The Company reported net income of $0.5 million for the year ended December 31, 2009 compared to a net loss of $3.2 million for the year ended December 31, 2008. The Company reported basic earnings per common share of $0.007 for the year ended December 31, 2009 compared to a basic loss of $0.050 for the year ended December 31, 2008. Fully diluted earnings per common share for the year ended December 31, 2009 were $0.007 compared to a diluted loss of $0.050 for the year ended December 31, 2008. The pre-tax income was $0.9 million for the period ended December 31, 2009 as compared to a pre-tax loss of $3.2, which includes a goodwill impairment of $3.4 million.
The improvement in the Company’s 2009 earnings was driven by improved performance in the Company’s wholesale operation (AAIC and MGA) and benefits from cost reduction in the Company’s retail operations. The wholesale operations benefited from a decrease in loss and loss adjustment expenses as a percentage of earned premiums (“Loss Ratio”). In 2009, the Loss Ratio was 73.3%, compared to 82.5% in 2008. Additionally, the wholesale operation benefited from higher fee income associated with an increase in premium production mainly in AAIC in the states of Florida, Arizona and Texas. The improvement in the retail (TrustWay) results was driven by reduced costs, offset by lower commissions and fee income in TrustWay, which was impacted by difficult economic conditions.
Gross premiums written for the year ended December 31, 2009 were $107.2 million compared to $93.3 million in gross premiums written in 2008. In 2009 gross premiums written includes insurance premiums written directly by AAIC, “direct premiums written,” of $107.2 million, plus $0.2 million of premiums associated with the insurance risk transferred to AAIC by two unaffiliated insurance companies pursuant to a reinsurance contract, referred to as “assumed premiums written.” In addition, the Company classified certain policy fees as premium $3.5 million in 2009. AAIC recorded assumed premiums written of $1.1 million in the year ended December 31, 2008. The decrease in assumed premiums written in 2009 as compared to 2008 is due to a shift of business away from the unaffiliated carriers to AAIC in order to increase profit margins. The majority of our premium growth in 2009 occurred in Arizona, Florida, Indiana and South Carolina and Texas. AAIC increased premiums by $4.7 million in Florida primarily due to a rate change. Additionally, $1.5 million of premium produced by a non-affiliated carrier in Florida contributed to the increase. The Company implemented a new one month policy product in Texas during 2009, and it generated $1.4 million in additional premium in relation to 2008. Further, the Company generated $2.0 million of premium increases in Indiana and South Carolina as a result of market penetration. The remaining increases relates to market penetration in the states of Indiana and South Carolina of $2.0 million. This was offset by a decline in premium in Georgia of $1.1 million due to a continued soft market and pricing pressures. Policies in force increased 10% during 2009. The Company ceded approximately 70% of its direct premiums written to its reinsurers during 2009, and the total amount ceded was $72.0 million for the year end December 31, 2009.
In our MGA operations, we receive managing general agent fees for agency, underwriting, policy administration, and claims adjusting services performed on behalf of insurers. We also receive commission and service fee income in TrustWay on other insurance products produced for unaffiliated insurance companies on which we do not bear underwriting risk, including travel protection, vehicle protection and hospital indemnity insurance policies. Commission rates vary between carriers and are applied to premiums written to determine commission income.
Commission income for the year ended December 31, 2009, was $21.6 million, an increase of $0.2 million, compared to the same period ended December 31, 2008. The increase in commissions primarily related to increased premium volume generated by the MGA of $1.5 million, offset by a decline in TrustWay commissions due to lower premium volume of $1.3 million. Also AAIC pays MGA commission on 30% of premium, which AAIC retains and this amount is subsequently eliminated upon consolidation.
Managing general agent fees for the period ended December 31, 2009 were $10.3 million, a decrease of $2.2 million when compared to the same period of 2008. The decrease is due to the classification of $3.5 million in policy fees as premiums, beginning in 2009, offset by an increase in fees of $1.4 million due to higher premium production.
Our investment portfolio is generally highly liquid and consists substantially of readily marketable, investment-grade debt and equity securities. Net investment income is primarily comprised of interest and dividends earned on these securities and related investment expenses, net of realized investments losses. Net investment income, net of realized investment losses was $0.3 million for the periods ended December 31, 2009 and 2008.
The selling, general and administrative expenses increased $0.2 million for the year ended December 31, 2009 when compared to the same period of 2008. These increases are associated, in part, with the growth of AAIC and related operations. AAIC and MGA experiences proportionate increases in selling costs as the premiums written increase. As a percentage of revenue, selling, general and administrative expenses for the twelve-month period ended December 31, 2009 decreased from 61.2% to 58.0% when compared to the 2008 period. This decrease is primarily attributable to the increase in revenue production in proportion to the increase in expenses related to the MGA. Depreciation and amortization expense decreased $0.1 million for the year ended December 31, 2009 when compared to the same period of 2008. This decrease is associated with the decrease in fixed and intangible assets additions during the year. Finally, the interest expense was lower in 2009 as compared to 2008 by $0.3 million due to a decrease in the interest rate on the Trust Preferred Junior Subordinated Debenture. The Stock option expenses increased by $0.3 million mainly as a result of new issuance of options in 2009.
The provision for income taxes for the year ended December 31, 2009 was $0.4 million, and consists of federal and state income taxes at an effective rate of 50%. The Company had a tax benefit of $1.4 million for the period ended December 31, 2008, representing an effective tax rate of 30%. The effective tax rate increased in 2009 due to the impact of the permanent differences for stock options in 2009.
Premiums receivable as of December 31, 2009, increased $4.1 million to $35.2 million compared to $31.1 million as of December 31, 2008. The balance represents amounts due from AAIC’s insureds and the increase is directly attributable to the increase in AAIC’s premium writings during 2009. The Company’s policy is to write off receivable balances immediately upon cancellation or expiration, and the Company does not consider an allowance for doubtful accounts to be necessary.
Other receivables as of December 31, 2009 increased $0.1 million to $1.8 million compared to $1.7 million as of December 31, 2008. The balances represent TrustWay receivables from insurance carriers for direct bill commissions and balances due to MGA from insurance carriers for amounts owed in accordance with the terms of its managing general agency agreements. The increase in the receivable is directly attributable to expense reimbursements due from two non-affiliated MGA’s in the states of Florida and Texas.
Intangible assets as of December 31, 2009, decreased $0.3 million to $7.5 million from the balance of $7.8 million as of December 31, 2008. This decrease is related to the reduced amortization of intangible assets in 2009.
Prepaid income taxes remained flat as of December 31, 2009 compared to $0.2 million as of December 31, 2008. The tax benefit mainly resulted from the utilization of net operating loss carry-forwards, which were deferred in the prior period.
Deferred tax assets decreased $0.8 million to $2.9 million as of December 31, 2009, compared to the balance as of $3.7 million as of December 31, 2008. This decrease primarily related to the amortization of net operating loss carry forwards during 2009.
Index to Financial Statements Unearned premium as of December 31, 2009 increased $3.0 million to $36.0 million as of December 31, 2009 from $32.9 million as of December 31, 2008, and represents premiums written but not earned. This is directly attributable to the increase in AAIC’s premium writings during 2009.
Notes payable as of December 31, 2009, decreased $0.9 million to $0.8 million compared to $1.7 million as of December 31, 2008. The change resulted primarily from $1.0 million in payments applied to the principal balances payable on promissory notes to the Company’s Chairman.
Funds held from reinsurers increased by $1.8 million as a result of restricted cash received from one of the Company’s reinsurers in order to cover certain future reinsurance contractual obligations.
Net cash used by operating activities for the year ended December 31, 2009, was $0.8 million compared to net cash provided by operating activities of $0.9 million for the same period of 2008. The decrease in operating activities was mainly due to an increase in premiums collected offset by higher claims paid.
On July 17, 2009, the Company entered into an agreement with Wachovia Bank for a $1.5 million revolving line of credit which expires July 16, 2010, unless terminated earlier according to the terms. The credit facility is secured by a pledge of the Company’s ownership interests in two of the Company’s subsidiaries, TrustWay Insurance Agencies, LLC and AssuranceAmerica Managing General Agency LLC, and is guaranteed by the same entities. In addition, TrustWay Insurance Agencies, LLC pledged its ownership interest in TrustWay T.E.A.M., Inc., which is also a guarantor. The Loan Agreement includes customary covenants, including financial covenants regarding minimum fixed charge coverage ratio and minimum net worth. As of December 31, 2009, management believes the Company was in compliance with all these covenants. The interest rate is 3.00% plus 90-day LIBOR due and payable monthly commencing on September 1, 2009. Currently there is $1.5 million in borrowings outstanding under the credit agreement.
Index to Financial Statements The Company’s liquidity and capital needs have been met in the past through premium, commission and fee income, loans from its Chairman, its former Chief Executive Officer, and former Division President of the Company and the issuance of its Series A Convertible Preferred Stock, Common Stock and Debt Securities. The Company’s related party debt consists of unsecured promissory notes payable to its Chairman. The promissory notes carry an interest rate of 8% per annum and provide for the repayment of principal on an annual basis.
On December 22, 2005, the Company consummated the private placement of 5,000 of the Trust’s floating rate capital securities, with a liquidation amount of $1,000 per capital security (the “Capital Securities”). In connection with the Trust’s issuance and sale of the Capital Securities, the Company purchased from the Trust 155 of the Trust’s floating rate common securities, with a liquidation amount of $1,000 per common security (the “Common Securities”). The Trust used the proceeds from the issuance and sale of the Capital Securities and the Common Securities to purchase $5,155,000 in aggregate principal amount of the floating rate junior subordinated debentures of the Company (the “Debentures”). The Capital Securities mature on December 31, 2035, but may be redeemed at par beginning December 31, 2010. The Capital Securities require quarterly distributions by the Trust to the holders of the Capital Securities, at a floating rate of three-month LIBOR plus 5.75% per annum, reset quarterly. Distributions are cumulative and will accrue from the date of original issuance but may be deferred for a period of up to 20 consecutive quarterly interest payment periods, if the Company exercises its right under the Indenture to defer the payment of interest on the Debentures.
On March 10, 2009, AAIC purchased all of Capital Securities issued by the Trust at a discounted price of $1,000,000 from the non-affiliated holder of those securities. The discount is being accreted to the interest income over the remaining life of the Capital Securities using the interest method. The purchase resulted in an increase in our investment portfolio for redeemable preferred stock in the amount of $1,015,374.
At December 31, 2009 and 2008, we had $ 12.3 million and $12.8 million of net loss and LAE reserves, which included $6.4 million and $4.6 million of case reserves and $5.9 million and $8.2 million of IBNR reserves. During 2009, the company had an increase in case reserves, offset by a reduction in IBNR reserves. This shift is due to a new claims strategy that was implemented in 2009 to strengthen the case reserves by setting up claim reserves more quickly, thereby reducing the need for IBNR reserves. This would ultimately have a positive impact on earnings as the claims will be settled sooner as well.
GROSS RESERVES BY LINE OF BUSINESS AS OF DECEMBER 31, 2009 AND 2008
The decrease in gross reserves was $0.6 million due to increased production in the liability line of business of $1.9 million, offset by a decline in auto physical damage of $2.6 million, resulting from improved claim handling, lower average frequency and severity in this line of business.
We begin our determination of loss and LAE reserves by line of business by producing multiple estimates of required reserves, using both paid and incurred data, to determine if a change in the loss and LAE reserves is required. If our initial projections vary significantly, our internal staff performing actuarial functions will further analyze the data using additional techniques. Each review develops a point estimate, which allows us to establish meaningful reserve levels.
Ultimate Loss and ALAE by coverage method to predict ultimate losses and ALAE.
For each line of business evaluated, each test generates a low, high and medium point estimate based on development factors applied to known paid and incurred losses. Selections of factors are based on historical loss development patterns with adjustments based on actuarial judgment where anticipated development patterns vary from those seen historically. This estimation of IBNR requires selection of various factors. A single point estimate for the line of business being evaluated is then selected from the results of various tests, based on a combination of simple averages of the point estimates of the various tests and selections based on actuarial judgment.
During the fiscal year ended December 31, 2009, the Company began using average paid losses to establish estimated case reserves. The Company believes that the average paid losses are more indicative of the reserve estimates than average case reserve estimates, which were used previously. The average paid losses better reflect the aforementioned underlying factors used to estimate reserves, thereby improving the accuracy of the reserving.
Our best estimates of the appropriate amounts for our reserves as of December 31, 2009 and 2008 are included in our financial statements for those years. Our goal is to establish the total reserves and determine the adequacy of reserves to cover all loss costs, while sustaining minimal variation from the time reserves are initially established until losses are fully developed. At the point in time when we establish the reserves, we have no way of knowing whether our reserve estimates will prove to be high or low and, thus, whether future reserve development will be favorable or unfavorable.
AssuranceAmerica estimates liabilities for the costs of losses and LAE for both reported and unreported IBNR claims based on the historical trends and assumptions set forth above. When possible, where deviations
from historical trends in these key areas exist, quantitative and qualitative modifications to, or selections of, such factors are made to reflect such deviations. Management analyzes the adequacy of reserves using actuarial data and analytical reserve development techniques, including projections of ultimate paid losses, to determine the ultimate amount of reserves. The key assumptions and factors discussed under “Critical Accounting Policy Section” previously are taken into account in developing these estimates. AssuranceAmerica reviews loss reserve adequacy monthly by accident year at a line of business level. Reserves are adjusted as additional information becomes known. Such adjustments are reflected in current year operations. Loss and LAE reserves are also certified to state regulators annually.
During each monthly review by the internal staff, factor selections are updated using the additional information obtained with the passage of time. The ultimate loss estimates and held IBNR reserves for the line of business and accident periods effected are adjusted through this updating process. Additionally, the internal staff evaluates the overall reasonableness of the loss and LAE ratios by accident year and by line of business.
Management believes that there are no reasonably likely changes in the key factors and assumptions that materially affect the Company’s estimate of the reserve for loss and LAE that would materially impact the Company’s financial position, liquidity and results of operations. The Company’s low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity, thereby limiting the potential variability the reserve level may have on reported results. For example, approximately 98% of policies included within the nonstandard book of business include only the state-mandated minimum policy limits for bodily injury and property damage, which mitigates the complexity 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.
Index to Financial Statements During the year ended December 31, 2009, our loss and LAE ratio decreased approximately 9%, which reflects 8.3% related to higher premiums due to increased policy fees in 2009 and a slight decrease of 0.9% in industry-wide loss costs and lower personal auto paid severity in both bodily injury and auto physical damage coverages. During the year ended December 31, 2008 our loss and LAE ratio increased approximately 8%, reflecting industry-wide increases in loss costs and higher personal auto paid severity in both bodily injury and personal injury protection coverage. The increase in bodily injury is primarily due to higher medical costs. We continuously monitor internal and industry-wide severity trends and adjust rates as appropriate to compensate for the higher loss costs.
Reinsurance assets include balances due from other contracted reinsurers under the terms of reinsurance agreements. Amounts applicable to ceded unearned premiums, ceded loss payments and ceded claims liabilities
are reported as assets in the accompanying balance sheets. Under the reinsurance agreements, the Company has four reinsurers that are required to collateralize the reinsurance recoverables. As of December 31, 2009, all reinsurers have provided a letter of credit or a secured trust account to provide security sufficient to satisfy AssuranceAmerica’s obligations under the reinsurance agreement. The Company believes the fair value of its reinsurance recoverables approximates their carrying amounts.