Midland owns its 480,000 square foot principal offices located in Amelia, Ohio. Midland’s insurance subsidiaries lease office space in Montgomery, Alabama and St. Louis, Missouri. Midland’s transportation subsidiaries lease offices in Metairie, Louisiana and St. Louis, Missouri. As described under “Liquidity, Capital Resources and Changes in Financial Condition” on page 27. Midland’s premises are suitable and adequate for their intended use.
The Midland Company (“Midland” or the “Company”) is a highly focused provider of specialty insurance products and services through its American Modern Insurance Group, Inc. (“AMIG” or “American Modern”) subsidiary, which contributes approximately 95 percent of the company’s revenues. The Company also maintains an investment in a niche river transportation business, M/G Transport Services Inc. The Company has divided its insurance products into four distinct groups: residential property, recreational casualty, financial institutions, and all other insurance products. The discussions of “Results of Operations” and “Liquidity, Capital Resources and Changes in Financial Condition” address these four reportable insurance segments and our transportation business. A summary description of the operations of each of these segments is included below.
On October 16, 2007 Midland entered into an Agreement and Plan of Merger (the “Merger Agreement”), with Munich-American Holding Corporation, a Delaware corporation (“Parent”), and Monument Corporation, an Ohio corporation and wholly owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub will be merged with and into Midland (“the Merger”) and each common share of Midland (other than shares owned by Midland, Parent and Merger Sub) will be converted into the right to receive $65.00 in cash, without interest. The merger is subject to shareholder approval, approval by state insurance regulators and other customary closing conditions. Certain of our shareholders (who hold approximately 30% of our outstanding common shares) have agreed to vote all of their shares in favor of the merger pursuant to a Voting Agreement, subject to the terms and conditions contained therein. We expect the merger to be completed in the first half of 2008, but no assurance can be made in this regard. For further information regarding the proposed merger, we refer you to our current report on Form 8-K dated October 16, 2007 as filed with the Securities and Exchange Commission as well as the merger proxy material filed on February 25, 2008.
Midland Company Enters Into Material Definitive Agreement with M/G Transport Holdings, LLC
American Modern has continued to experience significant premium growth in its non-manufactured housing product lines, including mortgage fire, collateral protection, and credit life product lines. Collectively, our non-manufactured housing direct and assumed written premiums grew 24.4% in 2007 compared to 2006. Non-manufactured housing products represented 64% and 60% of American Modern’s direct and assumed written premiums and related pre-tax profit, respectively, during 2007.
The following chart shows American Modern’s gross written premium, net written premium and net earned premium by business segment for the years ended December 31, 2007 and 2006 (in millions). Gross written premium, also described as direct and assumed written premium, is the amount of premium charged for policies issued during a fiscal period. Net written premium is the amount of premium that American Modern retains after ceding varying portions of its gross written premium to other insurance companies. Net earned premium is the amount included in our consolidated statements of income. Premiums for physical damage and other property and casualty related coverages, net of premium ceded to reinsurers, are considered earned and are included in the financial results on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the lives of the policies in proportion to the amount of insurance protection provided. The portion of written premium applicable to the unexpired terms of the policies is recorded as unearned premium in our consolidated balance sheets.
Gross written premium, net written premium and net earned premium increased 16.1%, 15.8% and 12.4%, respectively, in 2007 compared to 2006. The most significant contributors to the growth in premiums in 2007 were the mortgage fire, collateral protection, and credit life insurance products included in the financial institutions business segment.
The results from this segment are driven primarily by the manufactured housing and site-built dwelling products. Although the manufactured housing industry continues to be depressed, American Modern’s diverse distribution channels have enabled gross written premiums related to this product to increase to $352.0 million in 2007 compared to $337.8 million in 2006. Site-built dwelling gross written premiums increased 3.4% to $109.2 million in 2007 compared to $105.6 million in 2006.
The increase in pre-tax income was primarily due to the improved underwriting results reflected in our combined ratio of our manufactured housing and site built dwelling products. The combined ratios decreased to 92.8% and 94.6% from 93.5% and 99.5%, respectively in 2006. The decrease in loss and combined ratios is mainly due to the decreased catastrophe losses experienced during 2007 as compared to 2006.
Direct and assumed written premiums for our recreational casualty products increased due primarily to the increase of $4.3 million, $2.6 million and $1.9 million for our collector car, recreational vehicle and motorcycle products, respectively. These increases were offset by a $5.8 million decrease in our watercraft product. The decrease in watercraft direct and assumed written premiums was due primarily to underwriting actions taken to balance our coastal exposures. Although these actions are currently reducing our ability to grow these lines, we believe the recreational casualty products are now better positioned to provide profitable growth in the upcoming years.
The following chart is an overview of the results of operations of the Company’s other insurance segment (in 000’s).
American Modern’s credit life product was the primary driver of the increase in direct and assumed written premiums in 2007 compared to 2006 which increased to $59.4 million from $51.0 million in 2006. A large percentage of credit life direct and assumed written premium is ceded to an insurance affiliate of the producing agent. The growth in our credit life insurance line was assisted by the acquisition of Southern Pioneer Life Insurance Company in July of 2006. The improvement in profitability in 2007 compared to 2006 is due primarily to the improved underwriting results related to the commercial park and dealer property lines.
Realized investment gains and losses are comprised of three items: capital gains and losses from the sale of securities, derivatives features of certain convertible securities and other-than-temporary impairments. The following chart shows the gain or loss from these sources as well as their impact on diluted earnings per share (amounts in $000’s except per share amounts):
American Modern’s commissions and other policy acquisition costs increased 18.7% in 2007 to $248.9 million from $209.7 million in 2006. This fluctuation is consistent with the increase in net earned premium. In addition, our financial institutions segment, which has grown net premiums 81.9% in 2007, generally has a higher commission rate than our other products. In addition, in our residential property and recreational casualty segments, the increase is attributable to American Modern’s “Pay for Performance” commission policy, with agents representing the Company, which reduces the up-front commission paid but rewards favorable underwriting and growth performance with a higher performance-based commission.
M/G Transport, Midland’s transportation subsidiary, contributed $21.2 million of income, before taxes, in 2007 compared to $7.8 million in 2006. In addition, M/G Transport’s revenues increased to $64.7 million in 2007 compared to $49.8 million in 2006. The increases in transportation revenues and pre-tax income are due primarily to an improved freight rate environment.
The following chart shows American Modern’s gross written premium, net written premium and net earned premium by business segment for the years ended December 31, 2006 and 2005 (in millions). Gross written premium, also described as direct and assumed written premium, is the amount of premium charged for policies issued during a fiscal period. Net written premium is the amount of premium that American Modern retains after ceding varying portions of its gross written premium to other insurance companies. Net earned premium is the amount included in our consolidated statements of income. Premiums for physical damage and other property and casualty related coverages, net of premium ceded to reinsurers, are considered earned and are included in the financial results on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the lives of the policies in proportion to the amount of insurance protection provided. The portion of written premium applicable to the unexpired terms of the policies is recorded as unearned premium in our consolidated balance sheets.
Direct and assumed written premiums for our recreational casualty products decreased due primarily to the decreases of $5.6 million and $2.5 million for our watercraft and motorcycle products, respectively. The decrease in motorcycle direct and assumed written premiums was due primarily to the implementation in recent years of new underwriting modifications such as restrictions on certain types of coverages and implementation of a more sophisticated motorcycle make/model table to improve accuracy of class and identification of ineligible units. The decrease in watercraft direct and assumed written premiums was due primarily to underwriting actions taken to balance our coastal exposures. Although these actions are currently reducing our ability to grow these lines, we believe the recreational casualty products are now better positioned to provide profitable growth in the upcoming years.
Overall, American Modern’s losses and loss adjustment expenses increased 7.3% in 2006 to $307.5 million from $286.7 million in 2005. The increase was due primarily to the related 7.0% increase in earned premiums in 2006 compared to 2005 combined with slight increases in loss ratios related to the manufactured housing, collateral protection and excess and surplus lines products. While the overall financial impact of catastrophes in 2006 improved compared to 2005, due to reinstatement premiums and other catastrophe related items in 2005, loss and loss adjustment expenses due to catastrophes remained relatively constant in 2006 at $34.5 million compared to $34.9 million in 2005.
The Company’s operating and administrative expenses increased 13.3% to $127.7 million in 2006 compared to $112.7 million in 2005. This increase is due primarily to expenses related to an increase in employee salaries and benefits.
The above table includes obligations and commitments related to the M/G Transport subsidiary, which is included in discontinued operations
Also included in the above table are four fifteen-year operating lease arrangements relating to the lease of 80 barges used in the transportation operations. The barges can be purchased near the end of the fifteen-year terms at predetermined prices or, at the end of each lease period, the Company can either return the barges or purchase the equipment at fair market value. For all of the aforementioned operating leases, the 15-year lease periods were more attractive at the time than the traditional financing term for conventional long-term debt. As of December 31, 2007 future lease payments required under these operating lease arrangements are (000’s): 2008 - $2,444; 2009 through 2010 - $5,001; 2011 through 2012-$5,069; after 5 years - $17,812. M/G Transport’s operating cash flow is currently sufficient to pay the financial obligations under this agreement.
The Company may periodically repurchase stock in connection with associate stock programs. During 2007, the Company repurchased 48,921 shares for approximately $2.3 million in connection with associate stock programs.
We paid dividends to our shareholders of $7.1 million during 2007, $4.6 million during 2006 and $4.2 million in 2005. In 2008, we intend to pay a quarterly dividend to our shareholders consistent with the 2007 level until the completion of the Merger Agreement with Munich Re.
Midland has a commercial paper program under which qualified purchasers may invest in the short-term unsecured notes of Midland. As of December 31, 2007, we had $8.3 million of commercial paper debt outstanding, $6.9 million of which represented notes held either directly or indirectly by our executive officers and directors. The effective annual yield paid to all participants in this program was 4.9% as of December 31, 2007, a rate that is considered to be competitive with the market rates offered for similar instruments. As of December 31, 2007, Midland also had $83.0 million of conventional short-term credit lines available at costs not exceeding prime borrowing rates, none of which was outstanding. These lines of credit contain minimal covenants and are typically drawn and repaid over periods ranging from two weeks to three months. We also have a mortgage obligation related to the financing of our corporate headquarters building. As of December 31, 2007, the outstanding balance of this mortgage was $13.9 million. This mortgage obligation includes normal and customary debt covenants for instruments of this type. Monthly interest payments are required until maturity in December 2009. The effective interest rate on this obligation is based on the 3-month LIBOR plus 0.75% and was 5.73% at December 31, 2007.
The average duration of the Company’s debt security investment portfolio as of December 31, 2007 was 4.7 years which management believes provides adequate asset/liability matching.
American Modern generates cash inflows primarily from insurance premiums, investment income, proceeds from the sale of marketable securities and maturities of debt security investments. The principal cash outflows for the insurance operations relate to the payment of claims, commissions, premium taxes, operating expenses, capital expenditures, income taxes, interest on debt, dividends and inter-company borrowings and the purchase of marketable securities. In each of the periods presented, funds generated from the insurance operating activities were used primarily to purchase investment grade marketable securities, accounting for the majority of the cash used in investing activities.
Accounts receivable is primarily comprised of premium due from both policyholders and agents. In the case of receivables due directly from policyholders, policies are cancelable in the event of non-payment and thus offer minimal credit exposure. Approximately 65% of American Modern’s accounts receivables relate to premiums due directly from policyholders as of December 31, 2007. In the case of receivables due from agents, American Modern has extended payment terms that are customary and normal in the insurance industry. Management monitors its credit exposure with its agents and related concentrations on a regular basis. However, as collectibility of such receivables is dependent upon the financial stability of the agent, American Modern cannot assure collections in full. Where management believes appropriate, American Modern has provided a reserve for such exposures.
The increase in property, plant and equipment of $24.2 million at December 31, 2007 compared to 2006 is due to the costs incurred related to the expansion of the Company’s headquarters and the continuing investment in modernLINK®.
The $45.0 million increase in unearned insurance premiums at December 31, 2007 compared to year end 2006 is related to the $134.6 million increase in the Company’s direct and assumed written premiums.
The increase of $8.6 million in insurance loss reserves was due primarily to the increase in written premiums during 2007. The following table provides additional detail surrounding the Company’s insurance policy loss reserves at December 31, 2007 and 2006 (amounts in 000’s):
As of December 31, 2007, the transportation subsidiaries have $15.3 million of collateralized equipment obligations outstanding.
The differences between our net income and comprehensive income are changes in unrealized gains on marketable securities, changes in the fair value of the interest rate swap agreement and changes in liability requirements related to our defined benefit pension plans. For the years ended December 31, 2007, 2006 and 2005, such changes increased or (decreased), net of related income tax effects, by the following amounts (amounts in 000’s):
Net unrealized investment gains in equity securities (net of income tax effects) decreased $13.3 million in 2007, increased $16.6 million in 2006 and decreased $2.9 million in 2005. For fixed income securities, net unrealized gains decreased $1.2 million in 2007, increased $0.3 million in 2006 and decreased $11.0 million in 2005.
Revenues for river transportation activities are recognized when earned. If freight services are in process at the end of a reporting period, an allocation of revenue between reporting periods is made based on relative transit time in each reporting period with expenses recognized as incurred. Transportation operations have been classified as discontinued operations for all periods presented.
A summary of our loss reserves at December 31, 2007 and 2006 is included below:
As noted in the table above, case base loss reserves represent the largest component of our loss reserves at approximately 75 percent of our net property and casualty loss reserves. Primarily composed of case base loss reserves, our total loss reserves are relatively short-tailed in nature and less as a percentage of statutory surplus than the property and casualty industry average. In total, our net property and casualty loss reserves represented 35 percent and 32 percent of the statutory property and casualty surplus at December 31, 2007 and 2006, respectively. Case base loss reserves tend to be more mechanical in nature and are based on specific facts and circumstances related to reported claims as compared to IBNR loss reserves, which have a higher degree of estimation and uncertainty.
At December 31, 2007, the recorded net property and casualty loss reserves were in the acceptable actuarial range.
We have considered that our historical loss development factors are more fully encompassing favorable development patterns that we have experienced over the last few years.
We have consistently applied our approach to loss reserves. Our estimates for loss reserves utilize historical loss development patterns. As new patterns emerge, they are reflected in our assumptions. Due to the significant amount of judgment and estimation that is required to estimate loss reserves, the actual loss development is likely to be different than the amounts recorded. For example, during the last 10 years we have experienced both favorable and unfavorable development in individual calendar years. Looking back at our net property and casualty loss reserves over the last ten years, we have experienced nine years where redundancy has developed and one year where a deficiency developed. The table below outlines the cumulative (deficiency)/redundancy for the net property and casualty loss reserves since 1997, based on re-estimated amounts at December 31, 2007.
Motorcycle is a less mature product line that we began writing in 2001. We, therefore, did not have as much historical data related to this product. In addition, as we began writing this business, we experienced a very high loss ratio, relative to our, and industry standards. This was largely due to the initial underwriting criteria and our limited claim handling experience. Since 2001, we have made significant underwriting changes to this product and have also developed claim expertise and experience in settling claims related to this line thus causing more favorable development in recent years.
Personal liability and park and dealer liability tend to be more volatile due to the liability component of these risks, which has a higher degree of complexity and a longer development period when compared to the larger property portion of our business. We exited the park and dealer liability lines in 2001 and we had experienced several years of volatility and inadequate reserves related to this line at December 31, 2003. Subsequently, we have experienced claims being settled for less than the amount reserved.
As previously mentioned, management engages a credentialed consulting actuary to affirm the recorded amount of loss reserves with an acceptable actuarial range. The consulting actuarial firm utilizes a variety of actuarial and statistical methods in determining the ultimate liabilities within acceptable actuarial range for loss reserves. These methods include, but are not limited to:
Tends to be responsive to changes in reported losses. May also provide more accurate estimate of ultimate losses for less mature years if historical levels of reserve accuracy are maintained.
The number of open claims is the basis of this approach and consequently, changes in reserve adequacy will not affect the result of this method.
Generally, the incurred loss development method is the primary method used by our external actuary in determining the ultimate liability for the property lines of business. For our liability lines of business, our consulting actuary will generally utilize estimates from several of the models listed above and develop a blended average. This process requires significant judgment from our credentialed actuary and more emphasis may be applied to one model based on the judgment of the actuary.
The Company’s philosophy is to adequately reserve our case base claims in a consistent manner. We regularly monitor the development of our case base claims and make appropriate adjustments to our recorded reserve balances and in our reserving practices. In addition, the following factors contribute to the variability in establishing case base loss reserves:
In order to determine an acceptable actuarial range of loss reserves, the consulting actuary utilizes various statistical models. The most significant assumptions relate to the development factors which are utilized to predict the ultimate losses expected to be incurred. The consulting actuary utilizes historical development factors, including the use of 3- and 5-year historical development averages to estimate the ultimate liability. Our consulting affirming actuary utilizes development factors that are applicable to certain lines of business based on their risk characteristics (i.e., property, liability, motorcycle, excess and surplus). Additionally, development patterns are developed for each accident year. The development factors that are used by the actuaries are generally based on our historical patterns, rather than the development from any one year, which balances stability and responsiveness in developing age to age factors. For example, in determining the 2005 loss reserves, the most recent favorable one year development patterns were considered as part of historical averages. However, the impacts of the latest one-year favorable development factors were only partially recognized in the external actuary’s contemplation of loss reserves. As development factors continue to emerge they will be a larger part of the historical three- and five-year averages, and will be more heavily weighted when reflected in the range of our affirming external actuary. For example, we have experienced more favorable development patterns over the last couple of years in our motorcycle coverages than our historical patterns would indicate.
Both management and the consulting actuary utilize various assumptions for loss adjustment expense and salvage and subrogation, and are based on historical averages. However, these assumptions have not changed significantly and have not materially affected management’s best estimate of loss reserve or the external actuary’s acceptable actuarial range of insurance loss reserves.
1. To reduce total statutory liabilities to a level appropriate for American Modern’s capital and surplus.
3. To facilitate relationships with business partners who want to participate in the insurance risk through their own reinsurance companies.
The Company’s reinsurance treaties are prospective reinsurance agreements, contain no adjustable features, and do not include any profit sharing provisions. The costs associated with these reinsurance treaties are calculated and expensed based on the subject earned premium recorded in revenue multiplied by the corresponding rate. Any ceding commission is recorded according to the terms of the reinsurance treaty based on the percentage of the corresponding premiums. Ceded commissions are deferred and recognized as income over the life of the corresponding policies. The term is typically no more than twelve months due to the short-tail nature of our business. The costs associated with our catastrophe reinsurance program are generally amortized over the term of the coverage on a pro-rata basis.
Due to the nature of our non-catastrophe related reinsurance programs, the results of operations related to these programs did not significantly fluctuate during the three year period ended December 31, 2007.
However, our operating results were impacted to varying degrees by our catastrophe reinsurance program. Catastrophe reinsurance costs, including reinstatements, totaled $34.9 million, $25.8 million and $31.9 million during 2007, 2006 and 2005, respectively. The Company’s gross catastrophe losses for 2007, 2006 and 2005 were $31.3 million, $41.9 million and $232.1 million, respectively, of which $8.5 million, $7.4 million and $179.4 million, respectively, were recovered through our catastrophe reinsurers.
In order to identify other-than-temporary impairments, we conduct quarterly comprehensive reviews of individual portfolio holdings that have a market value less than their respective carrying value. As part of our review for other-than-temporary impairment, we track the respective carrying values and market values for all individual securities with an unrealized loss. We, with the assistance of our external professional money managers, apply both quantitative and qualitative criteria in our evaluation, including facts specific to each individual investment such as, but not limited to, the length of time the fair value has been below the carrying value, the extent of the decline, our intent to sell or hold the security, the expectation for each individual security’s performance, the credit worthiness and related liquidity of the issuer and the issuer’s business sector.
The evaluation for other-than-temporary impairment requires a significant amount of judgment. As such, there are a number of risks and uncertainties inherent in the process of monitoring for potential impairments and determining if a decline is other-than-temporary. These risks and uncertainties include the risks that:
issuer news releases, including those disclosing that the issuer has committed an event of default (missed payment beyond grace period, bankruptcy filing, loss of principle customer or supplier, debt downgrade, disposal of segment, etc.)
For the years ended December 31, 2007, 2006, and 2005, we incurred no losses related to other-than-temporary impairments. Impairment charges, if incurred, would be included in the consolidated financial statements in “net realized investment gains (losses)”.
Midland maintains defined benefit pension plans for a limited number of active participants. The defined benefit pension plans are not open to employees hired after March 31, 2000. The pension expense is calculated based upon a number of actuarial assumptions, including an expected long-term rate of return and a discount rate. In determining our expected long-term rate of return and our discount rate, we evaluate input from our actuaries, asset allocations, long-term bond yields and historical performance of the invested pension assets over a ten-year period. If other assumptions were used, the amount recorded as pension expense would be different from our current estimate.
Also in September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statement No. 87, 88, 106 and 132 (R)” (“SFAS 158”). This Standard requires recognition of the funded status of a benefit plan in the statement of financial position. The Standard also requires recognition in other comprehensive income certain gains and losses that arise during the period but are deferred under pension accounting rules, as well as modifies the timing of reporting and adds certain disclosures. The recognition and disclosure elements of SFAS 158 were effective for fiscal years ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The adoption of SFAS 158 resulted in a reduction of shareholders’ equity of $3.6 million, net of tax, at December 31, 2006.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This Standard allows the valuation of certain financial assets and liabilities to be measured at fair value. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The Company is assessing the impact that SFAS 159 will have on its consolidated financial statements.
We have audited the accompanying consolidated balance sheets of The Midland Company and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedules listed in the index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Midland Company and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2008, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Marketable Securities - Marketable securities are categorized as fixed income securities (cash equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and equity securities (common, convertible and preferred stocks which do not have redemption provisions). The Company classifies all fixed income and equity securities as available-for-sale and carries such investments at market value. Unrealized gains or losses on investments, net of related income taxes, are included in shareholders’ equity as an item of accumulated other comprehensive income. Realized gains and losses on sales of investments are recognized in income on a specific identification basis. Embedded derivatives are valued separately and the change in market value of the derivatives is included in Net Realized Investment Gains on the Consolidated Statements of Income.
During 2006, the Company performed an extensive review of its useful life and salvage value estimates as they relate to M/G Transport’s barges. As a result of this review, the Company determined that the useful lives of the barges should be extended from 20 years to 23 years. In addition, the Company determined that the salvage values of each barge should be increased from $10,000 to $30,000. Both of these changes were implemented prospectively and were effective on October 1, 2006. The effect of this change in accounting estimate on the Company’s net income was $146,000 for the fourth quarter of 2006. (See Note 19)
In addition to the $3.2 million of goodwill mentioned above, the Company also has $2.1 million of goodwill related to past business combinations. The goodwill balances are recorded in Other Assets on the Company’s Consolidated Balance Sheets. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, the Company accounts for goodwill under the impairment approach. Based on the Company’s impairment review, no impairment charges were necessary for 2007, 2006 or 2005.
Stock Option and Award Plans - Midland has various plans which provide for granting options and common stock to certain employees and independent directors of the Company and its subsidiaries. During the fourth quarter of 2005, the Company elected to early adopt SFAS 123 (Revised 2004), Share-Based Payment (“SFAS 123(R)”) under the modified retrospective approach, restating only prior interim periods in fiscal 2005. As a result, the Company has applied SFAS 123(R) to new awards and to awards modified, repurchased or cancelled after January 1, 2005. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered, that were outstanding as of January 1, 2005, are being recognized as the requisite service is rendered on or after January 1, 2005 (generally over the remaining option vesting period). The compensation cost for that portion of awards has been based on the grant-date fair value of those awards as calculated previously for pro forma disclosures. Prior to the fourth quarter of 2005, the Company accounted for compensation expense related to such transactions using the “intrinsic value” based method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and its related interpretations. Midland’s equity compensation plans are described more fully in Note 13.
The fair values of the 2007, 2006 and 2005 option grants were estimated on the date of the grant using the Black Scholes option-pricing model with the following (weighted average) assumptions:
Also in September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statement No. 87, 88, 106 and 132 (R) (“SFAS 158”). This Standard requires recognition of the funded status of a benefit plan in the statement of financial position. The Standard also requires recognition in other comprehensive income certain gains and losses that arise during the period but are deferred under pension accounting rules, as well as modifies the timing of reporting and adds certain disclosures. The recognition and disclosure elements of SFAS 158 were effective for fiscal years ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The adoption of SFAS 158 resulted in a reduction of shareholders’ equity of $3.6 million, net of tax, at December 31, 2006.
Included in Buildings, Improvements, Fixtures, etc. in the above table is $30.5 million of cost related to the expansion of the Company’s headquarters, which was completed in September, 2007 including $1.2 million of capitalized interest. In 2006, Buildings, Improvements, and Fixtures contained $17.4 million of construction in progress related to the expansion of the Company’s headquarters including $0.3 million of capitalized interest.
Total rent expense related to the rental of equipment included in the accompanying Consolidated Statements of Income is (amounts in 000’s) $12,004 in 2007, $9,643 in 2006 and $3,808 in 2005, of which $8,815, $6,400, and $567 are related to discontinued operations (See Note 19). Future rentals under non-cancelable operating leases are approximately (amounts in 000’s): $2,573 - 2008; $2,466 - 2009; $2,534 - 2010; $2,534 - 2011; $2,534 in 2012 and $17,812 - thereafter. These amounts include future rentals of discontinued operations are approximately $2,468 - 2008; $2,466 - 2009; $2,534 - 2010; $2,534 - 2011; $2,534 in 2012 and $17,812 - thereafter.
The aforementioned notes payable, together with outstanding commercial paper, had weighted average interest rates of 4.87% and 5.67% at December 31, 2007 and 2006, respectively.
Long-term debt at December 31, 2007 and 2006 is summarized as follows (amounts in 000’s):
At December 31, 2007 and 2006, the carrying value of the Company’s long-term debt approximated its fair value.
Wholly-owned subsidiary trusts of Midland have issued preferred trust securities and, in turn, purchased a like amount of subordinated debt which provides interest and principal payments to fund the trusts’ obligations. The preferred trust securities are mandatory redeemable upon maturity or redemption of the subordinated debt and are an obligation of Midland. The interest rate related to these securities is based on the 90 day LIBOR rate plus 3.5%, not to exceed 12.5% through the optional redemption dates in April and May 2009, respectively. The interest rates were 8.4% and 8.9% at December 31, 2007 and 2006, respectively. The junior subordinated debentures are due in 2034. They consist of $12 million issued in April 2004 and $12 million issued in May 2004 that are redeemable at the Company’s option any time after April and May 2009, respectively.
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized approximately a $290,000 decrease in retained earnings as of January 1, 2007, for taxes, interest and penalties. A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows: (000’s)
The FIN 48 liability is a component of other payables and accruals on the balance sheet. Of the total $414,000 liability, the entire balance would affect the effective tax rate if recognized.
The Company believes that it is reasonably possible that approximately $82,000 of its currently remaining unrecognized tax positions may be recognized by the end of 2008 as a result of lapse of the statute of limitations.
For 2007, 2006, and 2005, $1,330 $1,420, and $455, respectively, of income tax benefits applicable to deductible compensation related to stock options exercised and restricted stock issued were credited to shareholders’ equity.
Premium income in the accompanying consolidated statements of income include (amounts in 000’s) $51,330, $63,580, and $54,386 of earned premiums on assumed business and is net of $162,111, $127,368, and $112,778 of earned premiums on ceded business for 2007, 2006, and 2005, respectively. Written premiums consist of the following (amounts in 000’s):
The Company uses a measurement date of December 31 for its pension plans. The following tables include amounts related to both the qualified and non-qualified defined benefit pension plans (amounts in 000’s except for percentages):
Plan assets consist primarily of equity and fixed income securities managed by non-affiliated professional investment managers. No plan assets are invested in either real estate or the Company’s stock. The following table reflects the asset allocations at fair value related to plan assets in 2007 and 2006:
The primary objective for the investment of plan assets is the preservation of capital with an emphasis on long-term growth without undue exposure to risk. Targeted allocations are 50% to 80% for equities and 20% to 50% for fixed income securities.
At December 31, 2006 (prior to adoption of SFAS 158) and 2005, the Company’s additional minimum pension liabilities were $4.1 million and $6.0 million, respectively. Related to these actuarially determined minimum pension liabilities, comprehensive income was increased by $1.2 million at December 31, 2006, net of deferred federal income taxes and prior to adoption of SFAS 158, and reduced by $1.6 million, net of deferred federal income taxes, at December 31, 2005.
Under the Company’s stock option plans, all of the outstanding stock options at December 31, 2007 were non-qualified options and had an exercise price of not less than 100% of the fair market value of the common stock on the date of grant. Of these stock options, 1,112,000 were exercisable at December 31, 2007, and 204,000, 159,000, 114,000 and 42,000 options become exercisable in 2008, 2009, 2010 and 2011, respectively. A summary of stock option transactions follows:
At December 31, 2007, 750,000 common shares are authorized for future option award or stock grants.
The following table is a reconciliation of the number of shares used to compute Basic and Diluted earnings per share. No adjustments are necessary to the income used in the Basic or Diluted calculations for the years ended December 31, 2007, 2006 or 2005.
In January 2001, the Company’s Board of Directors authorized the repurchase of up to 1,000,000 shares of the Company’s common stock and 414,000 of these shares have been repurchased as of December 31, 2007. No shares were repurchased under this program in 2007 or 2006.
The Company operates in several industries and Company management reviews operating results by several different classifications (e.g., product line, legal entity, distribution channel). Reportable segments are determined based upon Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” and includes residential property, recreational casualty, financial institutions, all other insurance and transportation.
The residential property segment includes primarily manufactured housing and site-built dwelling insurance products. Approximately 36% of American Modern’s property and casualty and credit life gross written premium relates to physical damage
No single customer contributed in excess of 10% of consolidated revenues in 2007, 2006, or 2005.
On February 15, 2008 The Midland Company, an Ohio corporation (“Midland” or the “Company”) entered into a Stock Purchase Agreement (“Agreement”) with M/G Transport Holdings LLC, a Delaware limited liability company and affiliate of Brooklyn NY Holdings LLC (the “Buyer”) pursuant to which the Company agreed to sell all of its shares of capital stock of M/G Transport Services, Inc., an Ohio corporation (“M/G Transport”) and MGT Services, Inc., an Ohio corporation (“M/G Services,” and collectively with M/G Transport, the “Barge Companies”). Pursuant to this Stock Purchase Agreement the Barge Companies would be sold to Buyer for an aggregate purchase price of approximately $112.8 million, subject to a working capital adjustment.