In 2010, Infinity entered into a definitive sales contract to purchase the 111,602 square foot Liberty Park facility that it currently leases in Birmingham for $16.1 million. Infinity expects to use current funds to complete the purchase in 2011.
Infinity had a net realized gain on investments of $10.4 million at December 31, 2010 compared to a net realized loss of $14.8 million in 2009. Included in the net realized gain for 2010 is $2.9 million of other-than-temporary impairments on fixed income securities compared with $19.9 million of impairments during 2009.
Recent accident years are less developed than prior years and must be interpreted with caution. However, the upward trend in the 2009 and 2010 accident year combined ratios reflects an increase in new business during these years. In 2009, new business earned premium accounted for 35% of total earned premium while, in 2010, new business accounted for 40% of total earned premium. Infinity’s new business combined ratios typically run 20 to 35 points higher than renewal business combined ratios due to higher commission and acquisition expenses as well as typically higher loss ratios. See Results of Operations - Underwriting - Profitability for a more detailed discussion of Infinity’s underwriting results.
IBNR reserves are established for the quarter and year-end based on a quarterly reserve analysis by the Company’s actuarial staff. Various standard actuarial tests are applied to subsets of the business at a state, product and coverage level. Included in the analyses are the following:
Paid and incurred frequency and severity methods utilizing paid and incurred claims count development and paid and incurred loss development to predict ultimate average frequency (i.e. claims count per auto insured) or ultimate average severity (cost of claim per claim); and
Management believes that Infinity’s relatively low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity. For example, approximately 89% of policies included within the nonstandard book of business include only the state-mandated minimum policy limits for bodily injury, which somewhat mitigates the challenge of estimating average severity. These low limits tend to reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout.
As compared with loss and LAE reserves held at December 31, 2010, the indicated results from utilized estimates of loss and LAE could range from an adequate reserve position to a redundancy of approximately 12%, or $56.3 million. These ranges do not present a forecast of future redundancy since actual development of future losses on current loss reserves may vary materially from those estimated in the year-end 2010 reserve tests. Reserves recorded are management’s best estimate of the ultimate amounts that will be paid.
The following table summarizes the effect on each calendar year of reserve re-estimates, net of reinsurance, for each of the accident years presented. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The table includes the loss reserves of the NSA Group, the Assumed Agency Business and those of Infinity combined. Favorable reserve re-estimates are shown in parentheses.
First, the Company changed its approach to handling claims in litigation. Historically, the majority of litigation claims were handled in the Company’s field offices utilizing outside legal counsel. In 2006 and 2007, the Company chose to utilize in-house legal counsel more extensively, which has proven to be more cost effective than outside counsel. This change in approach brought about a gradual reduction in legal costs, which began to lower LAE. During 2006 and 2007 the reduction in paid LAE was gradual, with little effect on historical LAE patterns. This gradual change resulted in slight decreases in development patterns and modest releases of LAE redundancy. However, by the end of 2008, the development patterns fell by anywhere from 8% to 13%, depending on the development period, from the level of the 2007 year-end analysis. The development patterns fell another 7% to 13% in 2009 from the level of the 2008 year-end analysis. These changes resulted in a more substantial release of LAE redundancy in 2008 and 2009.
For fixed maturity securities that are other-than-temporarily impaired, Infinity assesses its intent to sell and the likelihood that the Company will be required to sell the security before recovery of its amortized cost. If a fixed maturity security is considered other-than-temporarily impaired but the Company does not intend to and is not more than likely to be required to sell the security before its recovery to amortized cost, the amount of the impairment is separated into a credit loss component and the amount due to all other factors. The excess of the amortized cost over the present value of the expected cash flows determines the credit loss component of an impairment charge on a fixed maturity security. The present value is determined using the best estimate of cash flows discounted at (1) the effective interest rate implicit at the date of acquisition for non-structured securities or (2) the book yield for structured securities. The techniques and assumptions for determining the best estimate of cash flows vary depending on the type of security. The credit loss component of an impairment charge is recognized in net earnings while the non-credit component is recognized in accumulated other comprehensive income. If Infinity intends to sell or will more likely than not be required to sell a security, the entire amount of the impairment is treated as a credit loss.
The National Association of Insurance Commissioners’ (“NAIC”) model law for risk-based capital (“RBC”) provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At December 31, 2010, the capital ratios of all Infinity insurance subsidiaries exceed the RBC requirements.
Infinity is organized as a holding company whose operations are conducted by its insurance subsidiaries. Accordingly, Infinity will have continuing cash needs for administrative expenses, the payment of interest on borrowings, shareholder dividends, share repurchases and taxes.
At December 31, 2010, Infinity had $195 million principal of senior notes due 2014, bearing a fixed 5.5% interest rate (the “Senior Notes”) outstanding. Interest payments on the Senior Notes of $5.4 million are due each February and August through maturity in February 2014. During 2009, Infinity repurchased $5.0 million of the Senior Notes. (See Note 4 - Long-Term Debt of the Notes to Consolidated Financial Statements for more information on the Senior Notes).
Funds to meet expenditures at the holding company come primarily from dividends from the insurance subsidiaries as well as cash and investments held by the holding company. As of December 31, 2010, the holding company had $221.8 million of cash and investments. In 2010, Infinity’s insurance subsidiaries paid Infinity $100.0 million in dividends. In 2011, Infinity’s insurance subsidiaries may pay Infinity up to $96.0 million in ordinary dividends without prior regulatory approval.
In August 2008, Infinity entered into an agreement for a $50 million three-year revolving credit facility (the “Credit Agreement”) that requires Infinity to meet certain financial and other covenants. Infinity is currently in compliance with all covenants under the Credit Agreement. At December 31, 2010 and 2009, there were no borrowings outstanding under the Credit Agreement. Infinity intends to renew this agreement prior to its expiration in August 2011.
Infinity’s insurance subsidiaries generate liquidity to satisfy their obligations, primarily by collecting and investing premium in advance of paying claims. Infinity’s insurance subsidiaries had positive cash flow from operations of approximately $73.3 million in 2010, $85.0 million in 2009 and $27.0 million in 2008. In addition, to satisfy their obligations, Infinity’s insurance subsidiaries generate cash from maturing securities from their combined $1.0 billion fixed maturity portfolio.
Management believes that cash and investment balances, cash flows from operations or borrowings, and maturities and sales of investments are adequate to meet the future liquidity needs for Infinity and its insurance subsidiaries.
Infinity’s Investment Committee, which is composed exclusively of independent directors, has approved investment guidelines for the Company and its wholly owned subsidiaries. The guidelines specifically address overall investment objectives, permissible assets, prohibited assets, permitted exceptions to the guidelines and credit quality.
Infinity’s consolidated investment portfolio at December 31, 2010 contained $1.2 billion in fixed maturity securities and $42.3 million in equity securities, all carried at fair value with unrealized gains and losses reported as a separate component of shareholders’ equity on an after-tax basis. At December 31, 2010, Infinity had pretax net unrealized gains of $23.9 million on fixed maturities and pretax net unrealized gains of $13.0 million on equity securities. Combined, the pre-tax net unrealized gain increased by $7.9 million for the twelve months ended December 31, 2010.
Approximately 93.8% of Infinity’s fixed maturity portfolio at December 31, 2010 was rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. The average credit rating of Infinity’s fixed maturity portfolio was AA at December 31, 2010. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. Management believes that a high quality investment portfolio is more likely to generate stable and predictable investment return.
Since all of these securities are carried at fair value in the Consolidated Balance Sheets, there is virtually no effect on liquidity or financial condition upon the sale and ultimate realization of unrealized gains and losses. The average duration of Infinity’s fixed maturity portfolio was 3.6 years at December 31, 2010.
A third party nationally recognized pricing service provides the fair value of securities in Level 2. Infinity periodically reviews the third party pricing methodologies and tests for significant differences between the market price used to value the security and recent sales activity.
The following table presents the returns of Infinity’s investment portfolios based on quarterly investment balances as reflected in the financial statements.
The following table presents the credit rating and fair value (in thousands) of Infinity’s fixed maturity portfolio by major security type:
Other than securities backed by the U.S. government or issued by its agencies, Infinity’s fixed income portfolio contains no securities issued by any single issuer that exceed 1% of the fair value of the fixed income portfolio.
All of the $197.6 million of residential mortgage backed securities are government-sponsored enterprises (“GSE”).
None of the $35.1 million of commercial mortgage-backed securities are GSEs.
The following table presents the credit rating and fair value of Infinity’s ABS portfolio at December 31, 2010 by deal origination year (in thousands):
In 2008, several state and municipal bond insurers had their credit ratings downgraded or placed under review by one or more nationally recognized statistical rating organizations. These downgrades were a result of a perceived weakening of the insurers’ financial strength because of losses incurred on mortgage-backed and asset-backed securities. These securities experienced increased delinquencies and defaults because of a weakening economy and housing market in particular.
Infinity’s investment portfolio consists of $397.0 million of state and municipal bonds, of which $158.2 million are insured. Of the insured bonds, 45.5% are insured with MBIA, 30.9% with Assured Guaranty, 23.3% with AMBAC and 0.3% are insured with XL Capital. The following table presents the underlying ratings, represented by the lower of Standard and Poor’s, Moody’s or Fitch’s ratings, of the state and municipal bond portfolio (in thousands) at December 31, 2010:
The following table presents the credit rating and fair value of Infinity’s state and municipal bond portfolio, by state, at December 31, 2010 (in thousands):
The following table presents the fair value of the revenue category of Infinity’s state and municipal bond portfolio, by state and further classification, at December 31, 2010 (in thousands):
Gross written premium grew 12.2% during the twelve months ended December 31, 2010 compared with the twelve months ended December 31, 2009. During 2010, Infinity implemented 22 rate revisions in various states with an overall rate increase of 1.3%. Policies in force at December 31, 2010 increased 10.7% compared with the same period in 2009. Gross written premium grew more than policies in force due to a shift in business mix toward policies offering broader coverage. These policies typically generate a higher premium per policy than those with coverage that is more restricted.
California gross written premium grew 3.2% during 2010 compared to 2009. Infinity believes that two program revisions that became effective in California during the second quarter of 2010 have allowed the Company to segment its rates more effectively. These revisions, coupled with increases in commissions and other agency incentives, have stimulated growth in the state.
Florida gross written premium grew 50.6% during 2010 compared to 2009. The overall increase in Non-urban Zone premium is a result of growth in Florida. Florida’s gross written premium growth is attributable to increased marketing efforts coupled with underwriting restrictions and rate increases recently implemented by competitors. Infinity took aggressive actions in 2008 and 2009 in advance of competitors to improve profit margins in Florida. The Company has increased rates 14.9% in the twelve months ended December 31, 2010 and modified certain underwriting rules in the state.
Gross written premium in the Maintenance States declined 16.8% during 2010 compared to 2009, primarily due to declines in Connecticut and South Carolina. Infinity increased rates in several of the Maintenance States during 2009 in an effort to improve profitability.
In Arizona, gross written premium declined 22.3% during the twelve months ended December 31, 2009 as compared with the same period of 2008. This decline is primarily due to competitor rate decreases and worsening economic conditions in the state.
Gross written premium declined 11.1% in Florida, primarily due to Infinity raising rates 15.1% during 2008 and tightening underwriting standards to improve profitability in the state.
Infinity’s Commercial Vehicle gross written premium increased 25.3% during the twelve months ended December 31, 2009 as compared with the same period of 2008 because of growth in California, which was a new market for this product.
A key operating performance measure of insurance companies is underwriting profitability, as opposed to overall profitability or net earnings. Underwriting profitability is measured by the combined ratio. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income, interest expense, other expenses or federal income taxes.
The loss and LAE ratio for the Commercial Vehicle business declined by 3.9 points during the year ended December 31, 2010 when compared with 2009, primarily because of favorable development on loss reserves. Additionally, the Company experienced several large losses in its Commercial Vehicle business during 2009.
Overall, the statutory combined ratio for the year ended December 31, 2009 of 87.2% improved 4.0 points from 91.2% for 2008. For the twelve months ended December 31, 2009, Infinity had $65.4 million of favorable development on prior accident period loss and LAE reserves compared with $29.4 million of favorable development for the year ended December 31, 2008. Excluding the favorable development from both years, the combined ratio increased from 94.4% in 2008 to 94.9% in 2009. Catastrophe related losses were $1.0 million and $1.8 million during 2009 and 2008, respectively.
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Net investment income for the year ended December 31, 2010 declined compared to 2009 primarily due to a decline in book yields because of a general decline in market interest rates for high quality bonds.
The total realized gain in 2010 was primarily a result of securities sold to utilize a portion of Infinity’s capital loss carryforward.
Other income for the twelve months ended December 31, 2010 declined just $0.2 million when compared to 2009. The other items included in Other Income of $0.3 million in 2010 and $0.4 million in 2009 are of a non-recurring nature.
During 2009, Infinity repurchased $5.0 million of its long-term debt. Infinity recognized a loss of approximately $11,000 on the redemption due to unamortized bond issue costs and unamortized discount on the repurchased bonds. Infinity did not repurchase any of its long-term debt during 2010.
Other expenses declined $1.3 million for the twelve-month period ended December 31, 2010 as compared to 2009. The decline is primarily due to a decrease in corporate litigation expense, which includes the release of approximately $0.4 million in reserves related to class action lawsuits during 2010.
In October 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.” Deferred acquisition costs are amortized using methods dependent on the underlying insurance contract. Other costs that do not vary with and are not primarily related to the acquisition or renewal of an insurance contract are expensed as incurred. The purpose of this update is to standardize the interpretation of which types of costs incurred when acquiring or renewing an insurance contract qualify for deferral. The provisions of this ASU will be effective for interim periods and fiscal years beginning after December 15, 2011. Infinity has not yet determined what impact this ASU will have on the Company’s financial statements.