Overview The Company is a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles which we believe are predictable. We target lines of insurance that we believe generally are underserved by the market generally. The Company has grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets, including access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in three business segments:
• Specialty Risk and Extended Warranty coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans offered in connection with the sale of consumer and commercial goods, in the United States, United Kingdom and certain other European Union countries as well as other specialty coverages; and
• Specialty Middle Market Business, through which we write commercial insurance for homogeneous, narrowly defined classes of insureds requiring an in-depth knowledge of the insured’s industry segment, through general and other wholesale agents.
Small commercial, middle market property & casualty and specialty risk & extended warranty
Insurance, particularly workers’ compensation, is, generally, affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Middle Market Business segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality may be muted by our acquisition activity.
December 31, 2009, 2008 and 2007, respectively. A key factor in achieving our targeted net combined ratio is improvement of our net expense ratio. Our strategy across our segments is to maintain premium rates, deploy capital judiciously, manage our expenses and focus on the sectors in which we have expertise, which we believe should provide opportunities for greater returns.
ACHL During the three months ended March 31, 2009, the Company, through our subsidiary AII, acquired all the issued and outstanding stock of Imagine Captive Holdings Limited (“ICHL”), a Luxembourg holding company, which owned all of the issued and outstanding stock of Imagine Re Beta SA, Imagine Re (Luxembourg) 2007 SA and Imagine Re SA (collectively, the “Captives”), each of which is a Luxembourg domiciled captive insurance company, from Imagine Finance SARL (“SARL”). ICHL subsequently changed its name to
In October 2009, ACHL acquired all the issued and outstanding stock of Watt Re, a Luxembourg domiciled captive insurance company, from CREOS LUXEMBOURG S.A. (formerly CEGEDEL S.A.) and ENOVOUS Luxembourg S.A. (formerly CEGEDEL PARTICIPATIONS S.A.). Watt Re subsequently changed its name to AmTrust Re Gamma. The purchase price of Watt Re was approximately $30.2 million. The Company recorded approximately $34.5 million of cash, intangible assets of $5.5 million and a deferred tax liability of approximately $9.8 million. The Company assigned a life of three years to the intangible assets.
In December 2009, ACHL acquired all the issued and outstanding stock of Group 4 Falck Reinsurance S.A., a Luxembourg domiciled captive insurance company, from Group 4 Securitas (International) B.V. Group 4 Falck Reinsurance S.A. subsequently changed its name to AmTrust Re Omega. The purchase price of Group 4 Falck Reinsurance S.A. was approximately $22.8 million. The Company recorded approximately $25.1 million of cash, intangible assets of $2.2 million and a deferred tax liability of $4.5 million. The Company assigned a life of three years to the intangible assets.
Cardinal Comp During the third quarter of 2008, the Company entered into a managing general agency agreement with Cardinal Comp, LLC (“Cardinal Comp”) for the purpose of producing workers’ compensation premium. The agency writes premiums in the states of New York, Massachusetts and Texas. This relationship produced approximately $90 million and $63 million of gross written premium during the years ended December 31, 2009 and 2008, respectively.
UBI In June 2008, the Company completed a stock and asset purchase agreement with a subsidiary of Unitrin, Inc. (“Unitrin”) whereby the Company acquired its commercial package business (“UBI”) including its distribution networks, renewal rights and four insurance companies through which Unitrin wrote its UBI business. The acquired insurance companies are domiciled in Kansas, Texas and Wisconsin and are collectively licensed in 33 states. Consideration paid for the transaction was approximately $88.5 million and consisted of cash of $61.5 million, a note payable of $26.8 million, assumed liabilities of $0.3 million and direct transaction costs of $0.2 million. The Company recorded $35.1 million of goodwill and $15.0 million of intangible assets related to distribution networks and licenses and is included in the Small Commercial Business segment. The distribution networks have a life of ten years and the licenses have an indefinite live. The note is required to be paid in full immediately, under certain circumstances, including default of a payment or change of control of the Company. The results of operations have been included in the Company’s consolidated financial statements since the acquisition date. UBI produced approximately $100 million and $75 million of gross written premium during the years ended December 31, 2009 and 2008, respectively. Additionally, the Company assumed the existing unearned premium of UBI in the amount of $78.2 million and ceded one hundred percent of the unearned premium to Maiden Insurance during the second quarter of 2008 for which it received a 34.375% ceding commission.
Principal Revenue and Expense Items Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as part of an assigned risk plan, during a reporting period based on the effective date of the individual policy. Certain policies that are underwritten by the Company are subject to premium audit at that policy’s cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.
Net Written Premium. Net written premium are gross premiums written less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement.
Net Earned Premium. Net earned premium is the earned portion of our net premiums written. Insurance premiums are earned on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our workers’ compensation insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2009 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2009 and the other half in 2010. Our specialty risk and extended warranty coverages are earned over the estimated exposure time period. The terms vary depending on the risk and have an average duration of approximately 35 months, but range in duration from one month to 120 months.
Service and Fee Income. We recognize service and fee revenue as a servicing carrier for the Arkansas, Indiana, Illinois, Georgia and Virginia assigned risk plans. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties. We also recognize fee income associated with the issuance of workers’ compensation policies for installment fees, in jurisdictions where it is permitted and approved, and reinstatement fees, fees charged to reinstate a policy after it has been cancelled for non-payment, in jurisdictions where it is permitted and approved. Our Specialty Risk and Extended Warranty business generates fee revenue for product warranty registration and claims handling services provided to unaffiliated third parties. We also recognize certain brokerage, and asset management fees in association with our reinsurance agreement with Maiden. Additionally, in the fourth quarter of 2009, we began recognizing certain consulting and information technology consulting fees in accordance with agreements with American Capital Acquisition Corporation (“ACAC”).
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (“LAE”) incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of
• General and administrative expenses are comprised of other costs associated with the Company’s insurance activities such as federal excise tax, postage, telephones and internet access charges as well as legal and auditing fees and board and bureau charges.
Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense and income taxes.
Return on Equity. Return on equity is calculated by dividing net income (net income excludes results of discontinued operations as well as any currency gain or loss associated with discontinued operations on an after tax basis) by the average of shareholders’ equity.
Critical Accounting Policies It is important to understand our accounting policies in order to understand our financial statements. These policies require us to make estimates and assumptions. The Company’s management has discussed the development, selection and disclosure of the estimates and assumptions used with the audit committee of the board of directors. These estimates and assumptions affect the reported amounts of our assets, liabilities, revenues and expenses and the related disclosures. Some of the estimates result from judgments that can be subjective and complex, and, consequently, actual results in future periods might differ significantly from these estimates.
Ceding Commission Revenue. Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. Certain reinsurance agreements contain provisions whereby the ceding commission rates vary based on the loss experience under the agreements. The Company records ceding commission revenue based on its current estimate of subject losses. The Company records adjustments to the ceding commission revenue in the period that changes in the estimated losses are determined.
We utilize a combination of the Company’s incurred loss development factors and industry-wide incurred loss development factors. Our actuary generates a range within which it is reasonably likely that our ultimate loss and loss adjustment expenses for claims incurred in a particular time period, typically the calendar year, will fall. The low end of the range is established by assigning a weight of 100% to our ultimate losses obtained by application of the Company’s own loss development factors. The high end is established by assigning a weight of 50% each to our ultimate losses as developed through application of Company and through application of industry wide loss development factors. The determination to assign particular weights to ultimate losses developed through application of Company loss development factors and industry-wide loss development factors is made by our actuary and is a matter of actuarial judgment. In the selection of our reserves, the Company has given greater consideration over time to the results attributable to its own loss development factors.
We believe this method, by which we track the development of claims incurred in a particular time period, is the best method for projecting our ultimate liability. Loss development factors are dependent on a number of elements, including frequency and severity of claims, length of time to achieve ultimate settlement of claims, projected inflation of medical costs and wages (for workers’ compensation), insurance policy coverage interpretations, judicial determinations and existing laws and regulations. The predictive ability of loss development factors is dependent on consistent underwriting, claims handling, and inflation, among other factors, and predictable legislatively and judicially imposed legal requirements. If all things remain equal, losses incurred in 2009 should develop similarly to losses incurred in 2008 and prior years. Thus, if the Net Loss Ratio for premiums written in year one is 55.0% we expect that the Net Loss Ratio for premiums written in year two also would be 55.0%. However, due to the inherent uncertainty in the loss development factors, our actual liabilities may differ significantly from our original estimates.
In the event of a 5% increase in claims frequency as measured by payroll, which we believe is the most important assumption regarding our business, the Company’s loss reserves as of December 31, 2009 would be understated by $13.4 million and would result in an after tax reduction in shareholders’ equity of $8.7 million. In the event of a 5% increase in claim severity, which is the average incurred loss per claim, the Company’s loss and loss adjustment expense reserves would be understated by $4.8 million and would result in an after tax reduction in shareholders’ equity of $3.1 million.
Reinsurance. Reinsurance premiums, losses and LAE are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums earned and losses incurred ceded to other companies have been recorded as reductions of premium revenue and losses and LAE. Commissions allowed by reinsurers on business ceded have been accounted for as ceding commission revenue. Reinsurance recoverables relate to the portion of reserves and paid losses and LAE that are ceded to other companies. The Company remains contingently liable for all loss payments, in the event of failure to collect from the reinsurer.
Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and assessments as well as certain marketing, sales, underwriting and safety costs that vary with and are primarily related to the acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. The Company may realize deferred policy acquisition costs only if the ratio of loss and loss adjustment expense reserves (calculated on a discounted basis) to the premiums to be earned is less than
100%, as it historically has been. If, hypothetically, that ratio were to be above 100%, the Company could not continue to record deferred policy acquisition costs as an asset and may be required to establish a liability for a premium deficiency reserve.
Assessments Related to Insurance Premiums. We are subject to various assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and second injury funds. Assessments based on premiums are generally paid within one year after the calendar year in which the policies are written. Assessments based on losses are generally paid within one year of when claims are paid by us. State guaranty fund assessments are used by state insurance regulatory agencies to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. Second injury funds are used by states to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments and premium surcharges may be partially recovered through a reduction in future premium taxes.
Fixed-maturity securities and equity securities are reported at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders’ equity. Realized gains and losses are determined on the specific identification of the investments sold.
Income Taxes - The Company joins its domestic subsidiaries in the filing of a consolidated Federal income tax return and is party to Federal income tax allocation agreements. Under the tax allocation agreements, the Company pays to or receives from its subsidiaries the amount, if any, by which the group’s Federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated Federal return.
holding gains and losses on marketable equity securities. Changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income, primarily unrealized investment gains and losses and foreign currency translation gains and losses, are recorded directly to other comprehensive income. Otherwise, changes in deferred income tax assets and liabilities are included as a component of income tax expense.
Consolidated Results of Operations 2009 Compared to 2008 Gross Written Premium. Gross written premium increased $88.3 million or 8.0% to $1,198.9 million from $1,110.6 million for the years ended December 31, 2009 and 2008, respectively. The increase of $88.3 million was attributable to all segments and included an increase of $10.8 million in our Small Commercial Business, an increase of $45.4 million in our Specialty Risk and Extended Warranty business and an increase of $32.2 million in our Specialty Middle Market Business. The increase in Small Commercial Business resulted primarily from gross written premium attributable to the UBI acquisition in the second quarter of 2008, the managing general agency agreement with Cardinal Comp entered into in the third quarter
Net Written Premium. Net written premium increased $88.5 million or 15.9% to $643.4 million from $554.9 million for the years ended December 31, 2009 and 2008, respectively. The increase, by segment, was: Small Commercial Business - $28.9 million; Specialty Risk and Extended Warranty - $36.4 million; and Specialty Middle Market Business - $23.2 million.
Ceding Commission. Ceding commission represents commission earned, primarily, through the Maiden Quota Share, whereby AmTrust receives a 31% or 34.375% commission, depending on the type of business, on earned premium ceded to Maiden Insurance. The ceding commission earned during the years ended December 31, 2009 and 2008 was $113.9 million and $115.8 million, respectively. Ceding commission declined year over year as growth in premium ceded to Maiden Insurance in 2009 was offset by the incremental impact of ceding commission earned as a result of the 2008 cession to Maiden Insurance of $78.2 million of unearned premium assumed in connection with the acquisition of UBI during the second quarter of 2008.
Net Investment Income. Net investment income decreased $5.0 million or 8.4% to $54.5 million from $59.5 million for the years ended December 31, 2009 and 2008, respectively. The change period over period related primarily to a decline in the yields on the Company’s fixed maturities from 4.7% in 2008 to 4.0% in 2009.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $89.5 million or 37.5% to $327.8 million for the year ended December 31, 2009 from $238.3 million for the year ended December 31, 2008. The Company’s loss ratio for the years ended December 31, 2009 and 2008 was 57.1% and 54.3%, respectively. The loss ratio increased on a consolidated basis for the year ended December 31, 2009 over the year ended December 31, 2008 primarily because of the impact in 2008 of the reduction during the third quarter of 2008 in prior year loss reserves in the approximate amount of $15 million in our Small Commercial Business and Specialty Risk and Extended Warranty segments.
Income Tax Expense (Benefit). Income tax expense for the year ended December 31, 2009 was $27.5 million, which resulted in an effective tax rate of 21.0%. Income tax expense for the year ended December 31, 2008 was $20.6 million, which resulted in an effective tax rate of 19.9%. The increase in the Company’s effective rate resulted, primarily, from decreases in tax exempt interest as well as an increase in income from Company subsidiaries domiciled in the United States subject to tax for the year ended December 31, 2009 compared to the year ended December 31, 2008 partially offset by a one-time income benefit related to the acquisition of ACHL 2009.
business ceded, on ceded written premiums to Maiden. The ceding commission earned in 2008 and 2007 was $115.6 million and $62.8 million, respectively. The increase related primarily to the Company reflecting an entire year of cessions in 2008 compared to six months of cessions in 2007.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses decreased $38.7 million or 14.0% from $277.0 million to $238.3 million for the year ended December 31, 2007 and 2008, respectively. The Company’s loss ratio for the year ended December 31, 2008 decreased to 54.3% from 62.4% for the year ended December 31, 2007. The improvement of the loss and loss adjustment ratio resulted from a reduction in 2008 of prior year’s reserves of approximately $15.0 million as well as the continued improvement in the Company’s actual loss experience, which has continued to develop more favorably than projected.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $48.3 million or 31.1% from $155.4 million to $203.7 million for the years ended December 31, 2007 and 2008, respectively. The increase related primarily to higher policy and acquisition expenses resulting from growth in premium writings and additional salary expense resulting from the acquisitions of UBI and AIIC.
Income Tax Expense (Benefit). Income tax expense for the year ended December 31, 2008 was $20.6 million and resulted in an effective tax rate of 19.9%. Income tax expense for year ended December 31, 2007 was $36.7 million and resulted in an effective tax rate of 28.9%. The decrease in the effective tax rate in 2008 resulted primarily from Company subsidiaries, domiciled in the United States, recognizing net realized
losses on investments. Thus a higher percentage of income was earned by Company subsidiaries not subject to U.S. taxation. Additionally, the Company earned federal tax-exempt investment income during 2008.
Net Written Premium. Net written premium increased $28.9 million or 12.8% to $255.5 million from $226.6 million for the years ended December 31, 2009 and 2008, respectively. The increase is a function of higher gross written premium in the segment for the year as well as the effect the Company’s cession to Maiden of 100% of $19 million UBI pre-acquisition unearned premium assumed on June 1, 2008.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $47.5 million or 52.8% to $137.5 million for the year ended December 31, 2009 from $90.0 million for the year ended December 31, 2008. The Company’s loss ratio for the segment for the year ended December 31, 2009 increased to 57.5% from 52.0% for the year ended December 31, 2008. The increase in the loss ratio primarily reflected the effect of the $8 million reduction in 2008 of prior year loss reserves and the addition of the retail commercial package business acquired in the UBI acquisition in the second quarter of 2008.
Net Written Premium. Net written premium increased $33.0 million or 17.0% from $193.6 million to $226.6 million for the years ended December 31, 2007 and 2008, respectively. Net written premium reflected cessions of $173.2 million and $86.4 million to Maiden Insurance for the years ended 2008 and 2007, respectively, under the terms of the Maiden Quota share, which was entered into during the third quarter of 2007. Before cessions to Maiden Insurance, net written premium increased $119.8 million in 2008 compared to 2007 and was the result of an increase in gross written premium.
Specialty Risk and Extended Warranty Segment Results of Operations 2009 Compared to 2008 Gross Written Premium. Gross written premium increased $45.4 million or 10.9% to $461.3 million for the year ended December 31, 2009 from $415.9 million for the year ended December 31, 2008. The increase resulted from the underwriting of new coverage plans, primarily in Europe which was partially offset by the strengthening of the U.S. dollar in 2009, which negatively impacted the Company’s European business by approximately $19 million. Additionally, the segment was positively impacted by the assumption of unearned premium of approximately $37 million and $63 million in 2009 and 2008, respectively, on the underwriting of certain insurance programs.
Net Written Premium. Net written premium increased $36.4 million or 17.4% to $245.6 million from $209.2 million for the years ended December 31, 2009 and 2008, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2009 compared to gross written premium for the year ended December 31, 2008.
Net Earned Premium. Net earned premium increased $36.3 million or 23.6% to $190.2 million for the year ended December 31, 2009 from $153.9 million for the year ended December 31, 2008. As net premiums written are earned ratably over the term of a policy, which range from one to three years, the increase resulted from growth in net written premium between 2006 and 2009.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses were $98.8 million and $78.8 million for the years ended December 31, 2009 and 2008, respectively. The Company’s loss ratio for the segment for the year ended December 31, 2009 increased to 51.9% from 51.2% for the year ended December 31, 2008. The loss ratio remained consistent year over year as 2009 was impacted by a one-time benefit of $11.8 million related to the acquisition of ACHL and the strengthening of the U.S. dollar, which had the effect of reducing loss adjustment expenses for the Company’s European business by approximately $2.5 million. This was also offset by the impact of a reduction in 2008 of prior years loss reserves in the amount of $7 million and higher actuarial estimates based on actual losses in 2009.
Net Premiums Earned Less Expenses Included in Combined Ratio (Underwriting Income). Net premiums earned less expenses included in combined ratio increased $7.3 million or 13.4% to $61.8 million for the years ended December 31, 2009 from $54.5 million for the year ended December 31, 2008. This increase largely reflects the growth in earned premium period over period.
Net Written Premium. Net written premium increased $71.6 million or 52.0% from $137.6 million to $209.2 million for the years ended December 31, 2007 and 2008, respectively. Net written premium reflected cessions of $131.6 million and $101.1 million to Maiden Insurance for the years ended 2008 and 2007, respectively, under the terms of the Maiden Quota Share. Before cessions to Maiden Insurance, net written premium increased $102.1 million in 2008 compared to 2007 and was the result of an increase in gross written premium.
years ended 2007 and 2008, respectively, reflected cessions of $33.6 million and $91.2 million to Maiden Insurance under the terms of the Maiden Quota Share. Before cessions to Maiden Insurance, earned premium increased $95.4 million for 2008 compared to 2007. This increase resulted from an increase in gross written premium during the preceding 12 months.
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income increased to $54.5 million for the year ended December 31, 2008 from $22.3 million for the year ended December 31, 2007, an increase of $32.2 million or 144%. This increase was primarily attributable to growth in premium written combined with the improvement in the loss ratio.
Specialty Middle Market Business Segment Result of Operations 2009 Compared to 2008 Gross Written Premium. Gross written premium increased $32.2 million or 13.6% to $268.0 million for the year ended December 31, 2009 from $235.8 million for the year ended December 31, 2008. The increase resulted from organic growth of approximately $15 million in certain product lines including workers compensation and other commercial package business lines. Additionally, the Company entered into an agreement during the third quarter of 2009 by which the Company assumed premium of approximately $25 million during 2009 on certain commercial lines of business. The increase was partially offset by a decline of $8 million on business the Company wrote on behalf of HSBC Insurance Company of Delaware pursuant to a 100% fronting arrangement which was entered into in connection with the Company’s acquisition of WIC from an HSBC affiliate as an accommodation to HSBC and is now in run-off.
Net Earned Premium. Net earned premium increased $32.6 million or 29.0% to $144.7 million for the year ended December 31, 2009 from $112.1 million for the year ended December 31, 2008. As premiums written earn ratably primarily over a twelve month period, the increase was a result of higher net written premium for the twelve months ended December 31, 2009 compared to the twelve months ended December 31, 2008.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $22.0 million or 31.7% to $91.5 million for the year ended December 31, 2009 compared to $69.5 million for the year ended December 31, 2008. The loss ratio for the segment increased for the year ended December 31, 2009 to 63.2% from 61.9% for the years ended December 31, 2008. The increase in the loss and loss adjustment expense ratio in 2009 resulted primarily from higher actuarial estimates based on actual losses.
Ceding Commission Revenue. Ceding commission revenue increased $14.5 million or 97.3% from $14.9 million in 2007 to $29.4 million in 2008. The increase resulted from the impact of the Maiden Quota Share being in effect for a full year in 2008.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $13.5 million or 24.1% from $56.0 million to $69.5 million for the years ended December 31, 2007 and 2008, respectively. The loss ratio for the segment for the year ended December 31, 2008 increased to 62.0% from 61.9% for the year ended December 31, 2007. The Company’s actuarially projected ultimate losses remained consistent period over period.
Our investment portfolio, including cash and cash equivalents, increased $52.8 million or 3.9% to $1,400.8 million at December 31, 2009 from $1,348.0 million as of December 31, 2008 (excluding $14.0 million and $13.5 million of other investments, respectively). During the quarter ended June 30, 2009, the Company disposed of a portion of its fixed maturities classified as held to maturity. As such, the Company assessed the appropriateness of continuing to classify its remaining fixed maturity portfolio as held to maturity. The Company determined that all remaining fixed maturities should be classified as available for sale under the provisions of ASC 320, Investments - Debt and Equity Securities. The effect of this one time reclassification increased the carrying value of the fixed securities by approximately $1.0 million. Our fixed maturity securities, gross, as of December 31, 2009 had a fair value of $1,085.4 million and an amortized cost of $1,080.9 million. Our equity securities are classified as available-for-sale, as defined by ASC 320. These securities are reported at fair value and were $50.4 million with a cost of $60.6 million as of December 31, 2009. Securities sold but not yet purchased, represent obligations of the Company to deliver the specified security at the contracted price and thereby create a liability to purchase the security in the market at prevailing rates. Sales of securities under repurchase agreements are accounted for as collateralized borrowing transactions and are recorded at their contracted amounts. Our investment portfolio is summarized in the table below by type of investment:
Other investments represented approximately 1.0% of the Company’s total investment portfolio as of December 31, 2009 and 2008, respectively. At December 31, 2009 other investments consisted primarily of limited partnerships or hedge funds totaling $4.4 million, the equity investment in Warrantech of $1.3 million, an annuity of $1.4 million and miscellaneous investments totaling $6.9 million. At December 31, 2008 other investments consisted primarily of limited partnerships or hedge funds totaling $3.6 million, the equity investment in Warrantech of $2.1 million, an annuity of $1.3 million, an equity investment in a company in the amount of $0.9 million in the form of a secured loan and miscellaneous investments totaling $5.6 million.
The table below summarizes the credit quality of our fixed maturity securities as of December 31, 2009 and 2008 as rated by Standard and Poor’s.
Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. The Company writes down investments immediately which it considers to be impaired based on the above criteria collectively. The investment committee maintains an individual list of investments that have been in a significant unrealized loss position in excess of 12 months for review of possible impairment. Absent any of the above criteria, the Company generally considers an investment to be impaired when it has been in a significant unrealized loss position for over 24 months.
During the year ended December 31, 2009, based on the criteria above, we determined that eleven equity securities and two fixed maturity securities were other-than-temporarily-impaired. The impairment charges of our fixed-maturities and equity securities for the years ended December 31, 2009, 2008 and 2007 are presented in the table below:
The tables below summarize the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2009:
Liquidity and Capital Resources AmTrust is organized as a holding company with eleven company insurance subsidiaries, primarily (“Insurance Subsidiaries”), as well as various other non-insurance subsidiaries. AmTrust’s primary liquidity needs include debt payments, interest on debt, taxes and shareholder dividends. AmTrust’s income is generated primarily from our insurance subsidiaries and investment income.
We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short-term and long-term basis. Cash payments for claims were $180.1 million, $257.9 million and $313.1 million in 2007, 2008 and 2009, respectively. Since December 31, 2001, we have funded claim payments from cash flow from operations (principally premiums) net of amounts ceded to our third party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and investment portfolio has increased from $1,348.0 million (excluding $13.5 million of other investments) at December 31, 2008 to $1,400.8 million (excluding $14.0 million of other investments) at December 31, 2009. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and could reduce investment income in future periods.
Comparison of Years Ended December 31, 2009 and 2008 Net cash provided by operating activities was $164 million for the year ended December 31, 2009, compared to $64.3 million for the same period in 2008. For the year ended 2009, major components of cash provided by operating activities were premiums settled of $1,147.0 million offset by claim payments of $313.1 million, and overall higher level of cessions and operating expenses. For the year ended 2008, major components of cash provided by operating activities were premiums settled of $996.5 million offset by claim payments of $257.2 million, and overall higher level of cessions and operating expenses.
Net cash provided by investing activities was $26 million for the year ended December 31, 2009. Net cash used in investing activities was $176.0 million for the year ended December 31, 2008. In 2009, major components of net cash provided by investing activities primarily include net sales of investments for $32.4 million offset by capital expenditures of $5.5 million. In 2008, major components of net cash used in investing activities primarily included the acquisition of UBI for $55.9 million and net purchases of investments of $109.9 million.
In 2009, premium receivables increased $76,294 as a result of a higher overall level of premium writing in 2009, related primarily to the acquisition of the CyberComp distribution network and renewal rights in the third quarter 2009 and the entering into a managing general agency relationship with Cardinal Comp in the fourth quarter of 2008. Reinsurance recoverable increased $58,499 and prepaid reinsurance premium increased $38,523 as a result of increased cessions to Maiden due to higher premium volumes. Deferred acquisition cost increased by $76,214, primarily, as result of increase in written premium volume and an associated increase in unearned premium. The premium growth was driven by business which has higher direct acquisition costs.
(3) At the time of the Company’s acquisition of AIIC, PMA was a reinsurer of AIIC. PMA has subsequently changed its name to Excalibur. We continue to collect payments from Excalibur on a timely basis.
Third Party Excess of Loss Reinsurance We purchase excess of loss reinsurance for our workers’ compensation, commercial property and casualty business attributable to both the Small Commercial Business segment and the Specialty Middle Market Business segment, from third party reinsurers. Under excess of loss reinsurance, covered losses above a specified amount up to the limit of the reinsurance coverage are paid by the reinsurer. Our excess of loss reinsurance is written in layers, in which our reinsurers accept a band of coverage up to a specified amount. In return for this coverage, we pay our reinsurers a percentage of our net or gross earned insurance premiums subject to certain minimum reinsurance premium requirements. Different layers in our excess of loss reinsurance program are scheduled to renew at different times during the year.
Workers’ Compensation Excess of Loss The following description of our third party workers’ compensation reinsurance protection covers the period from January 1, 2006 through December 31, 2009 and certain periods prior to January 1, 2006. While coverage effective dates vary by layer of coverage, we have grouped the coverages according to the effective date of the first excess layer. Some layers of this reinsurance include so-called “sunset clauses” which limit reinsurance coverage to claims reported within periods ranging from eight to eleven years of the inception of a 12-month contract period and may also include commutation clauses which permit reinsurers to terminate their obligations by making a final payment to us based on an estimate of their remaining liabilities, which may ultimately prove to be inadequate. In addition to insuring employers for their statutory workers’ compensation liabilities, our workers’ compensation policies provide insurance for the employers’ tort liability (if any) for bodily injury or disease sustained by employees in the course of their employment. Certain layers of our workers’ compensation reinsurance exclude coverage for such employers’ liability insurance or provide coverage for such insurance at lower limits than the applicable limits for workers’ compensation insurance.
• The fifth layer provides $50.0 million of coverage per occurrence for claims in excess of $80.0 million. It reinsures losses greater than $80.0 million per occurrence up to $130.0 million per occurrence. A maximum of $10.0 million per individual claimant may be included as part of any loss. The fifth layer has an aggregate limit of $100.0 million for each 12-month contract period.
January 1, 2006 to January 1, 2008. From January 1, 2006 to January 1, 2008, we retain the first $1 million per occurrence on workers’ compensation claims other than those arising out of acts of terrorism. We cede losses greater than $1.0 million for such claims. Our reinsurance for such claims totals $129.0 million, structured as a five layer tower. The first two layers of this reinsurance exclude coverage for our participation in assigned risk plans.
• The third layer provides $30.0 million of coverage per occurrence for claims in excess of $20.0 million. This layer provides coverage for losses in excess of $20.0 million per occurrence up to $50.0 million. It has limits of $10.0 million per individual. This means that if an individual is involved in a compensable claim, the maximum coverage provided under this layer would not exceed $10.0 million for that individual. The third layer has an aggregate limit of $60.0 million for the each 12-month contract period;
• The fourth layer provides $30.0 million of coverage per occurrence for claims in excess of $50.0 million. It reinsures losses in excess of $50.0 million per occurrence up to $80.0 million. The fourth layer has limits of $10.0 million per individual and an aggregate limit of $60.0 million for each 12-month contract period; and
• The first layer of this reinsurance provides $4.4 million of coverage per occurrence excess of our $0.6 million retention. It has an annual aggregate deductible of $1.25 million and reinsures losses in
• The second layer provides $5.0 million of coverage per occurrence excess of $5.0 million. This layer reinsures losses in excess of $5.0 million per occurrence up to $10.0 million;
• The fourth layer provides $30.0 million of coverage per occurrence for claims excess of $20.0 million. This layer provides coverage for losses in excess of $20.0 million per occurrence up to $50.0 million. It has limits of $10.0 million per individual. This means that if an individual is involved in a compensable claim, the maximum coverage provided under this layer would not exceed $10.0 million for that individual. The fourth layer has an aggregate limit of $60.0 million for the entire 12-month contract period;
• The fifth layer provides $30.0 million of coverage per occurrence for claims excess of $50.0 million. It reinsures losses in excess of $50.0 million per occurrence up to $80.0 million. The fifth layer has limits of $10.0 million per individual and an aggregate limit of $60.0 million for the entire 12-month contract period; and
• The sixth layer provides $50.0 million of coverage per occurrence for claims excess of $80.0 million. It reinsures losses greater than $80.0 million per occurrence up to $130.0 million. The sixth layer has limits of $10.0 million ($5.0 million for losses occurring before May 1, 2005) per individual and an aggregate limit of $100.0 million for the entire 12-month contract period.
Certain layers of our reinsurance provide coverage for losses caused by terrorism. For terrorism losses in excess of $20.0 million per contract year, we have two layers of reinsurance, neither of which provides coverage for nuclear, biological or chemical terrorism. This reinsurance is provided net of any recovery that we receive from the federal government pursuant to the Terrorism Risk Insurance Act of 2002, as modified by the Terrorism Risk Insurance Extension Act of 2005 and Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIA”).
• The third layer of this reinsurance provides $20 million of coverage per occurrence in excess of $12 million per occurrence. This layer has an annual aggregate reinsured limit of $40 million.
• The first layer of this reinsurance provides $3 million of coverage per risk in excess of our $2 million per risk retention. Recovery under this layer is limited to $6 million reinsured per occurrence and is further subject to an annual aggregate reinsured limit of $12 million; and
TRIA, will expire at the end of 2014 and no assurance can be given that it will be renewed or that any such renewal will not be on materially less favorable terms.
Specialty Risk and Extended Warranty Reinsurance Variable Quota Share Reinsurance. Since January 1, 2003, we have maintained variable quota share reinsurance with Munich Reinsurance Company (“Munich Re”) for our Specialty Risk and Extended Warranty insurance. The scope of this reinsurance arrangement is broad enough to cover all of our Specialty Risk and Extended Warranty insurance worldwide, except for creditor and GAP insurance. However, we do not cede to Munich Re the majority of our U.S. specialty risks and extended warranty business, although we may cede more of this U.S. business to Munich Re in the future.
Under quota share reinsurance arrangements, the ceding company cedes a percentage of each risk within the covered class or classes of business to the reinsurer and recovers the same percentage of the ceded loss and loss adjustment expenses. The ceding company pays the reinsurer the same percentage of the insurance premium on the ceded business, less a ceding commission. The ceding commission rate for our reinsurance with Munich Re is based upon a certain net loss ratio for the ceded business.
Reinsurance Agreement with Maiden Holdings, Ltd. During the third quarter of 2007, the Company and Maiden entered into a master agreement, as amended, by which they caused the Company’s Bermuda affiliate, AII and Maiden Insurance to enter into a quota share reinsurance agreement (the “Maiden Quota Share”) by which (a) AII retrocedes to Maiden Insurance an amount equal to 40% of the premium written by AmTrust’s U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated insuring reinsurance (and in the case of
Maiden Holdings, Ltd. (“Maiden”) is a publicly-held Bermuda insurance holding company (Nasdaq: MHLD) formed by Michael Karfunkel, George Karfunkel and Barry Zyskind, the principal shareholders, and, respectively, the chairman of the board of directors, a director, and the chief executive officer and director of the Company. As of December 31, 2009, assuming full exercise of outstanding warrants, Michael Karfunkel owns or controls approximately 15% of the issued and outstanding capital stock of Maiden, George Karfunkel owns or controls approximately 10.5% of the issued and outstanding capital stock of Maiden and Mr. Zyskind owns or controls approximately 5.7% of the issued and outstanding stock of Maiden. Mr. Zyskind serves as the non-executive chairman of the board of Maiden’s board of directors. Maiden Insurance Company, Ltd (“Maiden Insurance”), a wholly-owned subsidiary of Maiden, is a Bermuda reinsurer.
Promissory Note In connection with the stock and asset purchase agreement with a subsidiary of Unitrin, Inc., the Company issued a promissory note to Unitrin in the amount of $30 million. The note is non-interest bearing and requires four annual principal payments of $7.5 million, the first of which was paid June 1, 2009, and the remaining principal payments are due on June 1, 2010, 2011 and 2012. The Company calculated imputed interest of $3.2 million based on current interest rates available to the Company. Accordingly, the note’s carrying balance was adjusted to $26.8 million at inception. The note is required to be paid in full immediately, under certain circumstances, including a default of payment or change of control of the Company. The Company recorded $1.1 million of interest expense during 2009 and the note’s carrying value at December 31, 2009 was $21.1 million.
Line of Credit On June 3, 2008, the Company entered into an agreement for an unsecured line of credit with JP Morgan Chase Bank, N.A. in the aggregate amount of $25 million. The line is used for collateral for letters of credit. On June 30, 2009, the Company amended this agreement, whereby, the line was increased in the aggregate amount to $30 million and its term was extended to June 30, 2010. Interest payments are required to be paid monthly on any unpaid principal and bears interest at a rate of LIBOR plus 150 basis points. As of December 31, 2009, there was no outstanding balance on the line of credit. At December 31, 2009, the Company had outstanding letters of credit in place for $26.5 million which reduced the availability on the line of credit to $3.5 million as of December 31, 2009.
(4) The interest related to the debt by period is as follows: $14.5 million - less than 1 year, $26.9 million - 1 - 3 years, $23.2 million - 3 - 5 years and $215.7 million - more than 5 years. In addition included within debt and interest is $168.0 million related to the Maiden collateral loan and $11.8 million of associated interest.
Financial Statements and Supplementary Data The financial statements and financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules at page are filed as part of this report.