The Company designs, markets, and underwrites specialty commercial and personal property and casualty insurance products for select markets or niches by offering differentiated products through multiple distribution channels. The Company’s operations are classified into three reportable business segments which are organized around its three underwriting divisions: The Commercial Lines Underwriting Group has underwriting responsibility for the commercial multi-peril package, commercial automobile, specialty property and inland marine and the antique/collector car insurance products; The Specialty Lines Underwriting Group, has underwriting responsibility for the professional and management liability insurance products; and The Personal Lines Group, has responsibility for personal property insurance products for the homeowners and manufactured housing markets. The Company operates solely within the United States through its 13 regional and 25 field offices.
During 2006, the Company experienced strong gross written premium growth for its commercial and specialty lines segments due to an increase in policy counts resulting from continued expansion of marketing efforts through the Company’s field organization and preferred agents; and the introduction of several new niche product offerings. For the Company’s personal lines segment, gross written premiums declined due to a decrease in policy counts resulting from the continued shift in product mix from mobile homeowners policies to homeowners policies, restricted new business production due to the significant increase in catastrophe reinsurance rates and restricted availability of coverage experienced at the June 1, 2006 catastrophe reinsurance renewal; and continued efforts to manage the probable maximum loss exposure. Realized average rates for commercial and specialty lines renewal business were basically unchanged, and realized average rate increases on personal lines renewal business approximated 26%.
The Company believes its core strategy of adhering to an underwriting philosophy of sound risk selection and pricing discipline have enabled the Company to produce loss ratios that have been well below industry averages. The Company monitors certain measures of growth and profitability for each business unit, including, but not limited to: number of policies written, renewal retention ratios, new business production, pricing, risk selection and loss ratios. Other key financial metrics that are regularly monitored in evaluating financial condition and operating performance include, but are not limited to: level of expenses, investment performance, return on equity, cash flow and capital leverage.
The carrying amount for the Company’s investments approximates their estimated fair value. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from third party broker-dealers. Material assumptions and factors utilized by such broker-dealers in pricing these securities include: future cash flows, constant default rates, recovery rates and any market clearing activity that may have occurred since the prior month-end pricing period. The Company’s total investments include $3.3 million in securities for which there is no readily available independent market price.
The Company regularly performs impairment reviews with respect to its investments. For investments other than interests in securitized assets, these reviews include identifying any security whose fair value is below its cost and an analysis of securities meeting predetermined impairment thresholds to determine whether such decline is other than temporary. If the Company determines that it does not intend to hold a security to maturity or determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized investment loss in the period the impairment arose (See Investments). Gross unrealized losses for investments excluding interests in securitized assets at December 31, 2006 were $11.4 million. The Company’s impairment review also includes an impairment evaluation for interests in securitized assets conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Gross unrealized losses for investments in securitized assets at December 31, 2006 were $9.3 million.
The liability for unpaid loss and loss adjustment expenses reflects the Company’s best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. The process of establishing the liability for property and casualty unpaid loss and loss adjustment expenses is a complex and imprecise process, requiring the use of
The Company’s methodology is to employ several generally accepted actuarial methods to determine loss reserves, each of which has its own strengths and weaknesses. These methods generally fall into one of the categories described below, or they are hybrids of one or more of them (e.g., the Bornhuetter-Ferguson method which blends development and expected methods). The predictive accuracy of any of these methods may vary by line of business, age of development, and credibility of underlying historical experience data. Loss development methods tend to be more accurate where claims data are relatively stable and for older accident years within most lines of business. Expected loss methods and hybrid methods can be more appropriate for more recent accident years. Adjusted historical loss development methods are employed where volatile claims data can be largely attributed to discernable events, such as changes in claim handling procedures. Accordingly, more or less weight is placed on a particular method based on the facts and circumstances at the time the actuarially determined loss reserve estimates are made.
These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors which have affected paid losses in the past, such as claim settlement patterns, inflation, or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods that use incurred losses in situations where there are significant changes in how case reserves are established by claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses, because cumulative loss payments can take much longer to converge on the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
These methods take traditional historical paid and incurred loss development methods and adjust them for the estimated impact of recent changes, such as inflation, changes in coverage and/or demographics of the line of business, the speed of claim payments, or the adequacy of case reserves. During periods of significant change, adjusted historical paid and incurred loss development methods are often more reliable methods of predicting ultimate losses provided the actuaries can reasonably quantify the impact of each change.
The Company has a loss reserve review committee consisting of senior members of actuarial, corporate, claims, underwriting and financial management. This committee generally meets monthly to review and discuss the various monthly and quarterly actuarial analyses which are performed, as well as to discuss any other factors or trends that may influence the Company’s claims activity. Generally, loss reserves are recorded in accordance with the actuarially determined estimates by line of business. However, based upon review performed by the loss reserve committee, the committee may make a “management adjustment” to an actuarially determined estimate for a line of business if, in the committee’s collective judgment, factors affecting ultimate losses in a line have not been fully captured or considered by actuarial methods. This may be the case with newer product lines, lines that are growing, and/or lines which may be exposed to claims with latent emergence patterns that extend beyond the credible historical period that the Company has experienced to date. Any such “management adjustment” is documented and reported to the Company’s audit committee. The Company’s loss reserve committee did not establish a management adjustment as of December 31, 2006. Accordingly, the loss reserves recorded in the financial statements as of December 31, 2006 are equal to the actuarially determined estimate for each line of business.
For example, a 5% increase in an expected loss ratio of 50% would equal 55% (50% + 5%)
The Company’s 175 Preferred Agents are eligible to receive profit sharing based upon achieving minimum premium production thresholds and profitability results for their business placed for a contact year with the Company. The ultimate amount of profit sharing may not be known until the final contractual loss evaluation of the profit sharing is completed 6.5 years after the contract year business has been written. The Company estimates the liability for this profit sharing based upon the contractual provisions of the profit sharing agreements and the Company’s actual historical profit sharing payout. As of December 31, 2006, the Company has accrued a liability for profit sharing of $21.9 million, of which $20.6 million relates to business written for contract years commencing January 1, 2003 and thereafter. The Company has estimated the profit sharing liability to be 2.4% of the preferred agent business written for contract years commencing January 1, 2003 and thereafter. For each 100 basis points increase or decrease from the currently estimated 2.4% payout, the estimated profit sharing liability would increase or decrease by approximately $11.6 million. The maximum potential ultimate profit sharing payout is 5.0% of preferred agent business written for contract years commencing January 1, 2003 and thereafter.
Effective January 1, 2006, the Company adopted on a modified prospective transition method Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including stock options, stock settled stock appreciation rights (“SARS”), restricted stock and employee and director stock purchases related to the Employee Stock Purchase Plan, Nonqualified Employee Stock Purchase Plan, and Directors Stock Purchase Plan based on fair values. The Company’s financial statements as of and for the year ended December 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Share-based compensation expense recognized in the Company’s Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2006 includes compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for its pro forma information required under SFAS 123. Share-based compensation expense related to stock options and SARS was $7.3 million, before income taxes for the year ended December 31, 2006. During the year ended December 31, 2005, no share-based compensation expense related to stock options was recognized under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”). During the year ended December 31, 2006, share-based compensation expense related to restricted stock grants and employee and director stock purchase plans was $2.7 million. During the year ended December 31, 2005, share-based compensation expense related to restricted stock grants was $0.4 million under APB 25. See Note 15 to the Consolidated Financial Statements for additional information.
Upon adoption of SFAS 123(R), the Company elected to value share-based payment awards granted beginning in 2006 using the Black-Scholes option-pricing model, (“Black-Scholes model”) which was also previously used for the pro forma information required under SFAS 123. For additional information, see Note 15 to the Company’s Consolidated Financial Statements. The
determination of fair value of share-based payment awards on the date of grant using the Black-Scholes model is affected by the Company’s stock price, as well as the input of other subjective assumptions. These assumptions include, but are not limited to the expected term of stock options and SARS and the Company’s expected stock price volatility over the term of the awards. Options and the option component of the Employee and Directors Stock Purchase Plans shares have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.
The expected term of stock options and SARS represents the weighted-average period the stock options and SARS are expected to remain outstanding. The expected term is based on the observed and expected time to post-vesting exercise and forfeitures of options by the Company’s employees. Upon the adoption of SFAS 123(R), the expected term of stock options and SARS was determined based on the demographic grouping of employees. Prior to January 1, 2006, the expected term of stock options was determined based on a single grouping of employees. Upon adoption of SFAS 123(R), historical volatility was utilized in deriving the expected volatility assumption as allowed under SFAS 123(R). Prior to January 1, 2006, the historical stock price volatility in accordance with SFAS 123 for purposes of the Company’s pro forma information was utilized. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant appropriate for the expected life of the Company’s stock options and SARS. The dividend yield assumption is based on the history and the expectation of no dividend payouts.
The Company has no off-balance sheet arrangements (as that term is defined in Item 303(a) (4) of Regulation S-K) that have or are reasonably likely to have a current or, as of December 31, 2006, future effect on its financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors as of December 31, 2006.
Prospecting efforts by marketing personnel in conjunction with long term relationships formed by the Company’s marketing Regional Vice Presidents continue to result in additional prospects and increased premium writings in existing product offerings,
Continued expansion of marketing efforts relating to Commercial Lines and Specialty Lines products through the Company’s field organization and preferred agents.
An increase to in-force policy counts as of December 31, 2006 versus December 31, 2005 of 15.7% for the Specialty Lines segment, primarily as a result of the factors discussed above.
Realized average rate increases on renewal business approximating 0.9%, and 26.3% for the Commercial and Personal Lines segments, respectively.
This growth in gross written premiums was offset in part by:
A decrease in Liberty’s renewal retention percentage to 65.1% in the fourth quarter of 2006, as compared to its year-to-date renewal retention for the nine months ending September 30, 2006 of 90.9%. This decrease in renewal retention is primarily attributed to Liberty’s implementation of rate increases effective September 1, 2006, relating to higher reinsurance costs. These rate increases are subject to reduction pending Florida Office of Insurance Regulation final approval.
A decrease in the lawyers professional liability gross written premium of $7.1 million as a result of non-renewing policies due to unacceptable underwriting results. Total 2006 gross written premium for the lawyers professional liability product was $11.8 million. The Company will continue to non-renew its remaining lawyers professional liability business in 2007.
During the year ended December 31, 2005, the Company experienced catastrophe losses attributable to Hurricanes Dennis, Katrina, Rita and Wilma. These multiple hurricane events resulted in the recognition of reinstatement and accelerated catastrophe reinsurance premium expense of $3.9 million ($0.6 million for the Commercial Lines Segment and $3.3 million for the Personal Lines Segment) during the year ended December 31, 2005 due to the utilization of certain of the catastrophe reinsurance coverages. This recognition of reinstatement and accelerated reinsurance premium expense increased reinsurance ceded written and earned premiums and reduced net written and earned premiums. The Company experienced no such catastrophe losses during 2006.
The Company also experienced higher property catastrophe reinsurance costs, increased catastrophe loss retentions, and decreased catastrophe coverage limits for its June 1, 2006 reinsurance renewal compared to the June 1, 2005 renewal as a result of the hardening property catastrophe reinsurance market.
Other Income: Other income approximated $2.6 million and $1.5 million for the years ended December 31, 2006 and 2005, respectively. Other income consists primarily of commissions earned on brokered personal and commercial lines business, and fees earned on servicing personal lines business.
An $18.3 million reduction in ceded loss and loss adjustment expenses pursuant to a 10% quota share agreement (See Premiums). Ceded loss and loss adjustment expenses pursuant to this quota share agreement for the year ended December 31, 2005 were $18.3 million; however, due to the Company’s decision to terminate this agreement on a run-off basis effective December 31, 2004, there were no losses ceded to this agreement during 2006.
A $21.3 million decrease in ceding commission earned pursuant to the Company’s quota share agreements (See “Premiums”). During the year ended December 31, 2006, the Company earned no ceding commissions related to quota share agreements, as compared to $21.3 million of ceding commissions earned during 2005. There were no ceded earned premiums pursuant to these quota share agreements for the year ended December 31, 2006 as compared to $43.7 million for 2005 due to the Company’s decision to terminate its 10% quota share agreement on a run-off basis effective December 31, 2004.
These increases were partially offset by a $9.3 million change in net charges related to assessments from Citizen’s Property Insurance Corporation (“Citizens”). During 2006, the Company recognized a net reduction to expense of $3.4 million related to Citizens assessments, compared to a net increase to expense of $5.9 million related to Citizens assessments during 2005. The $3.4 million reduction to expense during 2006 is comprised of:
Citizens was established by the State of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. Citizens assessments may be recouped through future insurance policy surcharges to Florida insureds. These surcharges are recorded in the Company’s consolidated financial statements as the related premiums are written.
Other Operating Expenses: Other operating expenses decreased by $4.5 million to $12.6 million for the year ended December 31, 2006 from $17.1 million for the same period of 2005. Of this decrease, $2.0 million is due to a bonus accrual for the year ended December 31, 2005 related to the terms of an employment agreement with the Company’s founder and Chairman. There was no such bonus accrual for 2006.
The introduction of a number of new Sports and Fitness niche products.
lines segment, and $(0.2) million for the personal lines segment) of net written premiums, respectively, and $43.7 million ($36.5 million for the commercial lines segment, $7.1 million for the specialty lines segment and $0.1 million for the personal lines segment) and $132.5 million ($103.6 million for the commercial lines segment, $23.4 million for the specialty lines segment, and $5.5 million for the personal lines segment) of net earned premiums, respectively.
During the year ended December 31, 2004, the Company experienced catastrophe losses attributable to Hurricanes Charley, Frances, Ivan and Jeanne. Due to these multiple hurricane events, the Company purchased additional catastrophe reinsurance coverages (which provided coverage from the inception date of the coverage through May 31, 2005) to supplement its original reinsurance programs. The estimated aggregate pre-tax cost of these additional catastrophe reinsurance coverages is $22.9 million. Additionally, these multiple hurricane events resulted in accelerating the recognition of $26.0 million (Commercial Lines Segment ($2.2 million), and Personal Lines Segment ($23.8 million)) catastrophe reinsurance premium expense during 2004 due to the utilization of certain of the catastrophe reinsurance coverages. Of this $26.0 million, $10.3 million was attributable to the additional reinsurance coverages referred to above. This acceleration of reinsurance premium expense increased reinsurance ceded written and earned premiums and reduced net written and earned premiums.
The total return, which includes the effects of both income and price returns on securities, of the Company’s fixed income portfolio was 2.34% and 4.05% for the years ended December 31, 2005 and 2004, respectively, compared to the Lehman Brothers Intermediate Aggregate Bond Index (“the Index”) total return of 2.01% and 3.76% for the same periods, respectively. The Company expects some variation in its portfolio’s total return compared to the Index because of the differing sector, security and duration composition of its portfolio as compared to the Index.
A $5.9 million net charge during 2005 for assessments from Citizens Property Insurance Corporation (“Citizens”). Citizens was established by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market.
The following table summarizes the impact to the Company of Citizens assessments recognized during 2005:
A $42.5 million decrease in acquisition costs and other underwriting expenses due to an automobile excess liability customer’s decision to self insure business previously written by the Company (see Premiums). During the year ended December 31, 2005, the Company incurred $9.0 million in acquisition and underwriting expenses vs. $51.5 million during the same period in 2004 for the automobile excess liability product. Net earned premiums for this product were $13.8 million for the year ended December 31, 2005 vs. $71.3 million for the same period of 2004.
A $40.2 million decrease in ceding commission earned pursuant to quota share agreements (see Premiums). During the year ended December 31, 2005, the Company earned $21.3 million in ceding commissions vs. $61.5 million during the same period of 2004. Ceded earned premiums pursuant to these quota share agreements were $43.7 million for the year ended December 31, 2005 vs. $132.5 million for the same period of 2004.
The Company’s fixed maturity portfolio amounted to $2,129.6 million and $1,761.5 million, as of December 31, 2006 and December 31, 2005, respectively, of which 99.9% of the portfolio as of December 31, 2006 and December 31, 2005 was comprised of investment grade securities. The Company had fixed maturity investments with gross unrealized losses amounting to $18.1 million and $23.5 million as of December 31, 2006 and December 31, 2005, respectively. Of these amounts, interests in securitized assets had gross unrealized losses amounting to $9.3 million and $9.7 million as of December 31, 2006 and December 31, 2005, respectively.
The Company’s impairment evaluation as of December 31, 2006 for interests in securitized assets resulted in the following conclusions:
The Company’s impairment evaluation as of December 31, 2006 for equity securities resulted in the conclusion that the Company does not consider the equity securities to be other than temporarily impaired. Of the 3,555 investment positions held, approximately 14.8% were in an unrealized loss position.
As mentioned above, there are certain risks and uncertainties inherent in the Company’s impairment methodology, including, but not limited to, the financial condition of specific industry sectors and the resultant effect on any underlying security collateral values and changes in accounting, tax, and/or regulatory requirements which may have an effect on either, or both, the investor and/or the issuer. Should the Company subsequently determine that it does not intend to hold the security until maturity or should it determine that a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included as a realized loss for the period in which such determination was made, thereby reducing earnings for such period by the amount of such realized loss.
$1.2 million of the $5.5 million gross loss on the sale of equity securities for the year ended December 31, 2005 was the result of the liquidation of certain of the Company’s equity portfolios following the Company’s decision to change four of its common stock
investment managers. This $1.2 million realized gross loss was in addition to the previously reported $1.4 million impairment loss recognized during the three months ended December 31, 2004 upon the Company’s initial decision to change three of its common stock investment managers and no longer hold the securities to recovery.
The table below provides information about the Company’s financial instruments that are sensitive to changes in interest rates and shows the effect of hypothetical changes in interest rates as of December 31, 2006 and 2005. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios. The information is presented in U.S. dollar equivalents, which is the Company’s reporting currency.
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose principal assets currently consist of 100% of the capital stock of its subsidiaries. PCHC’s primary sources of funds are payments received pursuant to tax allocation agreements with the Insurance Subsidiaries, dividends from its subsidiaries, and proceeds from the issuance of shares pursuant to the Company’s Stock Purchase and Performance Based Compensation Plans. For the year ended December 31, 2006, payments to PCHC pursuant to such tax allocation agreements totaled $160.8 million. The payment of dividends to PCHC from the Insurance Subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania and State of Florida. Accumulated statutory profits of the Insurance Subsidiaries from which dividends may be paid totaled $734.4 million at December 31, 2006. Of this amount, the Insurance Subsidiaries are entitled to pay a total of approximately $270.9 million of dividends in 2007 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida (see Business Regulation). During 2006, no dividends were paid by the Insurance Subsidiaries, and no capital contributions were made by PCHC to the Insurance Subsidiaries. During 2006, there were no stock repurchases under the stock repurchase authorization. At December 31, 2006, the remaining stock repurchase authorization is $45.0 million.
The Company produced net cash from operations of $506.8 million, $430.7 million and $390.5 million in 2006, 2005 and 2004, respectively. Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses and to purchase investments. Cash from operations in 2006 was primarily generated from strong premium growth during the year due to new business written and strong renewal business retention. Net loss and loss expense payments were $313.8 million, $234.7 million and $285.9 million in 2006, 2005 and 2004, respectively. Net cash from operations also included cash provided from tax savings from the issuance of shares pursuant to stock based compensation plans amounting to $1.5 million, $7.0 million and $1.0 million for 2006, 2005 and 2004, respectively. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
The Company produced $20.3 million of net cash from financing activities during 2006. Cash provided from financing activities consisted of an $8.7 million excess tax benefit from the issuance of shares pursuant to stock based compensation plans; $7.1 million from the Company’s stock purchase plans; $6.7 million from the exercise of stock options issued under the Company’s performance based compensation plan and $2.5 million from the collection of notes receivable associated with the Company’s employee stock purchase plans. Cash used for financing activities consisted of $4.7 million for shares withheld to satisfy a minimum required tax withholding obligation arising upon the exercise of employee stock options.
During 2006, $274.7 million of the fixed maturity portfolio principal was received through either maturity, call option, paydown or sinking fund transactions. The fixed maturity portfolio cash flow profile has been structured such that approximately 10% of the portfolio principal as of December 31, 2006 will be received from maturity, call option, paydown or sinking fund transactions each year through 2012. It is estimated that approximately $250.0 million will be received from these transactions during 2007.
Represents open commitments under certain limited partnership agreements, information technology development agreements, corporate sponsorship and renewal rights agreements.
As of December 31, 2006, the Company has recorded a $2.0 million liability for a bonus amount due to the Company’s founder and Chairman under the terms of his employment agreement with the Company. This payment is due to be paid six months after the date of the termination of his employment with the Company. Since his date of termination is uncertain, this payment has been excluded from the above table.
the financial instrument, resulting in the host and the embedded derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities to account for financial instruments with an embedded derivative at fair value thus negating the need to bifurcate the instrument between its host and the embedded derivative. SFAS No. 155 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. The Company will adopt SFAS No. 155 on January 1, 2007 and believes the financial impact of application will not be significant.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred. SFAS No. 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. An entity is prohibited from retrospectively applying SFAS No. 159, unless it chooses early adoption. SFAS No. 159 also applies to eligible items existing at November 15, 2007 (or early adoption date). The Company is currently in the process of evaluating the impact of SFAS No. 159.
Consolidated Balance Sheets - As of December 31, 2006 and 2005
Consolidated Statements of Cash Flows - For the Years Ended December 31, 2006, 2005, and 2004
Condensed Financial Information of Registrant As of December 31, 2006 and 2005 and For Each of the Three Years in the Period Ended December 31, 2006
Supplementary Insurance Information As of and For the Years Ended December 31, 2006, 2005 and 2004
Supplementary Information Concerning Property-Casualty Insurance Operations As of and For the Years Ended December 31, 2006, 2005 and 2004
We have completed integrated audits of Philadelphia Consolidated Holding Corp. and Subsidiaries’ 2006, 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
The carrying amount for the Company’s investments approximates their estimated fair value. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from third party broker-dealers. Material assumptions and factors utilized by such broker-dealers in pricing these securities include: future cash flows, constant default rates, recovery rates and any market clearing activity that may have occurred since the prior month-end pricing period. For mortgage and asset-backed securities (“structured securities”) of high credit quality, changes in expected cash flows are recognized using the retrospective method. For structured securities where the possibility of credit loss is other than remote, changes in expected cash flows are recognized on the prospective method over the remaining life of the securities. Cash flow assumptions for structured securities are obtained from a primary market provider of such information. These assumptions represent a market based best estimate of the amount and timing of estimated principal and interest cash flows based on current information and events. The Company’s total investments include $3.3 million and $3.4 million in securities as of December 31, 2006 and 2005, respectively, for which there is no readily available independent market price.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for asset backed, mortgage pass-through and collateralized mortgage obligation securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain asset backed, mortgage pass-through and collateralized mortgage obligation security repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Asset backed, mortgage pass-through and collateralized mortgage obligation securities, on a cost basis, amounted to $202.1 million, $425.5 million and $293.1 million, respectively, as of December 31, 2006 and $138.3 million, $282.3 million and $227.0 million, respectively, as of December 31, 2005.
The Company regularly performs impairment reviews with respect to its investments. For investments other than interests in securitized assets, these reviews include identifying any security whose fair value is below its cost and an analysis of securities meeting predetermined impairment thresholds to determine whether such decline is other than temporary. If the Company determines that it does not intend to hold a security to maturity or determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized investment loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $8.8 million, $2.2 million and $2.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company’s impairment review also includes an impairment evaluation for interests in securitized assets conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. This evaluation resulted in no non-cash realized investment losses for the years ended December 31, 2006 or 2005. For the year ended December 31, 2004, this evaluation resulted in non-cash realized investment losses of $7.3 million
The Company carried no goodwill in its consolidated balance sheets as of December 31, 2006 or 2005.
Through December 31, 2005, the Company performed an annual impairment analysis to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). This annual test was performed at December 31 of each year or more frequently if events or circumstances changed that required the Company to perform the impairment analysis on an interim basis.
Other Intangible Assets are carried in the Consolidated Balance Sheet as a component of Other Assets. Other intangible assets consist of rights with respect to the renewals of insurance policies and a trade name pertaining a purchase during 2006 of an antique/collector vehicle insurance program. As of December 31, 2006, total gross intangible assets amounted to $15.3 million, and accumulated amortization amounted to $0.8 million. Renewal rights are being amortized over a period of 12 years, and the trade name is being amortized over a period of three years. The aggregate amortization expense of other intangible assets was $0.8 million during the year ended December 31, 2006. The Company carried no other intangible assets as of December 31, 2005.
Premiums are generally earned on a pro-rata basis over the terms of the policies. Premiums applicable to the unexpired terms of the policies in-force are reported as unearned premiums. The Company records an allowance for doubtful accounts for premiums receivable balances estimated to be uncollectible. At December 31, 2006 and 2005, the allowance for doubtful accounts amounted to $0.3 million and $0.8 million, respectively.
Certain of the Company’s reinsurance contracts have reinstatement or additional premium provisions under which the Company must pay reinstatement or additional reinsurance premiums to reinstate coverage provisions upon utilization of initial reinsurance coverage. The Company accrues reinstatement and additional premiums based on ultimate loss estimates. During the years ended December 31, 2006 and 2005, the Company accrued $5.3 million and $3.7 million, respectively, of additional reinsurance premium under its casualty excess of loss reinsurance treaties as a result of changes in ultimate loss estimates.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS 123(R)”) using the modified prospective transition method, which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including stock options, stock settled appreciation rights (“SARS”), restricted stock and employee and director stock purchases related to the Employee Stock
Components of comprehensive income, as detailed in the Consolidated Statements of Operations and Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising during the year was $11.4 million, $(8.8) million and $1.9 million in 2006, 2005 and 2004, respectively. The related tax effect of Reclassification Adjustments was $3.5 million, $(3.4) million and $(0.3) million in 2006, 2005 and 2004, respectively.
accounting for interim periods, disclosure and transition. The Company will adopt FIN 48 on January 1, 2007 and expects that it will not have a material effect on financial condition or results of operations.
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”), which clarifies that the term fair value is intended to mean a market-based measure, not an entity-specific measure and gives the highest priority to quoted prices in active markets in determining fair value. SFAS No. 157 requires disclosures about (1) the extent to which companies measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair value, and (3) the effect of fair value measures on earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently in the process of evaluating the impact of SFAS No. 157.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred. SFAS No. 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. An entity is prohibited from retrospectively applying SFAS No. 159, unless it chooses early adoption. SFAS No. 159 also applies to eligible items existing at November 15, 2007 (or early adoption date). The Company is currently in the process of evaluating the impact of SFAS No. 159.
Under SAP, investments in debt securities are carried at amortized cost, while under GAAP, investments in debt securities classified as Available for Sale are carried at fair value.
Under SAP, unpaid losses and loss adjustment expenses and unearned premiums are reported net of the effects of reinsurance transactions, whereas under GAAP, unpaid loss and loss adjustment expenses and unearned premiums are reported gross of reinsurance.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which the Insurance Subsidiaries may pay to the Philadelphia Insurance during 2007 without prior approval is $270.9 million. There were no dividends paid by the Insurance Subsidiaries for the years ended December 31, 2006 or 2005.
The Company’s impairment evaluation as of December 31, 2006 for fixed maturities available for sale excluding interests in securitized assets resulted in the following conclusions:
The unrealized losses on the Company’s investments in long term tax exempt securities which have ratings of A1/A+ to AAA/Aaa are generally caused by interest rate increases. Of the 736 investment positions held, approximately 49.3% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments.
The unrealized losses on the Company’s investments in Mortgage Pass-Through Securities which have ratings of Aaa/AAA are generally caused by interest rate increases. Of the 130 investment positions held, approximately 58.5% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments.
During 2006, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $1.7 million and $7.0 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $185.2 million and $40.5 million, respectively. During 2005, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $0.9 million and $5.5 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $63.6 million and $56.5 million, respectively. During 2004, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $1.3 million and $1.9 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $30.7 million and $7.5 million, respectively.
Original cost adjusted for amortization of premiums and accretion of discounts. All amounts are shown net of impairment losses.
The sources of net investment income for the years ended December 31, 2006, 2005 and 2004 are as follows (in thousands):
There was one non-income producing fixed maturity security, with a carrying value of $0.8 million, in the investment portfolio as of December 31, 2006.
The Company maintains investments in trust accounts under certain reinsurance agreements with unrelated insurance companies. These investments collateralize the Company’s obligations under the reinsurance agreements. The Company possesses sole responsibility for investment and reinvestment of the trust account assets. All dividends, interest and other income resulting from investment of these assets are distributed to the Company on a monthly basis. At December 31, 2006 and 2005, the carrying values of these trust fund investments were $2.0 million and $1.7 million, respectively.
Subsequent to the purchase of the cash flow hedge, the Company decided against the issuance of a debt offering. As a result, the cash flow hedge became an ineffective hedge and the change in fair value of the hedge was reported as a component of earnings immediately. The cash flow hedge settled on May 9, 2005. For the year ended December 31, 2005, the Company recorded the change in fair value of $3.2 million as a reduction to net realized investment gain. The Company does not hold any other derivative instruments.
The following table summarizes property and equipment as of December 31, 2006 and 2005 (dollars in thousands):
The Company has no goodwill carried on its Consolidated Balance Sheets as of December 31, 2006 or 2005. During the fourth quarter of 2005, the Company recorded a $25.7 million impairment charge related to the write-down of goodwill arising from the acquisition of the Company’s personal lines segment. This loss, which was the same on a pre-tax and after-tax basis, was a result of the Company’s annual evaluation of the carrying value of goodwill. The write-down was determined by comparing the fair value of the Company’s personal lines segment and the implied value of the goodwill with the carrying amounts on the balance sheet. The write-down resulted from changes in business assumptions primarily due to the following: the unprecedented hurricane activity and associated catastrophe losses experienced in 2004 and 2005; the uncertainty of 2006 catastrophe reinsurance renewal rates; the forecasted weather pattern of increased hurricane activity; the decision to change the personal lines segment business model to discontinue writing the mobile homeowners business and target new construction homeowners business; and the disruption in the Florida marketplace.
For accident years 2002 and prior, the decrease in estimated net unpaid loss and loss adjustment expenses was principally due to lower estimates for rental/leasing auto coverages due to better than expected case incurred loss development resulting from less than anticipated incurred frequency emergence on rental/leasing auto coverages, and less than anticipated incurred severity emergence on rental supplemental liability coverages.
During 2005, the Company decreased its estimated total net unpaid loss and loss adjustment expenses for prior accident years by the following amounts:
During 2004, the Company increased its estimated total gross and net ultimate losses and loss adjustment expenses, primarily for accident years 1997 through 2002, and decreased its estimated total gross and net ultimate losses and loss adjustment expenses for accident year 2003. This increase in the liability for unpaid loss and loss adjustment expense, net of reinsurance recoverables, was primarily due to the following:
Effective April 1, 2003, the Company entered into a quota share reinsurance agreement. Under this agreement, the Company ceded 22% of its net written premiums and loss and loss adjustment expenses for substantially all of the Company’s lines of business on policies effective April 1, 2003 through December 31, 2003, and 10% of its commercial and specialty lines net written premiums and loss and loss adjustment expenses for policies effective January 1, 2004 through December 31, 2004. The Company received a provisional ceding commission of 33.0% adjusted pro-rata based upon the ratio of losses incurred to premiums earned. Pursuant to this reinsurance agreement, the Company withheld the reinsurance premium due the reinsurers, reduced by the reinsurers’ expense allowance and the Company’s ceding commission allowance in a Funds Held Payable to Reinsurer account. This Funds Held Payable to Reinsurer account was also reduced by ceded paid losses and loss adjustment expenses under this agreement, and increased by an interest credit. In addition, the agreement allowed for a profit commission to be paid to the Company upon commutation.
Reinsurance Contract, respectively. As a result of the commutation effective January 1, 2005, the Funds Held Payable to Reinsurer liability was reduced by approximately $77.9 million, offset by an increase to net Unpaid Loss and Loss Adjustment Expenses of $64.3 million, an increase to net Unearned Premiums of $0.2 million and a reduction to the profit commission receivable by approximately $13.4 million. No gain or loss was realized as a result of this commutation. As a result of the commutation effective January 1, 2006, the Funds Held Payable to Reinsurer liability was reduced by approximately $39.2 million, offset by an increase to net Unpaid Loss and Loss Adjustment Expenses of $31.9 million, an increase to net Unearned Premiums of $0.3 million, and a reduction to the profit commission receivable of approximately $7.0 million. No gain or loss was realized as a result of this commutation.
On June 30, 2006, the Company entered into an unsecured Credit Agreement (the “Credit Agreement”) which establishes a revolving credit facility providing for loans to the Company of up to $50.0 million in principal amount outstanding at any one time, with a maturity date of June 29, 2007. The Credit Agreement contains an annual commitment fee of 8.0 basis points per annum on the unused commitments under the Credit Agreement. Each loan under the Facility will bear interest at a per annum rate equal to, at the Company’s option, (i) Libor plus 0.40% or (ii) the higher of the administrative agent and lender’s prime rate and the Federal Funds rate plus 0.50%. As of December 31, 2006, no borrowings have been made by the Company under this Credit Agreement.
The Credit Agreement contains various representations, covenants and events of default typical for credit facilities of this type. As of December 31, 2006, the Company was in compliance with all covenants contained in the Credit Agreement.
During 2005, options to purchase 45,000 shares of the Company’s common stock, which were granted at an exercise price of $28.30 per share, were outstanding during the fourth quarter of 2005, but were not included in the computation of earnings per share for 2005 because the options’ price was greater than the average market price of the Company’s common shares for 2005. The options, which expire on October 3, 2015, were still outstanding as of December 31, 2005.
The Philadelphia Consolidated Holding Corp Amended and Restated Employees’ Stock Incentive and Performance Based Compensation Plan (the “Plan”) (formerly known as Philadelphia Consolidated Holding Corp. Stock Option Plan) provides incentives and awards to those employees and members of the Board of Directors (“participants”) largely responsible for the long term success of the Company.
The maximum number of shares of the Company’s common stock which may be subject to awards granted under the Plan is 18,750,000. The Plan permits (but does not require) the grant of restricted stock awards under conditions meeting the “performance based” compensation requirements of Section 162(m) of the Internal Revenue Code. The maximum number of shares includes all shares previously available for grants under the stock option plan prior to the adoption of this Plan. As of December 31, 2006, 5,013,466 shares of common stock remain reserved for future issuance pursuant to awards granted under the Plan. Under the Plan, the Company may grant stock options, SARS, restricted stock awards and restricted stock units to participants. Stock options, restricted stock awards and SARS have been granted to certain employees, and restricted stock awards have been granted to the Company’s non-employee directors pursuant to the Plan as of December 31, 2006.
Compensation expense for restricted stock awards is recognized ratably over the vesting period (“Restriction Period”). Stock subject to restricted stock awards granted to employees during 2006 become free of the risk of forfeiture (i.e., become vested) generally after the expiration of five years following the grant date (the applicable Restriction Period). Stock subject to restricted stock awards granted to the Company’s non-employee directors during 2006 become free of the risk of forfeiture after the expiration of three years following the grant date. Generally, if a participant terminates employment prior to the expiration of the Restriction Period, the award will lapse and all shares of common stock still subject to the restriction are forfeited.
The aggregate intrinsic value of outstanding and exercisable options as of December 31, 2006 was $211.9 million and $63.3 million, respectively. The total fair value of exercisable options as of December 31, 2006 was $6.0 million. The weighted average remaining contractual life of options outstanding as of December 31, 2006 was 6.1 years.
There was no exercisable SARS outstanding as of December 31, 2006. The aggregate intrinsic value of outstanding SARS as of December 31, 2006 was $10.6 million. The weighted average remaining contractual life of SARS outstanding as of December 31, 2006 was 9.1 years.
The following table presents information regarding restricted stock award transactions for the years ended December 31, 2006 and December 31, 2005. There were no restricted stock award transactions during 2004.
As of December 31, 2006, there was $28.9 million of pre-tax unrecognized compensation costs related to stock options, SARS and restricted stock granted under the Company’s Plan. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.2 years.
The Nonqualified Employee Stock Purchase Plan (the “Nonqualified Stock Plan”): The aggregate maximum number of shares that may be issued pursuant to the Nonqualified Stock Plan is 3,000,000. Shares may be purchased under the Nonqualified Stock Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Shares purchased are restricted for a period of five years from the first day of the
Preferred Agents Stock Purchase Plan (“Preferred Agents Plan”): The Preferred Agents Plan has been established for the benefit of eligible Preferred Agents. The aggregate maximum number of shares that may be issued pursuant to the Preferred Agents Plan is 600,000. During designated offering periods, eligible Preferred Agents may either remit cash or have the Company withhold from commissions or other compensation amounts to be used for the purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Shares purchased are restricted for a period of two years from the first day of the offering period. Under the Preferred Agent Plan, the Company issued 60,492 shares in 2006. There were no shares issued during the year ended December 31, 2005. The weighted-average fair value of those purchase rights granted in 2006 was $5.80.
During the three years ended December 31, 2006, there were no repurchases under the Company’s stock repurchase authorization. At December 31, 2006, $45.0 million remains available under a $75.3 million stock purchase authorization.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS 123(R)”) using the modified prospective transition method, which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including stock options, stock settled appreciation rights (“SARS”), restricted stock and employee and director stock purchases related to the Employee Stock Purchase Plan, Nonqualified Employee Stock Purchase Plan, and Directors Stock Purchase Plan based on fair values. The Company’s financial statements as of and for the year ended December 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Share-based compensation expense recognized in the Company’s Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for its pro forma information required under SFAS 123. Share-based compensation expense related to stock options and SARS was $7.3 million, before income taxes for the year ended December 31, 2006. During the year ended December 31, 2005, no share-based compensation expense related to stock options was recognized under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”). During the year ended December 31, 2006, share-based compensation expense related to restricted stock grants and employee and director stock purchase plans was $2.7 million. During the year ended December 31, 2005, share-based compensation expense related to restricted stock grants was $0.4 million under APB 25.
Upon adoption of SFAS 123(R), the Company elected to value share-based payment awards granted beginning in 2006 using the Black-Scholes option-pricing model, (the “Black-Scholes model”), which was also previously used for the pro forma information required under SFAS 123. The Black-Scholes model requires the input of certain assumptions. The Company’s stock options and the
option component of the Employee Stock Purchase Plan shares have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.
The expected term of stock options and SARS represent the weighted-average period the stock options and SARS are expected to remain outstanding. The expected term is based on the observed and expected time to post-vesting exercise and forfeitures of options by the Company’s employees. The Company uses historical volatility in deriving the expected volatility assumption. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant appropriate for the expected life of the Company’s stock options and SARS. The dividend yield assumption is based on history and expectation of dividend payouts.
As the share-based compensation expense recognized in the Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS 123 for the periods prior to January 1, 2006, forfeitures were estimated based on historical experience.
The Company sponsors an unfunded nonqualified key employee deferred compensation plan. Under the plan, deferred compensation benefits are provided through deferrals of base salary and bonus compensation (“Employee Deferrals”) and discretionary contributions by the Company (“Employer Contributions”) for a select group of management and highly compensated employees of the Company and its subsidiaries. Each participant is permitted to specify an investment or investments from among permissible investments which shall be the basis for determining the gain or loss adjustment applicable to such participant’s plan deferral account. A participant’s interest in the portion of his or her plan deferral account that is attributable to Employee Deferrals are fully vested at all times. That portion of a participant’s plan deferral account attributable to Employer Contributions generally will vest over the course of a five year period beginning on the last day of the first year after the plan year for which the Employer Contribution was made. The amounts in each participant’s plan deferral account represent an obligation of the Company to pay the participant at some time in the future. The Company had a deferred compensation obligation pursuant to the plan amounting to $6.8 million and $4.7 million as of December 31, 2006 and 2005, respectively.
The Company also sponsors an unfunded nonqualified executive deferred compensation plan. Under the plan, deferred compensation benefits are provided by the Company through deferrals of base salary and bonus compensation for management and highly compensated executives designated by the Board of Directors. Each participant is permitted to specify an investment or investments from among permissible investments which shall be the basis for determining the gain or loss adjustment applicable to such participant’s plan deferral account. A participant’s benefit under the plan is the amount of such participant’s plan deferral amount. The Company had a deferred compensation obligation pursuant to the plan amounting to $3.8 million and $3.6 million as of December 31, 2006 and 2005, respectively.
The Company currently leases office space to serve as its headquarters location and 38 field offices for its production marketing and underwriting personnel. In addition, the Company leases certain computer equipment and licenses certain computer software. Rental expense for operating leases was $5.5 million, $5.1 million and $4.0 million for the years ended December 31, 2006, 2005, and 2004, respectively.
Each loan under the Facility will bear interest at a per annum rate equal to, at the Company’s option, (i) Libor plus 0.40% or (ii) the higher of the Administrative Agent and Lender’s prime rate and the Federal Funds rate plus 0.50%. The Credit Agreement contains various representations, covenants and events of default typical for credit facilities of this type. As of December 31, 2006, the Company was in compliance with all covenants contained in the Credit Agreement.
As of December 31, 2006 and December 31, 2005, included in Other Liabilities in the Consolidated Balance Sheets were $15.1 million and $12.8 million, respectively, of liabilities for state guaranty funds. As of December 31, 2006 and December 31, 2005, included in Other Assets in the Consolidated Balance Sheets were $0.2 million and $0.1 million, respectively, of related assets for premium tax offsets or policy surcharges, The related asset is limited to the amount that is determined based upon policy surcharges from policies in force.
Among other state insurance facilities, the Company is subject to assessments from Florida Citizens Property Insurance Corporation (“Florida Citizens”), which was created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. Florida Citizens, at the discretion and direction of its Board of Governors (“Florida Citizens Board”), can levy a regular assessment on participating companies for a deficit in any calendar year up to a maximum of the greater of 10% of the
Florida Citizens reported a deficit for the 2004 plan year. During 2005, the Company recognized a pre-tax $3.9 million net (of reinsurance recoveries) assessment expense for Florida Citizen’s amounts assessed and paid during 2005. Any recoupments of the Florida Citizens assessment through future policy surcharges are allocated between the Company and its reinsurers. Recoupments are recorded by the Company as the related premiums are written. During the year ended December 31, 2006, the Company recognized a pre-tax reduction to its net (of reinsurance recoveries) expense related to the Florida Citizens 2004 plan year of $1.6 million attributable to policyholder surcharge recoupments.
The Company and other insurance companies writing residential property policies in Florida must participate in the Florida Hurricane Catastrophe Fund (“FHCF”). If the FHCF does not have sufficient funds to pay its ultimate reimbursement obligations to participating insurance companies, it has the authority to issue bonds, which are funded by assessments on generally all property and casualty premiums in Florida. By law, these assessments are the obligation of insurance policyholders, which insurance companies must collect. The FHCF assessments are limited to 6% of premiums per year beginning the first year in which reimbursements require bonding, and up to a total of 10% of premiums per year for assessments in the second and subsequent years, if required to fund additional bonding. Upon the order of the Florida Office of Insurance Regulation (“FLOIR”), companies are required to collect the FHCF assessments directly from its policyholders and remit them to the FHCF as they are collected.
During June 2006, the FLOIR approved a 1% emergency assessment effective January 1, 2007 which the Company must collect from its policyholders and remit to the FHCF beginning January 1, 2007.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 2006 and 2005 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):
performance including investment income and net realized investment gain; acquisition costs and other underwriting expenses including commissions, premium taxes and other acquisition costs; and other operating expenses are managed at a corporate level by the corporate accounting function in conjunction with other corporate departments and are included in “Corporate”.
Following is a tabulation of business segment information for each of the past three years. Corporate information is included to reconcile segment data to the consolidated financial statements (in thousands):