We own our corporate headquarters building and the surrounding real estate located in Richfield, Ohio. The site consists of approximately 98,000 square feet of office space on ten acres. We occupy approximately 72,000 square feet and lease the remainder to an unaffiliated tenant. We lease office space in Duluth, Georgia; Honolulu, Hawaii; Mechanicsburg, Pennsylvania; and St. Thomas in the United States Virgin Islands. These leases account for approximately 17,100 square feet of office space. These leases expire within sixty months. The monthly rents, exclusive of operating expenses, to lease these facilities currently total approximately $23,000. We believe that these leases could be renewed or replaced at commercially reasonable rates without material disruption to our business.
The 2004 data includes $15.0 million note payable to Great American, junior subordinated debt and bank debt.
The statutory policyholder surplus of NIIC, which includes the statutory policyholder surplus of its subsidiary, National Interstate Insurance Company of Hawaii.
Statutory combined ratio of NIIC represents the sum of the following ratios: (1) losses and loss adjustment expenses incurred as a percentage of net earned premium and (2) underwriting expenses incurred as a percentage of net written premiums.
The following discussion and analysis of the historical consolidated financial statements of the Company should be read in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this Form 10-K. All historical per share amounts reflect a 200-for-1 share split as discussed elsewhere in this Form 10-K and the reclassification of all Class A common shares as common shares effective December 6, 2004.
The Company is a holding company with operations being conducted by subsidiaries.
Our specialty property and casualty insurance operations are licensed in all 50 states, the District of Columbia and the Cayman Islands. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. While many companies write property and casualty insurance for transportation companies, we believe that few write passenger transportation coverage nationwide and very few write coverage for several of the classes of passenger transportation insurance written by the Company and its subsidiaries. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. These niche markets typically possess what we view as barriers to entry, such as being too small, too remote or too difficult to attract or sustain most competitors. Examples of products that we write for these markets include property and casualty insurance for transportation companies (33.6% of 2005 gross written premiums), captive programs for transportation companies that we refer to as our alternative risk transfer operations (38.4%), specialty personal lines, primarily recreational vehicle coverage (17.0%) and transportation and general commercial insurance in Hawaii and Alaska (8.4%). We strive to become a market leader in the specialty markets that we choose and serve by offering what we believe are specialized products, excellent customer service and superior claims response.
The change in the percentage of the new applications received that do not receive a Company quote. We do not quote risks that do not meet our risk selection criteria or for which we have not been provided complete application data. We refer to this ratio as the “declination ratio” and an increasing declination ratio usually results in reduced opportunities to write new business.
The change in our rate structure from period to period. The rates we file and quote are impacted by several factors including: the cost and extent of the reinsurance we purchase; our operating efficiencies; our average loss costs, which reflect the effectiveness of our underwriting routines; our underwriting profit expectations; and our claims adjusting processes. The difference between our rates and the rates of our competitors is the primary factor impacting the revenue growth of our established product lines.
Our business model and bottom line orientation have resulted in what we believe is disciplined and consistent risk assessment and pricing adequacy.
Hawaii) into an independent catastrophe model that predicts our probable maximum loss at various statistical confidence levels. Our estimated probable maximum loss is impacted by changes in our in-force exposures as well as changes to the assumptions inherent in the catastrophe model. Hurricane and other weather-related events have not had a material negative impact on our past results. Severe hurricanes in the third and fourth quarter of 2005 and the same period in 2004 resulted in approximately $3.4 million and $2.6 million, respectively, in total incurred losses.
There are distinct differences in the timing of written premiums in traditional transportation insurance and our alternative risk transfer (captive) insurance components. We write traditional transportation insurance policies throughout all 12 months of the year and commence new annual policies at the expiration of the old policy. Under the captive programs, all members of the group share a common expiration date. These common expiration dates are scheduled throughout the calendar year, with a majority renewing during the first half of the year. Any new captive program participant written during the last half of the calendar year will be written for less than a full annual term so its next renewal date coincides with the common expiration date of the captive program it has joined. The alternative risk transfer component of our business grew to 38.4% of total gross premium written during 2005 as compared to 32.0% in 2004. This includes recognition of the Company and its subsidiaries’ traditional transportation policyholders that elected to convert to a captive program in 2005. Our traditional transportation insurance premiums are relatively unchanged as compared to 2004, reflecting the conversion of traditional transportation policyholders to the captive program.
All of our transportation products, traditional or alternative risk transfer, are priced to achieve targeted underwriting margins. Because traditional insurance tends to have a higher operating expense structure, the portion of the premiums available to pay losses tends to be lower for a traditional insurance quote versus an alternative risk transfer insurance quote. We use a cost plus pricing approach that projects future losses based upon the insured’s historic losses and other factors. Operating expenses, premium taxes, expenses and a profit margin are then added to the projected loss component to achieve the total premium to be quoted. The lower the projected losses, expenses and taxes, the lower the total quoted premiums regardless of whether it is a traditional or alternate risk transfer program quotation. Quoted premiums are computed in accordance with our approved insurance department filings in each state.
We employ what we consider to be a conservative approach to investment and capital management with the intention of supporting insurance operations by providing a stable source of income to offset underwriting risk and growing income to offset inflation. The primary goal of our investment policy is to preserve principal while optimizing income.
The Company’s net earnings for 2005 were $30.3 million or $1.60 per share (diluted), compared to $22.8 million or $1.47 per share (diluted) recorded in 2004. The Company’s earnings increased 33.0% compared to the same period in 2004. There are several factors that contributed to the increase in net earnings including continued growth in earned premium with loss and LAE trends that as expected, have shown a slight deterioration in 2005, but have been consistently favorable since 2004. The Company’s commissions and other underwriting expenses as a percentage of premiums earned are lower in 2005 than 2004, as a result of reductions in our estimated expenses related to insolvencies and other state fees and continued leverage of fixed expenses. While expenses are
higher in response to building our infrastructure and other related expenses of operating as a public entity, our overall increase in fixed expenses was lower than the revenue growth for 2005. Our investment portfolio has grown 40.2% during the year contributing to a 45.4% increase in investment income.
Our underwriting approach is to price our products to achieve an underwriting profit even if it requires us to forego volume. Since 2000, our insurance subsidiaries have been increasing their premium rates to offset rising losses and reinsurance costs. Rate increases have continued during 2005, but at a reduced pace and level as compared to 2004 and 2003.
There are distinct differences in the timing of written premiums in our traditional transportation component and our alternative risk transfer component composed primarily of captive programs compared to all of our other businesses. The captive programs focus on specialty or niche insurance businesses that provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention, and reinsurance placement, along with various types of property and casualty insurance coverage. Insurance coverage is provided primarily to associations or similar groups of members and to specified classes of business of the Company’s agent partners.
Except for our captive programs, we write most of our insurance policies throughout all 12 months of the year and commence new annual policies at the expiration of the old policy. Under most of our captive programs, all members of a particular captive share a common expiration date. Any policy for a new captive program participant will be written between incept date and the next common renewal date of the captive program. In the alternative risk transfer component, most captive members renew their contracts during the first six months of the year, resulting in a concentration of gross premiums during the first six months of a given fiscal year.
Gross written premium includes both direct premium and assumed premium. During 2005, as a percent of total gross premiums written, the alternative risk transfer component of the business had the largest increase of 6.4 points or $31.5 million compared to the same period in 2004. The alternative risk transfer component added two new captive programs in 2005, which accounted for 15.5% of the increase in the alternative risk transfer component. The
The underwriting expense ratio for the year ended December 31, 2005 decreased 2.7 points to 22.2% compared to 24.9% for the year ended December 31, 2004. The decrease in the underwriting expense ratio is primarily a result of four factors: increased risk retention, continued leverage of our fixed expense, a reduction in our estimated expenses for insolvencies and other state fees and recording of assigned business. In November 2004, we increased our risk retention on public transportation products, which contributes to a decrease in our expense ratio as the additional retained written premium is earned. While expenses are higher in response to building our infrastructure and other related expenses of operating as a public entity, our overall increase in fixed expenses was lower than the revenue growth for the year ended December 31, 2005. Using data available from the National Conference of Insurance Guarantee Funds, we reduced our estimated expenses for insolvencies and other state fees during the third quarter of 2005. The reduction in estimated expenses reduced our underwriting expense ratio by 0.7 points. We record our assigned risk premium quarterly based on reports from various states and agencies that manage the plans. The assignments are based on our written premium for specific coverages in certain states. We have written workers’ compensation insurance in several states beginning in 2004. Due to the lack of sufficient detail because the plans report to us on a lag, our estimated net share of the assigned risks were charged to commissions and other underwriting expenses, with a like amount recorded as assessments and fees payable in the correct periods. During the third and fourth quarter of 2005, sufficient information was obtained to enable us to classify the business on a gross basis, including premiums earned and losses and loss adjustment expenses. While this had no impact on net income, it reduced our underwriting expense ratio by 0.8 points.
Our net premiums earned increased $30.5 million, or 24.2%, to $156.9 million during 2004 compared to $126.4 million in 2003. Due to an increase in the number of policies in force primarily from expanded distribution, our specialty personal lines component increased 48.8% during 2004 compared to 2003. Our alternative risk transfer component increased 42.4% during 2004 compared to 2003, primarily due to new insureds. During this period and prior periods, our alternative risk transfer business was and continues to be one of the fastest growing
While designated as available for sale, we generally intend to hold our fixed maturities through maturity or recovery if in an unrealized loss position. When evaluating sales opportunities, we do not have any specific thresholds that would cause us to sell these securities prior to maturity. We consider multiple factors, such as reinvestment alternatives and specific circumstances of the investment currently held. Credit quality, portfolio allocation and other-than-temporary impairment are other factors that may encourage us to sell a security prior to maturity at a gain or loss. Historically and during the most recent extended low interest rate period, we have not had the need to sell our investment to generate liquidity.
At December 31, 2005 our investment portfolio contained $272.6 million in fixed maturity securities and $32.2 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, 2005 we had pretax net unrealized losses of $4.4 million on fixed maturities and a pretax unrealized gains of $0.2 million on equity securities.
At December 31, 2005, 99.2% of the fixed maturities in our portfolio were rated “investment grade” (credit rating of AAA to BBB) by Standard & Poor’s Corporation. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade.
In an initial public offering completed in February 2005, the Company sold 3,350,000 shares of common stock generating approximately $40.4 million of net proceeds. We used the net proceeds for the repayment in full of a $15.0 million loan plus the accrued interest from Great American, our majority shareholder, and the remainder will continue to be used for other general purposes including surplus contributions to our insurance company subsidiaries.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies.
We will have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends and taxes. Funds to meet these obligations will come primarily from dividend and tax payments from our insurance company subsidiaries and from our line of credit. Under the state insurance laws, dividends and capital distributions from our insurance companies are subject to restrictions relating to statutory surplus and earnings. The maximum amount of dividends that our insurance companies could pay to us without seeking regulatory approval in 2006 is $29.3 million. Our insurance subsidiaries paid no dividends in 2005 and paid $2.1 million in dividends in 2004 without the need for regulatory approval.
In May 2003, we purchased the outstanding common equity of a business trust that issued mandatorily redeemable preferred capital securities. The trust used the proceeds from the issuance of its capital securities and common equity to buy $15.5 million of debentures issued by us. These debentures are the trust’s only assets and mature in 2033. The interest rate is equal to the three-month LIBOR (4.41% at December 31, 2005 and 2.40% at
We also have a $2.0 million line of credit (unused at December 31, 2005) that bears interest at the lending institution’s prime rate (7.25% at December 31, 2005 and 5.25% at December 31, 2004) less 50 basis points and requires an annual commitment fee of $1 thousand. In accordance with the terms of the line of credit agreement, interest payments are due monthly and the principal balance is due upon demand. The line of credit is available currently, and has been used in the past, for general corporate purposes, including the capitalization of our insurance company subsidiaries in order to support the growth of their written premiums. We may request an increase in this line of credit in the future based on liquidity and capital needs, although we have no current plans to do so.
We have a term loan that is governed by a four-year, unsecured term loan agreement that was executed in August 2002. The note was originally issued for $5.0 million and bears interest at the lender’s prime rate (7.25% at December 31, 2005 and 5.25% at December 31, 2004) less 50 basis points. The outstanding principal amount at December 31, 2005 was $0.8 million. Payments on the note are due in monthly principal installments of $104,000 plus interest. The term loan agreement contains certain customary covenants for a term loan of this nature including covenants relating to delivery of financial statements, maintenance of insurance, payment of taxes, corporate existence, compliance with laws, maintenance of financial ratios, absence of liens and mergers and liquidations. At December 31, 2005 we were in compliance with all of our loan covenants.
We believe that the remaining net proceeds from our initial public offering, funds generated from operations, including dividends, and funds available under our line of credit will provide sufficient resources to meet our liquidity requirements for at least the next 12 months. However, if these funds are insufficient to meet fixed charges in any period, we would be required to generate cash through additional borrowings, sale of assets, sale of portfolio securities or similar transactions. Historically, and during the most recent extended low interest rate period, we have not had the need to sell our investments to generate liquidity. If we were forced to sell portfolio securities early for liquidity purposes rather than holding them to maturity, we would recognize gains or losses on those securities earlier than anticipated. If we were forced to borrow additional funds in order to meet liquidity needs, we would incur additional interest expense which would have a negative impact on our earnings. Since our ability to meet our obligations in the long term (beyond a 12-month period) is dependent upon factors such as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our operating needs.
At December 31, 2005, the Company had $11.8 million held in an escrow account for the purchase of TCC from Triumphe Insurance Holdings LLC by NIIC. The $11.8 million that was held in an escrow account is shown on the December 31, 2005, Consolidated Balance Sheet in “Other Assets.” On January 3, 2006, the first business day after the January 1 effective date of the purchase, the funds were released from the escrow account. The Company made a second payment of $1.2 million for the remaining balance of the purchase price.
Off-Balance Sheet Items. We do not have any off-balance sheet arrangements (as such term is defined in applicable Securities and Exchange Commission rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of that loss to us and our final payment of that loss, and its related LAE. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. At December 31, 2005 and December 31, 2004, we had $223.2 million and $171.0 million, respectively, of gross losses and LAE reserves, representing management’s best estimate of the ultimate loss. Management records on a monthly and quarterly basis its best estimate of loss reserves. For purposes of computing the recorded reserves, management utilizes various data inputs, including analysis that is derived from a review of prior quarter results performed by actuaries employed by Great American. In addition, on an annual basis, actuaries from Great American review the recorded reserves for NIIC and NIIC-HI utilizing current period data and provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the statutory reserves recorded by these U.S. insurance subsidiaries. Since 1990, our first full year of operations, the actuaries have opined each year that the reserves recorded at December 31 are reasonable. The actuarial analysis of NIIC’s and NIIC-HI’s net reserves as of the end of fiscal years ending December 31, 2005 and 2004 reflected point estimates that were within 1% of management’s recorded net reserves as of such dates. Using this actuarial data along with its other data inputs, management concluded that the recorded reserves appropriately reflect management’s best estimates of the liability as of each year end.
An important assumption underlying reserve estimates is that the cost trends implicitly built into development patterns will continue into the future. The sensitivity of recorded reserves to an unexpected change in the trends, is estimated by adding 1.0% to the trend that is embedded in the factors used to determine the reserves for ultimate liabilities. This unexpected change could arise from a variety of sources including a general increase in economic inflation, inflation from social programs, new medical technologies, or other factors such as those listed below in connection with our largest lines of business. The estimated cumulative unfavorable impact that this 1.0% change would have on our 2005 net income is shown below (in thousands):
Workers’ Compensation. In this line of business, we provide coverage for employees who may be injured in the course of employment. Some of the important variables affecting our estimation of loss reserves for workers’ compensation include:
The level of detail at which data is analyzed varies among the different lines of business. Data is generally analyzed by major product or coverage, using countrywide data. Appropriate segmentation of the data is determined based on data volume, data credibility, mix of business and other actuarial considerations. Point estimates are selected based on test indications and judgment.
When establishing and reviewing reserves, we analyze historic data and estimate the impact of various loss development factors, such as our historic loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments, judicial decisions, legal developments in imposition of damages, and changes and trends in general economic conditions, including the effects of inflation. A change in any of these factors from the assumptions implicit in our estimate can cause our actual loss experience to be better or worse than our reserves, and the difference can be material. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves. Currently established reserves may not prove adequate in light of subsequent actual occurrences. To the extent that reserves are inadequate and are increased or “strengthened,” the amount of such increase is treated as a charge to earnings in the period that the deficiency is recognized. To the extent that reserves are redundant and are released, the amount of the release is a benefit to earnings in the period that redundancy is recognized.
The changes we have recorded in our reserves in the past three years illustrate the potential for revisions inherent in estimating reserves. In 2005, we experienced favorable development of $5.2 million (4.7% of total net reserves) from claims incurred prior to 2005. In 2004, we experienced favorable development of $2.3 million (2.6% of total net reserves) from claims incurred prior to 2004. In 2003, we experienced favorable development of $3.7 million (5.5% of total net reserves) from claims incurred in years prior to 2003. We did not significantly change our reserving methodology or our claims settlement process in any of these years. The development reflected settlements that differed from the established case reserves, changes in the case reserves based on new information for that specific claim or the differences in the timing of actual settlements compared to the payout patterns assumed in our accident year IBNR reductions. The types of coverages we offer and risk levels we retain have a direct influence on the development of claims. Specifically, short duration claims and lower risk retention levels generally are more predictable and normally have less development. Future favorable or unfavorable development of reserves from this past development experience should not be assumed or estimated. The reserves reflected in the financial statements are our most accurate estimation.
When an investment is determined to have other-than-temporary impairment, in most cases we will evaluate the merits of disposing the investment, which will allow us to realize the loss for tax purposes and to reinvest the proceeds in what we view as more productive investments. For those investments we choose to retain, we record an adjustment for impairment. During the year ended December 31, 2005, the Company recorded a non-cash charge of $0.2 million related to General Motors Acceptance Corporation and Ford Motor Credit Corporation notes, with a combined par value of $1.5 million. In light of recent credit rating downgrades, and the difficulty in accurately projecting the future recovery period of the securities, the Company concluded that this unrealized loss was an other-than-temporary impairment in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 115. The 2005 charges established a new cost basis for these investment securities which are held as part of the available-for-sale portfolio. We experienced no impairment adjustments in 2004, $11 thousand in adjustments in 2003, respectively. Because total unrealized losses are a component of shareholders’ equity, any recognition of other-than-temporary impairment losses has no effect on our comprehensive income or book value. See “Management’s Discussions and Analysis of Financial Condition and Results of Operations - Investments.”
National Interstate Corporation (the “Company”) and its subsidiaries operate as an insurance holding company group that underwrites and sells traditional and alternative property and casualty insurance products to the passenger transportation industry and the trucking industry, general commercial insurance to small businesses in Hawaii and Alaska, and personal insurance to owners of recreational vehicles and watercraft throughout the United States.
The accompanying consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States, which differ in some respects from statutory accounting principles permitted by state regulatory agencies (see Note 10).
Historical financial statements have been adjusted to reflect the 200-for-1 common share split effective December 6, 2004 and the reclassification of all Class A common shares as common shares effective immediately prior to the Company’s February 2005 initial public offering (“IPO”). Certain reclassifications have been made to financial information presented for prior years to conform to the current year’s presentation.
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from the estimates and assumptions used.
Net investment income is adjusted for amortization of premiums to the earliest of the call date or maturity date and accretion of discounts to maturity. Realized gains and losses credited or charged to income are determined by the specific identification method for bonds, common and preferred stock. Estimated fair values for investments are determined based on published market quotations or where not available, based on broker quotations or other independent sources. When a decline in fair market value is deemed to be other-than-temporary, a provision for impairment is charged to earnings (included in realized gains) and the cost basis of that investment is reduced. Interest income is recognized when earned and dividend income is recognized when declared.
Property and equipment (including electronic data processing equipment and related software) are reported at cost less accumulated depreciation and amortization. Property and equipment are depreciated or amortized over the estimated useful lives on a straight-line basis. Upon sale or retirement, the cost of the asset and related accumulated depreciation are eliminated from their respective accounts, and the resulting gain or loss is included in operations. Repairs and maintenance are charged to operations when incurred.
Premiums receivable are carried at cost, which approximate fair value. Management provides an allowance for doubtful accounts in the period that collectibility is deemed impaired.
Statement of Financial Accounting Standard (“SFAS”) No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, permits entities to continue to apply the provisions of APB No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method, as defined in SFAS No. 123, Accounting for Stock-Based Compensation, had been applied. SFAS No. 148 provides alternative methods of transitioning to SFAS No. 123’s fair value method of accounting for stock-based employee compensation, but does not require companies to account for employee stock options using the fair value method. The Company has elected to continue to apply provisions of APB No. 25 and provide the pro forma disclosures required by SFAS No. 148.
The following table illustrates the effect on net income and earnings per share if the fair-value-based method described by SFAS No. 148 had been applied to all outstanding and unvested awards in each period. The fair value was calculated using the Black-Scholes option pricing method for options granted during 2005 and the minimum value option pricing method for all prior grants. Both the Black-Scholes method and the minimum value method reflect the value of the right to defer payment of the exercise price until the end of the option’s term but the Black-Scholes method also factors in the right to benefit from increases in the price of the underlying share without being exposed to losses beyond the premium paid (volatility value). Therefore, the Black-Scholes method is deemed more appropriate for a publicly traded company than the minimum value method and the Black-Scholes method was adopted for 2005 in conjunction with the 2005 initial public offering. Due to the change in valuation methods, the computations of the effect on net income and earnings per share for the years ended December 31, 2005, 2004 and 2003 are not comparable.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 requires that voluntary changes in accounting principles and corrections of errors be reported by retroactively restating prior periods’ financial statements unless it is impractical to do so. The standard is effective for fiscal years beginning after December 15, 2005.
In February 2005, the Company completed an IPO in which it issued 3,350,000 shares and selling shareholders sold 1,074,000 shares at an initial offering price of $13.50 per share. Proceeds from the offering totaled approximately $40,391 after a deduction for the underwriting discount and offering expenses. Net proceeds were used to repay a loan from the Company’s majority shareholder, Great American, and the remainder has been invested to be used in future periods for other general corporate purposes including surplus contributions to the Company’s insurance subsidiaries, as needed.
At December 31, 2005 and 2004, the carrying value of all deposits with state insurance departments was $10,379 and $9,869, respectively. These deposits consisted of fixed maturity investments, certificates of deposit and money market funds.
In May 2003, the Company purchased the outstanding common equity of a business trust that issued mandatorily redeemable preferred capital securities (capital securities). The trust used the proceeds from the issuance of its capital securities and common equity to buy $15,464 aggregate principal amount of debentures issued by the Company. These debentures are the trust’s only assets and mature in 2033. The interest rate is equal to the three-month LIBOR (4.41% at December 31, 2005 and 2.40% at December 31, 2004) plus 420 basis points with interest payments due quarterly. Payments from the debentures finance the distributions paid on the capital securities. The Company has the right to redeem its debentures, in whole or in part, on or after May 23, 2008. In accordance with FASB Interpretation No. 46(R), (and related amendments and interpretations) Consolidation of Variable Interest Entities, the Company determined that the business trust is a variable interest entity for which it is not the primary beneficiary and therefore, did not consolidate the trust with the Company. To the extent the trust does not have funds available to make payments, as guarantor, the Company unconditionally guarantees payment of required distributions on the capital securities, the redemption price when the capital security is redeemed, and amounts due if the trust is liquidated or terminated. The Company recorded its equity interest in the trust as a common stock investment.
plus interest. The term loan agreement contains certain covenants. At December 31, 2005 and 2004, the Company was in compliance with all of its loan covenants.
The Company’s principal insurance subsidiary, NIIC, is involved in both the cession and assumption of reinsurance. NIIC is a party to a reinsurance agreement, and NIIA, a wholly-owned subsidiary, is a party to an underwriting management agreement with Great American. The reinsurance agreement calls for the assumption by NIIC of all of the risk on Great American’s net premiums written for public transportation and recreational vehicle risks. NIIA provides administrative services to Great American in connection with Great American’s underwriting of public transportation risks.
Under SAP, policy acquisition costs, such as commissions, premium taxes, fees and other costs of underwriting policies, are charged to current operations as incurred, while under GAAP, such costs are deferred and amortized on a pro rata basis over the policy period.
Under SAP, net deferred income tax assets are recorded as assets following the application of certain criteria, with the resulting admitted deferred tax asset credited directly to surplus.
The statutory capital and surplus of NIIC-HI is included in the statutory capital and surplus of NIIC for reporting purposes. Statutory capital and surplus and income of HIL are nominal.
NIIC and NIIC-HI are subject to insurance regulations that limit the payment of dividends without the prior approval of their respective insurance regulators. Without prior regulatory approval, the maximum amount of dividend that may be paid by NIIC to the Company and NIIC-HI to NIIC in 2006 is $29,311 and $332, respectively. During 2004, NIIC paid dividends, which did not require regulatory approval, of $2,100. NIIC did not pay dividends in 2005. Also, in accordance with statutory restrictions, NIIC must maintain a minimum balance in statutory surplus of $5,000 and each of the insurance companies subsidiaries must meet minimum Risk Based Capital (RBC) levels. At December 31, 2005 NIIC and NIIC-HI exceeded the minimum RBC levels.
The Company has a Long Term Incentive Plan (“LTIP”), which provides for the granting of stock options to officers of the Company. At December 31, 2005, there were 1,162,400 of the Company’s common shares reserved for issuance upon exercise of stock options. Treasury shares are used to fulfill the options exercised. Options vest
Total rental expense (which includes utilities where charged by lessor) charged to operations for the years ended December 31, 2005, 2004 and 2003 were $323, $353 and $345, respectively.
Outstanding options of 215,000 for the year ended December 31, 2005 has been excluded from dilutive earnings per share as they were anti-dilutive. No options were anti-dilutive for the years ended December 31, 2004 and 2003.
The net earnings, net income per share - basic and net income per share - diluted amounts for the first three quarters of 2004 were incorrectly stated due to this clerical error. Corrected balances are reflected in the table above.
The Company announced the closing of the purchase of TCC from Triumphe Insurance Holdings LLC effective January 1, 2006 by the Company’s principal insurance subsidiary NIIC. Triumphe, a Pennsylvania domiciled property and casualty insurer, holds licenses for multiple lines of authority, including auto-related lines, in 24 states and the District of Columbia. Although it has maintained these licenses, Triumphe has not written any new policies since April 1, 2004.
The Company is still in the process of completing the purchase price allocation and any intangible asset that may result from this process. On a consolidated basis, this acquisition is not expected to have a material impact on earnings for the Company.