Favorable net loss reserve development reported on prior year loss reserves of $7.6 million
Total shareholders’ equity of $270.7 million, or $29.14 per diluted share
The Company’s general and administrative expenses consist primarily of compensation expense, employee benefits, professional fees and rental expense for office facilities. The Company’s policy acquisition costs include brokerage commissions and premium taxes both of which are primarily based on a percentage of premiums written. Acquisition costs have generally changed in proportion to changes in premium volume. Losses and loss adjustment expenses incurred in connection with insurance claims in any particular year depend upon a variety of factors including the rate of inflation, accident or claim frequency, the occurrence of natural catastrophes and the number of policies written.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005
The excess of loss reinsurance market for the marine and energy line of business significantly contracted in 2006, resulting in increases in both reinsurance costs and net loss retentions ($5,000,000 per risk and $6,000,000 per occurrence) to the Company effective January 1, 2006. This compared to a net loss retention of $3,000,000 per risk or occurrence in 2005. As a result of the tightening in the reinsurance market, the Company excluded energy business with exposures in the Gulf of Mexico from its ocean marine reinsurance program for 2006 and opted instead to enter into an 80% quota share reinsurance agreement for this portion of its energy business to reduce the potential impact of catastrophe losses to the Company. The quota share agreement and larger costs of excess of loss reinsurance accounted for a substantial portion of ocean marine ceded written premium in 2006.
The Company’s combined ratio (the loss ratio plus the ratio of policy acquisition costs and general and administrative expenses divided by premiums earned) was 98.0% for the 2006 year compared with 111.5% for 2005. Losses incurred, including reinsurance reinstatement costs, from hurricanes Katrina and Rita added 15.4% to the combined ratio for the year ended December 31, 2005.
portfolio income of $2.9 million and as a result of the deconsolidation of Tricadia effective August 1, included limited partnership hedge fund portfolio income of $1.8 million. This compared to $3.7 million of trading portfolio income for Tricadia during 2005. Trading portfolio income in 2006 also included $7.0 million from investments in U.S. Treasuries, as compared to none in 2005.
Total income tax expense as a percentage of income before taxes for year ended December 31, 2006 was 33.5% as compared to 34.0% for 2005. The decrease in the percentage was primarily attributable to a $500,000 reduction in taxes resulting from the resolution of tax uncertainties for the Company’s former subsidiary, MMO UK, which was sold in 2005.
Ceded reinsurance payable increased to $44.8 million at December 31, 2006 from $35.7 million at December 31, 2005 and prepaid reinsurance premiums increased to $29.6 million at December 31, 2006 from $22.2 million at December 31, 2005 mainly as a result of additional ceded premiums in the energy class in the ocean marine line, due to the 80% quota share treaty effective in 2006, and the excess of loss and higher quota share reinsurance percentage in the excess workers’ compensation class of the other liability line.
The impact from hurricanes Katrina and Rita to the Company in 2005 were as follows:
Net realized investment losses after taxes were $523,000, or $.06 per diluted share, as compared with net realized investment gains of $440,000, or $.04 per diluted share, for the years ended December 31, 2005 and 2004, respectively.
The Company’s combined ratio (the loss ratio plus the ratio of policy acquisition costs and general and administrative expenses divided by premiums earned) was 111.5% for the 2005 year compared with 98.8% for 2004. Losses incurred, including reinsurance reinstatement costs, from hurricanes Katrina and Rita added 15.4% to the combined ratio for the year ended December 31, 2005.
Investment income, net of investment fees, from each major category of investments is as follows:
As of December 31, 2005 and 2004 investments in limited partnerships amounted to approximately $139.6 million and $190.5 million, respectively. The equity method of accounting is used to account for the Company’s limited partnership hedge fund investments. Under the equity method, the Company records all changes in the underlying value of the limited partnership hedge funds to results of operations. Net investment income for 2005 and 2004 reflected approximately $17.6 million and $7.7 million, respectively, derived from limited partnership hedge fund investments.
As of December 31, 2005 and 2004 investments in the trading portfolio amounted to approximately $128.3 million and $17.8 million, respectively. Net investment income for 2005 and 2004 reflected approximately $8.5 million and $13.4 million, respectively, derived from trading portfolio activities. These activities include the trading of collateralized debt obligations (CDOs) and US Treasury notes. 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.
Net realized investment losses were $805,000 for the year ended December 31, 2005 as compared to net realized investment gains $678,000 for the year ended December 31, 2004. These amounts result from the sale of fixed income investments as well as write-downs from other-than-temporary declines in the fair value of securities, which amounted to $678,000 and $124,000 for the years ended December 31, 2005 and 2004, respectively.
Premiums and other receivables, net decreased to $25.3 million as of December 31, 2005 from $42.6 million as of December 31, 2004 primarily due to favorable cash collections and lower amounts due from the MMO pool companies.
Unpaid losses and loss adjustment expenses increased to $588.9 million at December 31, 2005 from $503.3 million at December 31, 2004. The increase was mainly due to hurricane losses in the ocean marine line, a few severe losses occurring in the inland marine/fire line of business, and an increase in the reserves in the professional liability and other liability classes as a result of the growth in premiums earned. These increases were partially offset by declines in the reserves in the runoff aircraft line of business.
Ceded reinsurance payable increased to $35.7 million at December 31, 2005 from $25.5 million at December 31, 2004 mainly as a result of reinsurance reinstatement costs arising from hurricane losses in the ocean marine line during 2005.
Cash flows provided by operating activities were $110.6 million for the year ended December 31, 2006 as compared to cash flows used in operating activities of $64.0 million for the year ended December 31, 2005 and $66.3 million provided by operating activities for the year
ended December 31, 2004. Any securities purchased by the Company in its trading portfolio would be reflected as a use of cash from operating activities and any securities sold from its trading portfolio would be reflected as a source of cash from operating activities. Trading portfolio activities of $110.6 million adversely affected cash flows for the year ended December 31, 2005 while trading portfolio activities of $109.8 million and $44.0 million favorably affected cash flows for the years ended December 31, 2006 and 2004, respectively. Trading portfolio activities include the purchase and sale of CDO securities and US Treasury securities. As the Company’s trading portfolio balance may fluctuate significantly from period to period, cash flows from operating activities may also be significantly impacted by such trading activities. Cash flows from operating activities were favorably impacted, other than trading activities, for the year ended December 31, 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. Cash flows in 2005 and 2004 were both favorably affected by increased cash collections on premium and other receivables.
Under the Common Stock Repurchase Plan, the Company may purchase up to $55,000,000 of the Company’s issued and outstanding shares of common stock on the open market. There were no repurchases of common stock under this Plan during 2006, 2005 and 2004, respectively.
In a transaction separate from its common stock repurchase plan, on January 7, 2005 the Company purchased from certain of its shareholders a total of 1,092,735 shares of common stock at $24.80 per share. The selling shareholders were Mark W. Blackman, a son of the Company’s founder who served on our board of directors from 1979 until May 2004 and who is currently the Company’s Chief Underwriting Officer (54,530 shares), his wife (50,000 shares), and two trusts for the benefit of their children (110,000 shares); Lionshead Investments, LLC, a company controlled by John N. Blackman, Jr., also a son of the Company’s founder who served on our board of directors from 1975 until May 2004 (495,030 shares), two of his children (67,664 shares), a trust for the benefit of a third child (25,158 shares), and a family trust (25,000 shares); and, two trusts and a foundation established by Louise B. Tollefson, the former wife of the Company’s founder (265,353 shares). Robert G. Simses, a director of NYMAGIC INC., is a trustee of the last mentioned entities.
On March 22, 2006, the Company entered into an agreement (the “Letter Agreement”) to amend the Option Certificate granted under a Securities Purchase Agreement, dated January 31, 2003, by and between the Company and Conning Capital Partners VI, L.P. (“CCP”). The Amended and Restated Option Certificate dated as of March 22, 2006 by and between the Company and CCP (“Amended and Restated Option”) decreases the number of shares of Company common stock that may be issued upon the exercise of the Amended and Restated Option from 400,000 to 300,000 and extends the term from January 31, 2008 to December 31, 2010.
The limitation restricts dividends paid or declared to the lower of 10% of policyholders’ surplus or 100% of net investment income as defined under state insurance laws. Within this limitation, the maximum amount which could be paid to the Company out of the domestic insurance companies’ surplus was approximately $19.6 million as of December 31, 2006.
On February 22, 2006, the Company declared a dividend of six cents per share to shareholders of record on March 31, 2006, payable on April 5, 2006. On May 24, 2006, the Company declared a dividend of eight cents per share to shareholders of record on June 30, 2006, payable on July 6, 2006. On September 18, 2006, the Company declared a dividend of eight cents per share to shareholders of record on September 29, 2006, payable on October 4, 2006. On December 8, 2006, the Company declared a dividend of eight cents per share to shareholders of record on December 29, 2006, payable on January 4, 2007. On February 22, 2005, the Company declared a dividend of six cents per share to shareholders of record on March 31, 2005, payable on April 6, 2005. On May 26, 2005, the Company declared a dividend of six cents per share to shareholders of record on June 30, 2005, payable on July 7, 2005. On September 15, 2005, the Company declared a dividend of six cents per share to shareholders of record on September 30, 2005, payable on October 6, 2005. On December 8, 2005, the Company declared a dividend of six cents per share to shareholders of record on December 30, 2005, payable on January 5, 2006. On February 26, 2004, the Company declared a dividend of six cents per share to shareholders of record on March 31, 2004, payable on April 6, 2004. On May 28, 2004, the Company declared a dividend of six cents per share to shareholders of record on June 30, 2004, payable on July 6, 2004. On September 15, 2004, the Company declared a dividend of six cents per share to shareholders of record on September 30, 2004, payable on October 6, 2004. On December 2, 2004, the Company declared a dividend of six cents per share to shareholders of record on December 31, 2004, payable on January 6, 2005.
During 2004, the Company granted options to a new director to purchase 10,000 shares of the Company’s common stock. During 2003, the Company granted options to purchase 20,000 shares of the Company’s common stock to certain directors of the Company, who are not officers of the Company. There were no stock options granted in 2006 and 2005. The exercise prices of these stock options are equal to the closing prices of the Company’s stock on the New York Stock Exchange on the dates of the underlying stock grants.
In 2006, 53,000 restricted share units were granted to certain officers and directors of the Company under the NYMAGIC, INC. Amended and Restated 2004 Long-Term Incentive Plan (the “LTIP”) for a total compensation expense of $1,212,149. The Company granted up to 36,000 performance share units to the President and Chief Executive Officer that vest over three years, of which $156,951 was recorded as compensation expense in 2006. The Company granted 21,000 shares of common stock and 122,000 of restricted share units, respectively to certain officers and directors of the Company in 2005 having a total compensation value of $674,911. In 2004 the Company granted 14,100 shares of common stock to certain officers and directors of the Company for a total compensation expense of approximately $369,000. Restricted share units (unvested shares) become shares of common stock when the restrictions applicable to them lapse. The Company granted 7,123 deferred share units to certain officers and directors of the Company in 2006 for a total compensation value of $227,500. The Company granted 8,679 of deferred share units to certain officers and directors of the Company in 2005 for a total compensation value of $184,000. The Company granted 8,557 deferred share units to certain directors in 2004 under the LTIP for a total expense of approximately $185,000. Deferred share units become shares of common stock issued upon the departure of the officer/director from the Company.
The allowance for doubtful accounts is based on management’s review of amounts due from insolvent or financially impaired companies. Allowances are estimated for both premium receivables and reinsurance receivables. Management continually reviews and updates such estimates for any changes in the financial status of companies. For a further discussion concerning reinsurance receivables see “Reinsurance Ceded.” The allowance for doubtful accounts on reinsurance receivables amounted to $13.9 million and $16.7 million at December 31, 2006 and 2005, respectively. The allowance for doubtful accounts on premiums and other receivables each amounted to $300,000 as of December 31, 2006 and 2005, respectively.
income securities available for sale amounting to $354,437. The Company believes these unrealized losses to be temporary and result from changes in market conditions, including interest rates or sector spreads. There were no unrealized gains or losses on equity securities at December 31, 2006 and 2005, respectively.
The Company utilizes the equity method of accounting to account for its limited partnership hedge fund investments. Under the equity method, the Company records all changes in the underlying value of the limited partnership to net investment income in results of operations. Net investment income before investment fees derived from investments in limited partnerships amounted to $16.5 million and $17.6 million for the years ended December 31, 2006 and 2005, respectively. See