We do not own or lease any plants, mines or physical properties.
The following discussion presents our financial condition and results of operations for the periods and as of the dates indicated.
We are an insurance company owned by 2,053 accounting firms and persons associated with accounting firms. We were formed in response to concerns about the pricing and availability of accountants’ professional liability insurance in a difficult or “hard” market. Our primary mission is to exert a stabilizing influence on the design, pricing and availability of professional liability insurance to reduce the likelihood of a hard market. We are prepared, subject to obtaining the required licenses and registrations, to step into a hard market and act as a direct issuer of accountants’ professional liability insurance policies.
We have satisfied our mission by reinsuring accountants professional liability insurance issued under a plan sponsored by the AICPA since 1989. This plan currently insures approximately 24,000 accounting firms in all 50 states of the United States, representing a broad cross section of small and mid-size firms.
In an effort to maximize the value of our shares, we have been looking at ways to expand our business, including possibly entering into other lines of insurance business. In 2003 we provided reinsurance of attorneys’ professional liability policies provided by Professional Direct Insurance Company. That activity was not a significant portion of our business in 2003 and was terminated at the end of the year. However, we continue to look for other ways to expand our business to include other lines of coverage, which may include attorneys’ professional liability coverage.
Our results of operations for the years ended December 31, 2004, December 31, 2003 and December 31, 2002 are discussed below. Results in 2003 were significantly impacted by the reduction of $5.0 million in our loss reserves as a result of our actuaries gaining more complete information from the primary carrier with respect to its experience under the AICPA plan.
The amount that we record as our liability for loss and loss adjustment expenses is a major determinant of net income each year. As discussed in more detail below under the heading “Loss and Loss adjustment Expenses,” the amount that we reserve is based on actuarial estimates. Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a “low”, “middle” and “high” estimate of the loss and loss adjustment expenses. As at December 31, 2004 the range of actuarially determined net liability for loss and loss adjustment expense reserves was as follows: the low estimate was $14.0 million, the high estimate was $30.3 million, and the middle estimate was $20.0 million. We selected reserves of $29.7 million as of December 31, 2004, which is near the high end of the range. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management’s policy has been to reserve conservatively at the higher end of the actuarial estimates. However, in recognition of the fact that, as more historical information becomes available, losses will become more predictable, management has a policy to bring our loss reserves for each policy year to the actuary’s middle estimate over succeeding years.
Our net income decreased to $1,749,007 in 2004, compared to a net income of $4,770,148 in 2003. We sustained a net loss of $(741,560) in 2002.
The significant decrease in net income from 2003 to 2004 is primarily due to the level of reduction in loss reserves between the two years. In 2003 loss reserves were reduced by $5.0 million, which was added to net income, whereas in 2004 the reduction was $2.5 million. Due to the uncertainty inherent in the reinsurance policies written by the Company, we have always adopted a conservative policy concerning our loss reserving. In the last two years, our actuary was able to obtain additional information which included breaking out loss development on CNA’s “premier,” and “value” plans which we reinsure. Our actuary determined in the course of his analysis that experience under the CNA plans has been more favorable than industry performance reflected in the reserves we established for our reinsurance of the plans. In light of this new information, we believed it was reasonable to reduce the prior year loss reserves by $5.0 million, which resulted in an increase in net income in 2003 by that amount. For 2004, we believed it reasonable that the reduction in loss reserves should be limited to $2.5 million. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our long established loss reserving philosophy. The Company will continue to review loss reserves periodically and, based on the actuarial projections, determine whether reserves are required to be increased or decreased. However, in recognition of the fact that, as more historical information becomes available, losses will become more predictable, management has a policy to bring our loss reserves for each policy year to the actuary’s middle estimate over succeeding years.
Net premiums earned increased by 5.5% in 2004 to $8,856,809 from $8,392,172 in 2003. Net premiums earned for 2003 increased by 23.9% from $6,775,407 in 2002. The increases in net premiums earned during 2004 and 2003 were primarily attributable to an increase in the number of AICPA insureds and rate increases under the current AICPA Professional Liability Plan treaty compared to the prior periods and due to premiums written for the attorneys’ professional liability business in the year ended December 31, 2003.
Net premiums written in 2004 were $8,885,926, a decrease of $17,650 from $8,903,576 in 2003. The decrease in net premiums written was primarily attributable to the termination of the attorney’s professional liability business on December 31, 2003. The 2003 net premiums written included $265,265 related to this carrier. This was partially offset by an increase of $247,615 of accountants’ professional liability premiums. Our relationship with the attorneys’ professional liability carrier was terminated on December 31, 2003. We continue to look for ways in which it may be advantageous to expand our business to include the reinsurance of lines of coverage other than accountants’ professional liability. Net premiums written in 2003 increased by 27.2% to $8,903,576 from $6,998,378 in 2002. The increase in net premium written during 2003 was attributable primarily to an increase in the number of insureds and rate increases under the AICPA Professional Liability Plan and net premiums written for the attorney’s professional liability business, compared to 2002.
Net investment income includes amounts earned on the Company’s investment portfolio and cash equivalents, and dividends on equity investments, net of investment expenses. Net investment income decreased $267,761 or 18.0% in 2004 to $1,227,610 from $1,495,371 in 2003. Net investment income in 2003 decreased by $392,407, or 20.8% from the $1,887,778 reported in 2002. The decrease in 2004 and in 2003 was due to a general decrease in interest rates and the shortening of the average duration of the fixed income portfolio.
Unrealized gain on investments was $6,282,073 at December 31, 2004 compared to $6,039,616 at December 31, 2003. We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at market value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The 4.0% increase in unrealized gain on investments was due primarily to movement in the company’s equity portfolio. Unrealized gain on investments was $3,330,260 at December 31, 2002. Declines in the market value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
Our hedge fund portfolio is managed to reduce overall portfolio risk. It is required to invest over all major strategies and is limited to 10% of the total equity portfolio. At December 31, 2004 our hedge fund portfolio was less than 5% of our total equity portfolio.
Our losses and loss adjustment expenses increased by 103.9% to $5,104,341 in 2004 from $2,502,884 in 2003, and for 2003 decreased by 54.2% from $5,468,410 in 2002. These amounts included favorable development of prior years’ estimates of losses and loss adjustment expenses of approximately $2,494,106 in 2004, $5,016,302 in 2003 and $577,001 in 2002. Our loss ratio, calculated as the ratio of losses and loss adjustment expenses to net premiums earned, was 57.6% in 2004, 29.8% in 2003 and 80.7% in 2002. Our losses and loss adjustment expenses in 2004, before the favorable development of prior years’ estimates of losses and loss adjustment expenses was $7,598,446. The reason for the favorable development of prior years’ estimates is discussed in more detail below under the caption “Losses and Loss Adjustment Expenses.” As noted above, the decrease in losses and loss adjustment expenses as a result of favorable development of prior years’ estimates of losses and loss adjustment expenses was the primary reason for our substantial increase in net income in 2003.
Policy acquisition costs of $2,591,612 were expensed in 2004 compared to $2,446,978 in 2003, an increase of 5.9%. Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. Policy acquisition costs expensed in 2003 reflected an increase of 23.4% from $1,983,400 in 2002. Such costs as a percentage of premiums earned (excluding the effects of increases to retrocession premiums) were 29.3% in 2004, 29.2% in 2003 and 29.5% in 2002.
Operating and management expenses increased by 24.5% in 2004 to $1,371,950 from $1,101,528 in 2003. The primary reasons for this increase were increased audit and legal fees, costs of SEC compliance, and expenses related to a shareholder’s revised offer to acquire the Company. That offer was made in September 2004 to purchase all of AmerInst’s shares for 82.54% of book value. That offer was rejected by the Board for an inadequate price to be paid for control of AmerInst and because it was inconsistent with our mission. Operating and management expenses for 2003 increased by 16.2% from $947,750 in 2002 due to increased legal fees for investigation of ways in which we may be able to expand our business, increased costs of SEC compliance and our response to an offer to acquire the Company made in August 2003. The majority of the cost increases in both 2003 and 2004 were due to additional legal expenses incurred because of offers to purchase the Company.
Our cash needs consist of settlement of losses and expenses under our reinsurance treaty and funding day-to-day operations. Our management expects to be able to meet these needs from premiums received and cash flows arising from our investment portfolio. Because substantially all of our assets are marketable securities, we expect that we will have sufficient flexibility to provide for unbudgeted cash needs which may arise without resorting to borrowing, subject to regulatory limitations.
Deferred policy acquisition costs, which represent the deferral of ceding commission expense related to premiums not yet earned, increased from December 31, 2003 along with the increase in unearned premiums. The current ceding commission rate, which became effective August 1, 1995, is 28.5% for CNA. The ceding rate for the carrier for the attorneys professional liability we reinsured in 2003 was 10%. In addition a federal excise tax of 1% is applied on premiums earned. The 2.6% increase over 2003 was due to the increase in net premiums earned by the Company.
Based in part upon the analysis that resulted in the $5.0 million reduction in our loss reserves discussed above, our Board of Directors determined that we had capital in excess of that currently required. Therefore, on December 22, 2003, the Board declared a special dividend of $10.50 per share, ($3.5 million in the aggregate) to return a portion of our capital to our shareholders. The special dividend was paid January 15, 2004.
AmerInst Insurance Company, Ltd.’s ability to pay dividends to AmerInst is subject to the provisions of the Bermuda insurance and companies laws. Under the Companies Act, that subsidiary would be prohibited from declaring or paying a dividend at December 31, 2004 if such payment would reduce the realizable value of its assets ($61,491,071) to an amount less than the aggregate value of its liabilities ($44,527,182), issued share capital ($120,000), and share premium (additional paid-in capital in the amount of $5,879,981) accounts. As at December 31, 2004, $10,963,908 was available for the payment of dividends to shareholders. In addition, that subsidiary must be able to pay its liabilities as they come due after the payment of a dividend. Our ability to pay dividends to common shareholders and to pay our operating expenses is dependent on cash dividends from our subsidiaries. The payment of such dividends by AmerInst Insurance Company, Ltd., including its subsidiary, AmerInst Investment Company, Ltd., to us is also limited under Bermuda law by the Insurance Act and related regulations which require that AmerInst Insurance Company, Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2004 and 2003 these requirements have been met as follows:
The Bermuda Monetary Authority previously authorized the purchase of up to 15,000 of our shares by AmerInst Investment Company, Ltd. Such purchases are made through privately negotiated transactions and are in addition to our practice of purchasing the shares of individuals who have died or retired from the practice of public accounting. Subsequently, the Authority authorized blanket permission for AmerInst Investment Company, Ltd. to purchase common shares without limit from individuals who have died or retired from the practice of public accounting and on a negotiated case-by-case basis. Through March 1, 2005, AmerInst Investment Company, Ltd. had purchased in negotiated transactions at various prices 17,692 common shares for a total purchase price of $565,043. In addition, through that date, AmerInst Investment Company, Ltd. had purchased 16,365 common shares from individuals who had died or retired for a total purchase price of $739,531. As a condition to the tender offer described below, the Authority authorized the acquisition by AmerInst Investment Company, Ltd. of up to 20% of our outstanding shares.
On December 17, 2004, AmerInst, through its indirect wholly owned subsidiary, AmerInst Investment Company, Ltd., commenced a “modified Dutch auction” self-tender offer for AmerInst shares. Pursuant to the tender offer, which expired on January 21, 2005, 65,959 shares were accepted for purchase at a price of $60.00 per share, for a total purchase price of $3,957,540.
In 2003, for the first time, our actuary was able to analyze the loss and allocated loss adjustment expenses separately for CNA’s value plan and premier plan policies. The analysis of this additional data, not previously available from the ceding company, resulted in a decrease in the actuary’s estimate of ultimate loss and loss adjustment expenses. In addition, the actuary was able to obtain more detailed information concerning the distribution of policy limits purchased by insureds under the value plan. Using more detailed limits information also resulted in a decrease in ultimate loss and loss adjustment expenses. Detailed information for value plan policies was only available for treaty periods December 1, 1999 and after. Consequently, value plan experience for periods earlier than December 1, 1999 was included in the premier plan analysis.
The attorneys’ professional liability coverage was a new program for the Company in 2003. The relationship with the carrier of that insurance was terminated December 31, 2003. Therefore, policies written during 2003 are the only ones we have reinsured. An estimated ultimate loss and allocated loss adjustment expense ratio of 75% was selected for this business.
The above table of losses reestimated has been prepared on a net basis - i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up. The schedule has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the costs of providing such information relative to any benefits of providing it.
AmerInst Insurance Group, Ltd., (“AMIG Ltd.” or the “Company”) was formed under the laws of Bermuda on July 16, 1998. The Company, through its wholly-owned subsidiary AmerInst Insurance Company, Ltd. (AMIC Ltd.) and its predecessor (AIIC Inc.), has been engaged in the reinsurance of claims-made insurance policies of participants in an AICPA-endorsed insurance program that provides accountants’ professional liability insurance coverage (“AICPA Plan”). In 1999, as part of the redomestication and restructuring, AMIC Ltd. assumed the rights and obligations of its predecessor under the reinsurance agreements.
The reinsurance activity of AMIC Ltd. depends upon agreements entered into with outside parties. In August 1993, the AICPA Plan endorsed the CNA insurance group as its insurance carrier. AIIC Inc. then began a reinsurance relationship with CNA, taking a 10% participation of the first $1,000,000 of liability of each policy written under the plan. Effective in December 1999, the Company began taking a 10% share of the “value plan” business from CNA. The “value plan” provides for separate $1,000,000 limits for losses and separate $1,000,000 limits for expenses per occurrence and $2,000,000 in the aggregate. Our maximum limits under the “value plan” are $2,000,000 per occurrence and $4,000,000 in the aggregate.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of AMIG Ltd. and its wholly-owned subsidiaries, AmerInst Mezco, Ltd. (“Mezco”), AMIC Ltd. and AmerInst Investment Company, Ltd. (“Investco”). Intercompany accounts and transactions have been eliminated in consolidation.
The anticipated effect of inflation is implicitly considered when estimating liabilities for unpaid losses and loss adjustment expenses. Future average severities are projected based on historical trends adjusted for anticipated trends, are monitored based on actual development and are modified if necessary.
Pursuant to the reinsurance agreements, AMIC Ltd. is required to provide the ceding companies with collateral for AMIC Ltd.’s liabilities to them. At December 31, 2004 and 2003 $137,328 was held in deposit pursuant to the 2003 excess reinsurance agreement with PDIC. Also at December 31, 2004 and 2003, the carrying value of investments in a trust account held by Bank of New York pursuant to reinsurance agreements in effect from 1989 to mid-1993 was $121,642 and $240,090, respectively. Additionally, at December 31, 2004 and 2003, AMIC Ltd. had provided CNA with a Section 114 Trust, held by JPMorgan Chase Bank, with investments with a carrying value of $17,102,599 and $17,518,895 respectively.
The cost or amortized cost, gross unrealized holding gains and losses, and estimated fair value of investments in fixed maturity investments, by major security type, and equity securities at December 31, 2004 and 2003 are as follows:
$22,321 of the gross unrealized losses have been unrealized losses for greater than 12 months and $388,006 of the gross unrealized losses have been unrealized losses for less than 12 months. As of December 31, 2004, none of these securities were considered to be other than temporarily impaired.
The cost or amortized cost and estimated fair value of fixed maturity investments at December 31, 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations without penalties.
Major categories of net interest and dividend income, and net realized gains (losses) on sales of investments are summarized as follows:
A reconciliation of assumed to net premiums, on both a written and an earned basis is as follows:
AMIG Ltd., AMIC Ltd., Mezco and Investco have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. USA Risk Group (Bermuda) Ltd. provides AMIG Ltd. and AMIC Ltd. certain management, administrative and operations services under the direction of the AMIG Ltd.’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party upon not more than ninety days nor less than 60 days prior written notice. Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $312,848 in 2004, $228,367 in 2003 and $212,192 in 2002.