 resulted primarily from the resolution of the dispute over reinsurance receivables with a reinsurer and the reevaluation of the reserve for doubtful reinsurance receivables that contributed $12.4 million of adverse development in 2008 for both the other liability and ocean marine lines of business for accident years prior to 1999. Further contributing to adverse loss development was $3.2 million from asbestos and environmental losses in the other liability line for accident years prior to 1999. Partially offsetting this adverse development in the other liability line was favorable development in the contractors class as a result of lower than anticipated incurred loss development of approximately $3.6 million in the 2004-2006 accident years. The ocean marine line also reported favorable development of approximately $14.0 million in the 2004-2006 accident years largely as a result of lower reported and paid loss trends. The inland marine/fire segment also reported favorable loss development partially due to larger than expected reinsurance recoveries in accident years 2005-2006. Contributing to the overall adverse development in 2008 was approximately $3.5 million in adverse development from the runoff aviation class relating to accident years prior to 2002.
As of December 31, 2008 and 2007 investments included in the trading and commercial loan portfolios amounted to approximately $31.9 million and $144.9 million, respectively. Net investment (loss) income for 2008 and 2007 reflected approximately $(43.8) million and $2.3 million, respectively, derived from trading and commercial loan portfolio activities. These activities include the trading of collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), commercial middle market debt, municipal bonds, preferred stocks and exchange traded funds. The Company’s trading portfolio is marked to market with the change recognized in net investment income during the current period. Any realized gains or losses resulting from the sales of trading securities are also recognized in net investment income. The ending balance in the trading portfolio can vary substantially from period to period due to the level of trading activity. There were no CDO or CLO securities held in the trading portfolio by the Company at December 31, 2008.
The Company’s investment income results may be volatile depending upon the level of limited partnerships, commercial loans and trading portfolio investments held. If the Company invests a greater percentage of its investment portfolio in limited partnership hedge funds, and/or if the fair value of trading and/or commercial loan investments held varies significantly during different periods, there may also be a greater volatility associated with the Company’s investment income. The Company will account for future purchases of fixed income and equity securities as part of its held to maturity or available for sale portfolio, and not its trading portfolio. This decision to include such securities in the held to maturity or available for sale portfolio was based upon our intent to hold and not trade such securities.
Commission and other income (loss) increased to $0.3 million for the year ended December 31, 2008 from $(4.2) million for the same period in the prior year. The Company’s write-off of $5.3 million relating to its computer systems in 2007 accounted for most of the change. Commission income in 2007 reflected a greater profit commission than in 2008 derived from ceded reinsurance in the ocean marine class of business.
Reserves for unearned premiums decreased to $83.4 million as of December 31, 2008 from $87.6 million as of December 31, 2007 primarily as a result of the decline in gross premiums written.
Reinsurance receivables on unpaid balances, net at December 31, 2008, decreased to $213.9 million from $250.1 million at December 31, 2007, and reinsurance receivables on paid balances, net at December 31, 2008, decreased to $28.4 million from $38.8 million at December 31, 2007 largely as a result of the payment of gross ocean marine losses and asbestos and environmental losses that were substantially reinsured, the collection of ceded hurricane loss payments, the write off of disputed receivable balances with a reinsurer, and the subsequent reevaluation of reserves for doubtful accounts.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006
Gross premiums written of $228.4 million decreased by 5% for the year ended December 31, 2007 compared to the same period of 2006. However, net premiums written of $167.9 million increased by 8% for the year ended December 31, 2007 over the same period of 2006, and net premiums earned of $166.1 million for the year ended of 2007 increased by 9% compared with the same period in 2006.
Ocean marine gross premiums written in 2007 decreased by 6%, primarily reflecting volume decreases in hull premium as a result of not renewing certain unprofitable accounts and declines in production of marine liability business. Rates in the various classes of marine business were generally flat to slightly declining when compared to 2006.
Effective January 1, 2007, the Company maintained its $5 million per risk and $6 million per occurrence net loss retention in the ocean marine line that was in existence during 2006; however, the Company could incur an additional loss amount, as large as $5 million, depending upon the gross loss to the Company in excess of $5 million. The 80% quota share reinsurance protection for the Company’s energy business, which commenced in 2006, also remained in effect for 2007. The Company terminated its relationship with one of its agents writing cargo business in 2007. Inland marine/fire gross premiums written, net premiums written and net premiums earned for the year ended December 31, 2007 decreased by 14%, 2% and 10%, respectively, when compared to 2006. Premiums in 2007 reflected mildly lower market rates when compared to 2006 as well as declines in production in certain property risks.
Other liability gross premiums written decreased by 3% for the year ended December 31, 2007 when compared to 2006. Net premiums written and net premiums earned for the year ended December 31, 2007 rose by 28% and 34%, respectively, when compared to 2006. The Company writes excess workers’ compensation insurance on behalf of certain self-insured workers’ compensation trusts. In 2006, the Company provided gross statutory limits on the renewals of its then existing in force book of excess workers’ compensation policies to these trusts. The reinsurance structure that was in effect in 2006 included a general excess of loss treaty in order to protect the Company on any one risk or occurrence and the resulting net retention was then subject to a 70% quota share reinsurance treaty. The Company terminated its relationship with its former primary source of excess workers’ compensation premium effective December 31, 2006. However, the Company’s alternative source of excess workers’ compensation production issued substantially all of the Company’s excess workers’ compensation premiums in 2007. These policies also provide excess workers’ compensation insurance on behalf of self-insured workers’ compensation trusts. Moreover, the Company maintains a general excess of loss treaty in order to protect the Company on any one risk or occurrence; however, the 70% quota share reinsurance agreement was terminated at the end of 2006.
Aircraft premiums were nominal in 2007 and 2006 as a result of the Company having ceased writing new aircraft policies subsequent to March 31, 2002.
General and administrative expenses increased by 15% for the year ended December 31, 2007 when compared to 2006. Expenses in 2007 include approximately $1.8 million resulting from the evaluation and negotiation of an investment in an asset management company that was not consummated. Larger expenses were incurred in 2007 to service the growth in the Company’s business operations, including higher personnel expense and rent expense on additional office space.
Net investment income for the year ended December 31, 2007 decreased by 26% to $35.5 million from $47.9 million in 2006. The decrease in 2007 when compared to 2006 reflected lower trading portfolio and limited partnership hedge fund income which was partially offset by increases in the fixed maturities available for sale and the short-term investment portfolios. The higher trading portfolio income in 2006 reflected a greater trading volume of securities (including $7.0 million from investments in U.S. Treasuries, as compared to none for 2007) and income from our Altrion investment. The investment income from Altrion amounted to $4.7 million for the year ended December 31, 2006 including trading portfolio income of $2.9 million and, as a result of the deconsolidation of Altrion effective August 1, limited partnership hedge fund portfolio income of $1.8 million. This compared to $7.9 million of income from Altrion in 2007, which was included in limited partnership hedge fund portfolio income. Income from Altrion increased in 2007 when compared to 2006 as a result of greater interest income earned from the warehousing of CDO/CLO debt securities and middle market commercial debt, as well as larger fee income earned for servicing such securities. Limited partnership hedge fund income in 2007, excluding income from Altrion, decreased from the prior year as a result of lower yields on the limited partnership hedge fund portfolio, which amounted to 3.4% in 2007 as compared to 10.0% in 2006.
As of December 31, 2007 and 2006 investments in trading portfolios amounted to approximately $144.9 million and $0, respectively. Net investment income for 2007 and 2006 reflected approximately $2.3 million and $15.8 million, respectively, derived from trading portfolio activities. These activities include the trading of collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), commercial middle market debt, municipal bonds, preferred stocks and US Treasury notes. The Company’s trading portfolio was marked to market with the change recognized in net investment income during this period. Any realized gains or losses resulting from the sales of trading securities are also recognized in net investment income. The ending balance in the trading portfolio can vary substantially from period to period due to the level of trading activity.
As a result of the accounting treatment of its limited partnerships and trading portfolio, the Company’s investment income results may be volatile. If the level or fair value of investments held in limited partnership hedge funds or trading securities change substantially, there may also be a greater volatility associated with the Company’s investment income.
Commission and other (loss) income decreased to $(4.2) million for the year ended December 31, 2007 from $1.1 million for the same period in the prior year. The Company’s write-off of $5.3 million relating to its computer systems in 2007 accounted for most of the decrease. The Company determined that certain computer equipment and software was inefficient and no longer possessed any future service potential, and accounted for it as an abandoned asset under the guidance of Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Commission income in 2007 and 2006 each reflected profit commissions derived from ceded reinsurance in the ocean marine class of business.
Unpaid losses and loss adjustment expenses decreased to $556.5 million at December 31, 2007 from $579.2 million at December 31, 2006. Reinsurance receivables on unpaid losses, net decreased to $250.1 million at December 31, 2007 from $286.2 million at December 31, 2006. These decreases were primarily due to the closing of novation agreements for certain excess workers’ compensation policies that resulted in a decreases of $41.5 million and $24.9 million in unpaid losses and loss adjustment expenses, and reinsurance receivables on unpaid losses, respectively.
Property, improvements and equipments, net decreased to $4.8 million at December 31, 2007 from $9.9 million at December 31, 2006 primarily due to the write off of $5.3 million in functionally inadequate computer software.
The Company monitors cash and short-term investments in order to have an adequate level of funds available to satisfy claims and expenses as they become due. As of December 31, 2008, the Company’s assets included approximately $185.9 million in cash and short-term investments. Fixed maturities held to maturity are comprised of $61.2 million in floating rate residential mortgage-backed securities. Cash and total investments decreased from $701.1 million at December 31, 2007 to $547.0 million at December 31, 2008, principally as a result of the fair value decline of the Company’s investments. Receivables for securities sold amounted to $25.4 million and $22.9 million as of December 31, 2008 and 2007, respectively. Payable for securities purchased amounted to $0 and $28.7 at December 31, 2008 and 2007, respectively. The level of cash and short-term investments of $185.9 million at December 31, 2008 reflected the Company’s high liquidity position.
For the year ended December 31, 2008, cash flows from operating activities excluding adjustments for trading and commercial loan activities were unfavorable and for the years ended December 31, 2007 and 2006, cash flows from operations excluding adjustments for trading and commercial loan activities were favorable. Cash flows were adversely impacted in 2008, principally as a result of lower investment income; were favorably impacted in 2007, principally as a result of collections of reinsurance recoverables on hurricane losses and lower net paid losses, which were partially offset by payments of quota share reinsurance premiums; and, were favorably impacted in 2006, by collections of premiums from a large increase in other liability premiums, which were mostly offset by a greater amount of paid losses and reinstatement reinsurance premiums, due in part to hurricane losses and partly due to payments on asbestos related losses.
In May 2007, the Company signed a lease for additional office space for its headquarters located on the 11th floor of 919 Third Avenue in New York City. The lease term provides for lease payments on two sections (Space A and Space B) of the 11th floor. The lease term for Space A commenced on September 1, 2007 and ends on July 30, 2016. Minimum monthly payments of $85,818 commenced on January 1, 2008 and will increase to $91,355 on the commencement of the sixth lease year. Total minimum lease rental payments over the term for Space A will amount to $9.4 million. The lease term for Space B commenced on April 30, 2008, and will end on July 30, 2016. Minimum monthly payments of $111,904 will increase to $119,123 on the commencement of the sixth lease year following the initial payment under the Space B lease. Total minimum lease rental payments over the term for Space B will be at least equal to $11.7 million. In connection with the 11th floor lease, the landlord will reimburse the Company up to $765,375 for qualified renovations.
A significant portion of the Company’s invested asserts are in hedge funds. The Company is in the process of redeeming its investment in both hedge funds. The level of liquidity of invested assets is impacted by hedge fund investments as one of our hedge funds (Mariner Voyager) has invoked gated provisions that allow the fund to disperse redemption proceeds to investors over an extended period. The Company is subject to such restrictions and they will affect the timing of the receipt of hedge fund proceeds. During January 2009, the Company received redemption proceeds of $2.6 million from Mariner Voyager. The timing of additional redemption proceeds is uncertain. The Company also maintains a significant investment in Altrion. The Company was previously committed to providing an additional $15.4 million, or a total of approximately $40 million, in capital to Altrion by August 1, 2008. Altrion, however, waived its right to require the Company to contribute its additional capital commitment of $15.4 million and accordingly, the Company’s obligation to make such capital contribution has expired. In addition, the Company withdrew $10 million of its capital from Altrion during July 2008. Withdrawals require one year’s prior written notice to the hedge fund manager. The Company has submitted a redemption notice to Altrion with an indicated redemption date of December 31, 2009. The Company is uncertain as to whether cash and/or securities will be received as payment of the redemption proceeds. See “Investment Management Arrangement” for a complete discussion of the Company’s investment in Altrion.
The Company has capitalized $3.1 million in computer software expenses in 2008. The Company anticipates additional expenses, in a range of $3-$5 million, to implement a new computer system in 2009.
During 2008, the Company also made capital contributions of $32.5 million to its insurance subsidiary New York Marine and purchased $6.1 million in overdue receivables from New York Marine.
New York Marine and Gotham collectively paid ordinary dividends of $6,795,000, $14,475,000 and $13,225,000 in 2008, 2007 and 2006, respectively.
On March 6, 2009, the Company declared a dividend of $.04 to shareholders of record on March 31, 2009, payable on April 7, 2009. The reduction in dividend amount from prior quarters reflected the Company’s cautious economic outlook.
The Company has established three share-based incentive compensation plans (the “Plans”), which are described below. Management believes that the Plans provide a means whereby the Company may attract and retain persons of ability to exert their best efforts on behalf of the Company. The Plans generally allow for the issuance of grants and exercises through newly issued shares, treasury stock, or any combination thereof to officers, key employees and directors who are employed by, or provide services to the Company. The compensation cost that has been charged against income for the Plans was $2,535,351, $2,210,615 and $2,116,929 for the years ended December 31, 2008, 2007 and 2006, respectively. Of the $2.1 million expensed in 2006, approximately $343,000 related to the adoption of accounting for share-based compensation under SFAS 123(R). The approximate total income tax benefit accrued and recognized in the Company’s financial statements for the years ended December 31, 2008, 2007 and 2006 related to share-based compensation expenses was approximately $887,000, $774,000 and $741,000, respectively.
The Company discloses significant accounting policies in the notes to its financial statements. Management considers certain accounting policies to be critical for the understanding of the Company’s financial statements. Such policies require significant management judgment and the resulting estimates have a material effect on reported results and will vary to the extent that future events affect such estimates and cause them to differ from the estimates provided currently. These critical accounting policies include unpaid losses and loss adjustment expenses, allowance for doubtful accounts, impairment of investments, investment accounting including limited partnerships and trading and held to maturity portfolios, reinstatement reinsurance premiums and stock compensation.