The following tables provide selected historical consolidated financial and operating data of Direct General as of the dates and for the periods indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the accompanying notes included in this report. We derived our selected historical consolidated financial data as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003 from our audited consolidated financial statements included in this report. We derived our selected historical consolidated financial data as of December 31, 2003, 2002 and 2001 and for the years ended December 31, 2002 and 2001 from our audited consolidated financial statements not included in this report. The results for past accounting periods are not necessarily indicative of the results to be expected for any future accounting period.
Gross premiums written is the sum of direct premiums written and assumed premiums written. Direct premiums written is the sum of the total policy premium, net of cancellations, associated with policies underwritten and issued by our insurance subsidiaries. Assumed premiums written is the sum of total premiums associated with
the insurance risk transferred to us by other insurance companies pursuant to reinsurance contracts. See Note 7 to our audited consolidated financial statements included in this report.
Net income for the year ended December 31, 2001 reflects a $7.4 million after-tax loss attributable to a write-off of reinsurance recoverables from Reliance Insurance Company. We consider net income adjusted for write-off of reinsurance recoverables from Reliance Insurance Company to be a non-GAAP financial measure. Because we have not had any other material write-offs of reinsurance recoverables in our history, we believe that the $7.8 million adjusted net income ($0.4 million reported net income plus the $7.4 million after-tax impact of the write-off) is useful to management and investors in understanding our improvement in operating results since 2001.
We generated net income of $39.0 million and a return on average equity of 16%.
Our overall capitalization was enhanced with the issuance of $40 million of junior subordinated debentures providing us with a long-term source of funds for various corporate purposes.
We completed the acquisition of three independent agency operations in Texas adding 82 sales offices in that State.
Our acquisition of a shell property and casualty insurance company, subsequently renamed Direct National Insurance Company, provided us with property casualty licenses in 39 jurisdictions including the majority of our future expansion states.
We introduced a new distribution channel, telephone sales, in our home state of Tennessee.
We refined our marketing strategy in all of our markets to incorporate media buys specifically targeted to our customers based on an analysis of approximately 70 designated marketing areas.
Expansion States Growth. We anticipate that the majority of our growth in 2006 will be generated by our expansion states of Texas, Missouri and Virginia.
Texas. Since March 2005, we have been converting our book of business in Texas from monthly policies to annual policies. As of December 31, 2005, approximately 63.5% of our book of business was written for an annual term. We have also been closely monitoring our competitive position within the state, which, coupled with our quarterly review of rates, loss experience and expected trends, indicated that we needed to adjust our rates for full coverage business. Accordingly, we implemented a 15% rate reduction in December 2005 related entirely to a reduction in rates for physical damage coverages with no overall change to our liability rates. We believe that this change, coupled with many of the Company’s growth initiatives and an expected increase our renewal business should result in another year of 25% or more growth in Texas. We also believe that we will see more of a seasonal trend in Texas during 2006, which is typical of our business in other states.
Missouri and Virginia. We have been developing our initial sales offices in Missouri and Virginia and, as of March 1, 2006, we have 25 offices in Missouri and 17 offices in Virginia. We are primarily selling annual policies in these states, which we finance. In addition, we are selling our term life and certain ancillary products in these states. We believe that these expansion states will begin to make a positive contribution to profits by the end of the year.
Profitability and Return. We expect that our 2006 accident year loss ratio could see some slight improvement over the 75.7% loss ratio we experienced in 2005, as catastrophe losses return to a more normal level. We expect that our expense ratio for 2006 will begin to trend down from the 16.5% we reported in the fourth quarter of 2005, as some of our growth initiatives take hold. Overall, we expect to generate a return on average equity of between 14% and 16% for the year.
the timely and successful development and opening of additional neighborhood sales offices in Texas, Missouri and Virginia;
the absence of our losses and loss adjustment expenses exceeding our reserves which would require us to increase our reserves which would lower our earnings.
Ancillary Income Measures. We have developed measures of our ability to generate ancillary income that reflect the differences between our business model and those used by our competitors. We measure our ancillary income as a percentage of premiums earned and as a percentage of our operating expenses. We believe that most of our competitors only achieve point of sale contact through an independent agent and are therefore typically unable to generate significant amounts of ancillary income.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change, thus having an impact on the amounts reported in the future. We view the estimates and assumptions used in establishing our reserves for losses and loss adjustment expenses, valuation of investments, the estimates of future policy cancellations used in determining the amounts recorded as commissions and service fees and ceding commissions, and establishing the allowance for finance receivable losses as our critical accounting policies.
The Company’s investment portfolio is primarily exposed to interest rate risk and to a lesser extent market and credit risk. The fair value of our portfolio is directly impacted by changing interest rates, market conditions and financial conditions of the issuer. The Company examines its portfolio on at least a quarterly basis for evidence of impairment with a particular emphasis on those securities with unrealized losses that satisfy certain conditions. Some of the factors that the Company considers in evaluating a security for other than temporary impairment
Allowance for Finance Receivable Losses. Losses on finance receivables include an estimate of future credit losses on premium finance accounts. Credit losses on premium finance accounts occur when the unearned premiums received from the insurer upon cancellation of a financed policy are inadequate to pay the balance of the premium finance account. The majority of these shortfalls result in the write-off of unrealized interest and premium finance acquisition fees. We review historical trends of such losses relative to finance receivable balances to develop estimates of future losses. However, actual write-offs may differ materially from the write-off estimates that we used. As of December 31, 2005, the allowance for finance receivable losses was $6.4 million.
We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and also to limit our exposure to loss. Generally, we ceded a portion of our non-standard automobile insurance premiums to unaffiliated reinsurers in order to maintain a net premiums written to statutory surplus ratio of approximately 3 to 1. Since our initial public offering in August 2003, we have contributed capital to our insurance subsidiaries enabling us to retain a higher percentage of our business and reducing our use of reinsurance. We retain 100% of our term life insurance premiums.
During 2005, we continued our expansion into Texas with the acquisition of the assets of three independent agencies in January 2005 that provided us with 82 sales offices. We also developed an additional 18 sales offices in the State. Beginning in March 2005, we started to convert our book of monthly policies in Texas to annual policies and, as of December 31, 2005, approximately 63.5% of the Texas business had been converted. Our broader distribution network, together with our increase in advertising and the conversion to annual policies resulted in a 32.1% increase in Texas premiums during 2005.
The declines in gross premiums written in most of our other existing states were primarily related to the competitive environment. However, we also experienced a 19.2% decline in Louisiana which we partially attributed to the impact of Hurricane Katrina. We believe that the displacement of a portion of the Louisianan population not only resulted in a premium decline in 2005, but we believe that the 2006 volumes in Louisiana will also be impacted.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. During 2004, gross premiums written increased $46.7 million to $481.9 million primarily as a result of our growth in Florida and Texas business. The Florida market represented 50.5% of our business and accounted for $19.8 million of the increase in 2004. We continued to experience solid growth in our renewal book of business in Florida during the year, which
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Net premiums written increased 38.7% to $409.4 million in 2004 from $295.1 million in 2003. The ratio of net premiums written to gross premiums written increased to 85.0% in 2004 from 67.8% in 2003 as we continued to reduce our use of quota share reinsurance that started with the proceeds raised in our initial public offering in the third quarter of 2003. Net premiums earned, a function of net premiums written over the current and prior periods, increased to $372.5 million and equaled 91.0% of net premiums written.
For the year ended December 31, 2005 and 2004, the ratio of ancillary income to gross premiums earned was 19.8% and 20.7%, respectively, and the ratio of ancillary income to operating expenses was 64.3% and 85.8%, respectively.
with the cash flows from our insurance operations and the invested assets acquired in conjunction with the purchase of the new life insurance company in January 2004, resulted in the significant increase in average invested assets. The average investment yield remained relatively consistent at 3.7% in both 2004 and 2003.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004. Gross gains on debt securities for the year ended December 31, 2005 were $0.2 million, which were more than offset by gross losses of $1.2 million. The sale of certain debt securities during the year were primarily driven by adjustments to the portfolio in conjunction with the changing interest rate environment. Comparatively, in 2004, we realized gross gains on debt securities of $0.4 million, which were more than offset by gross losses of $0.9 million, as we repositioned our bond portfolio based on our investment guidelines for changes in market conditions and other factors.
The Company also has a trading portfolio primarily consisting of futures contracts, swaps, and other derivative instruments. In 2005, we also realized gross gains of $2.6 million and gross losses of $1.9 million on closed contracts in this trading portfolio, as compared to 2004 where we realized gross gains of $2.4 million and gross losses of $2.2 million. This represents a speculative investment and does not represent a hedge; accordingly, all open contracts are marked to market with the change in market values included in “net realized (losses) gains on securities and other” in our consolidated statement of operations. The net unrealized gain (loss) on open contracts increased to a $0.2 million gain in 2005 from a $0.1 million loss in 2004. The 2005 net gain was comprised of gross unrealized gains of $0.4 million and gross unrealized losses of $0.2 million. For the year ended December 31, 2004, “net realized (losses) gains on securities and other” included a net gain of $0.3 million related to the increase in the market value of open contracts.
Insurance losses and loss adjustment expenses represent our largest expense item and include payments made to settle claims, estimates for future claim payments and changes in those estimates for current and prior periods, as well as loss adjustment expenses incurred in connection with settling claims. Insurance losses and loss adjustment expenses are influenced by many factors, such as claims frequency and severity trends, the impact of changes in estimates for prior accident years, and increases in the cost of medical treatment and automobile repairs among other factors. The anticipated impact of inflation is considered when we establish our premium rates and set loss reserves. We perform an actuarial analysis each quarter and establish or adjust (for prior accident quarters) reserves, based upon our estimate of the ultimate incurred losses and loss adjustment expenses to reflect loss
development information and trends that have been updated for the most recent quarter’s activity. Each quarter our estimate of ultimate loss and loss adjustment expenses is evaluated by accident quarter, by state and by major coverage grouping (e.g., bodily injury, physical damage) and changes in estimates are reflected in the period the additional information becomes known.
Under state insurance laws, dividends, which must be paid from earned surplus, and capital distributions from our insurance companies are subject to restrictions relating to statutory surplus and earnings. Our insurance companies collectively paid dividends of $1.7 million, $1.0 million and $1.0 million to Direct General Corporation in 2005, 2004 and 2003, respectively. These dividends were generally reinvested in the capital of other insurance subsidiaries. Prior approval from state insurance regulatory authorities is generally required in order for our insurance companies to declare and pay extraordinary dividends to us. The maximum amount of dividend capacity available for payment to Direct General Corporation during 2006 by our insurance subsidiaries without seeking regulatory approval is $18.1 million. Dividends from our premium finance subsidiary are limited by the minimum capital requirements in applicable state regulations and by covenants in our bank loan agreements, which require approval of our lenders. There are no restrictions on the payment of dividends from our agency, administrative and other non-insurance subsidiaries, other than typical state corporation law requirements to avoid insolvency. In addition, the NAIC Model Act for Risk Based Capital (“RBC”) provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired; a low RBC ratio would prevent an insurance company from paying dividends. At December 31, 2005, each of our insurance subsidiaries maintained an RBC level that is in excess of an amount that would require any corrective actions on our part.
Common Stock Repurchase. During 2005, the Company repurchased 2,157,871 shares of its outstanding common stock for an aggregate price of approximately $40.1 million. Under prior approval by the Board of Directors, the Company has the discretionary authority to buyback up to an additional $10.0 million of its outstanding common stock prior to the end of January 2007, in accordance with its capital management strategies.
September 15, 2010, at which time the preferred securities are callable. The debentures pay a fixed rate of 7.915% until September 15, 2010, after which the rate becomes variable.
Amounts outstanding under this facility were $150.0 million and $135.2 million as of December 31, 2005 and 2004, respectively. The average balances outstanding under this facility were $112.8 million in 2005 and $102.0 million in 2004. Interest on the facility is payable quarterly and all outstanding advances and accrued interest are due on or before June 30, 2007. The weighted average interest rate in effect was 5.2% in 2005 and 3.4% in 2004. The loan is principally secured by our finance receivables of our premium finance subsidiaries and is guaranteed by Direct General Corporation. See Note 6 to our audited consolidated financial statements included in this report for further discussion regarding our current outstanding debt.
In an effort to manage our interest rate risk related to our premium finance revolving credit agreement, effective November 1, 2001, we purchased a derivative instrument known as a zero-cost collar from JP Morgan Chase Bank, NA. This derivative instrument requires monthly settlements whereby we pay the difference to the extent the then current 30-day LIBOR rate is below the floor of 5.05% on $25 million and receive the excess of the 30-day LIBOR rate over the cap of 5.05% on $50 million. This derivative instrument was designed to reduce our exposure to changes in LIBOR under our bank loan facilities. Payments associated with the floor were $0.4 million, $0.9 million, and $1.0 million and for the years ended December 31, 2005, 2004 and 2003, respectively, and were reported in the income statement as interest expense. This derivative instrument terminated on November 1, 2005.
For the year ended December 31, 2005, we received net proceeds of $40.0 million from the issuance of the trust preferred securities. Repurchases of common stock totaled $40.1 million and the Company received $0.6 million from the exercise of employee stock options. During 2005, we had net proceeds under our premium finance revolving credit facility of $14.8 million and net proceeds of $1.4 million of principal associated with other notes
and capital lease obligations. Interest paid on outstanding indebtedness totaled $8.5 million and dividends paid on common stock were $3.4 million for the year.
Contractual Obligations. The following table summarizes estimated payments under our contractual obligations as of December 31, 2005.
Our investment strategy recognizes our need to maintain capital adequate to support our insurance operations. Our investment objectives also include maximizing the benefit from premium tax credits. Certain of the states in which we do business provide relief from premium taxes to the extent we maintain qualifying investments in those states and their municipalities. As a result, historically a significant amount of debt securities in our portfolio were comprised of tax-exempt obligations of the states of Louisiana, Mississippi and Tennessee, in order to maximize these premium tax credits.
Our investment guidelines also permit us to invest up to 2% of the fair value of our investment portfolio in alternative investments, including commodities. Within those guidelines, we invested $1.0 million in September 2002 in a managed trading account with a commodities trading company. Net realized gains from the trading activities have continually been reinvested and the fair value of this account has increased to $4.2 million as of December 31, 2005. This investment represents approximately 1% of our entire investment portfolio. Generally, only 15% of the account balance is invested in commodities and related investments and the remaining portion of the account balance is held in cash, cash equivalents and U.S. Treasury obligations. Because this is a “margin” account, the ultimate losses generated by this investment may greatly exceed the portion of the account balance so invested. However, we reduce the risk of margin call by limiting our investment to 15% of the account balance. In addition, we closely monitor the performance of the account in an effort to reduce the risk of losses. During 2005, we realized gross gains of $2.6 million and gross losses of $1.9 million on closed contracts in our trading portfolio. Since the trading portfolio, which primarily consists of futures contracts, swaps, and other derivative instruments, represents a speculative investment and does not represent a hedge, all open contracts are marked to market with the change in market values included in “net realized gains (losses) on securities and other” in our consolidated statement of operations. The net unrealized gain (loss) on open contracts increased to a net gain of $0.2 million from a net loss of $0.1 million in 2004. This net gain was comprised of gross unrealized gains of $0.4 million and
We realized a net pretax loss on the sale of securities of $0.9 million in 2005. Comparatively, we realized pretax net losses of $0.5 million in 2004 when we repositioned our portfolio for changes in market conditions and other factors. The weighted average book yield of the portfolio was 4.1% for 2005, 3.9% for 2004 and 3.7% for 2003. The effective duration of our investment portfolio was 4.4 years at December 31, 2005 compared to 4.2 years at December 31, 2004.
We evaluate the risk versus reward tradeoffs of investment opportunities, measuring their effects on the stability, diversity, overall quality and liquidity of our investment portfolio. The primary market risk exposure to our debt securities portfolio is interest rate risk, which we strive to limit by managing duration to a defined range of three to four years. Interest rate risk includes the risk from movements in the underlying market rate and in credit
spreads of the respective sectors of debt securities held in our portfolio. The fair value of our fixed maturity portfolio is directly impacted by changes in market interest rates.
As of December 31, 2005, the impact of an immediate 100 basis point increase in market interest rates on our debt securities portfolio would have resulted in an estimated decrease in fair value of 4.4%, or approximately $17.2 million. As of the same date, the impact of an immediate 100 basis point decrease in market interest rates on our debt securities portfolio would have resulted in an estimated increase in fair value of 4.4%, or approximately $17.2 million.
An additional exposure to our debt securities portfolio is credit risk. Our ability to manage credit risk is essential to our business and our profitability. We attempt to manage our credit risk through issuer and industry diversification. Our investment committee establishes our investment guidelines and supervises our investment activity. It regularly monitors our overall investment results, reviews compliance with our investment objectives and guidelines, and ultimately reports our overall investment results to our board of directors. Our investment guidelines include limitations on the minimum rating of debt securities in our investment portfolio as well as restrictions on investments in debt securities of a single issuer.
Based upon our analysis, we believe that we will recover all contractual principal and interest payments related to those securities that currently reflect unrealized losses and that we have the ability and intent to hold these securities until they mature or recover in value. Should either of these beliefs change with regard to a particular security, a charge for impairment would likely be required. While it is not possible to accurately predict if or when a specific security will become impaired, charges for other than temporary impairment could be material to our results of operations in a future period. Management believes it is not likely that future impairment charges will have a significant effect on our liquidity.
As of December 31, 2005, cash and investments carried at fair value totaling approximately $16.9 million were on deposit with state insurance regulatory authorities. Additionally, investments carried at fair value totaling approximately $3.6 million had been pledged to an unaffiliated insurer to secure our assumed reinsurance obligations.
Ernst & Young LLP, the Company’s independent registered public accounting firm has audited the financial statements presented in this Form 10-K. Ernst & Young LLP has also audited the effectiveness of the Company’s internal control over financial reporting and management’s assessment of that effectiveness as of December 31, 2005, as stated on their report included on the following page of this Form 10-K.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Direct General Corporation and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Direct General Corporation and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We have audited the accompanying consolidated balance sheets of Direct General Corporation and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Direct General Corporation and Subsidiaries as of December 31, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Direct General Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006 expressed an unqualified opinion thereon.
Policy acquisition costs include advertising, commissions, premium taxes and certain other underwriting and direct sales costs incurred in connection with writing business. These costs are deferred and are reported net of the related ceding commission received from reinsurers. Such deferred policy acquisition costs are being amortized over the effective period of the related insurance policies. Amortization charged to operations amounted to $39,429,000, $33,328,000 and $26,271,000 in 2005, 2004 and 2003, respectively. The Company considers anticipated investment income in determining the recoverability of these costs and believes they will be fully recovered over the next twelve months.
The Company uses various derivative financial instruments known as interest rate collars and interest rate swaps primarily for the purpose of hedging exposures to the variability in future cash flows associated with fluctuating interest rates on its revolving credit agreement. At the inception of each derivative contract and at least quarterly thereafter, the Company formally documents and updates the risk management strategy, the underlying exposure of the hedge, and the effectiveness of the hedging transaction in offsetting changes in the fair value or cash flows of the exposure being hedged. These derivatives are recorded at fair value on the balance sheet with the changes in fair value recognized in earnings or other comprehensive income. Gains or losses reported in other comprehensive income are reclassified into income in the period in which earnings are affected by the underlying hedged item. The ineffective portion of the hedges, if any, is recognized in earnings in the current period.
A valuation allowance for deferred tax assets is provided for all or some portion of the deferred tax asset when it is more likely than not that an amount will not be realized. An increase or decrease in a valuation allowance that results from a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset is included in income. The Company believes its deferred tax assets are fully realizable at December 31, 2005.
The Company has determined that it has two reportable segments. The primary reportable segment is comprised of principally all of the Company’s operations. The Company’s primary operating segments have been aggregated into this primary reportable segment. The other reportable segment consists of corporate operations and is not material to either revenues or net income.
The Company primarily analyzes its results on a state-by-state basis because the insurance rates and finance plan structures are subject to state regulation. All revenue and expense streams are considered when analyzing a particular state’s operating results. Accordingly, management may change any number of factors to achieve the desired results in a state including the premium rates, finance plan structure, amount of advertising, or other factors. The Company’s state operating segments constitute one primary reporting segment that can be appropriately aggregated because each of the state operating segments has identical operations and products; however, varying state regulations require the operations to be divided geographically.
As of December 31, 2005, the Company has determined that all of the unrealized losses in the table above were temporary. There were no fundamental issues with any of these securities and the Company has the ability and intent to hold the securities until there is a recovery in fair value. There were no securities with unrealized losses of greater than 10% of book value. Substantially all of the gross unrealized losses on securities at December 31, 2004 were attributable to securities purchased within the previous twelve months.
Realized losses on investments in 2005 include a $15,000 write-down on a security that was determined to have an other-than-temporary decline in fair value. There were no such write-downs in 2004.
The amortized cost and fair value of debt securities available-for-sale at December 31, 2005, by contractual maturity, is shown below:
During April 1998, the Company entered into a sale and leaseback transaction of its building located in Baton Rouge, Louisiana. The gain of $1,068,000 is being amortized over the term of the lease. At December 31, 2005 and 2004, the unamortized portion of the deferred gain was $242,800 and $349,600, respectively, and is included as a component of other liabilities. The building under capital lease was capitalized using the Company’s average borrowing rate at inception of the lease. Depreciation expense on the capitalized building lease was $636,000 during 2005, 2004 and 2003, and related accumulated depreciation on the building under capital lease was approximately $4,773,000 and $4,137,000 at December 31, 2005 and 2004, respectively.
The Company’s net loss and LAE reserve development was primarily attributable to revisions to the Company’s estimate of ultimate frequency and severity trends. In 2005, approximately $5,800,000 of the unfavorable development was related to our Florida business, generally attributable to higher than expected severity trends on personal injury protection and property damage coverages. In 2004, approximately $4,500,000 of the unfavorable development was related to our Florida business and approximately $1,100,000 was related to Tennessee. The Florida development was largely attributable to increases in expected frequency and severity trends related to the personal injury protection and property damage coverages while the Tennessee development was generally evenly split between increases to expected bodily injury frequency trends and increases to the expected average severity of property damage claims.
The Company has maintained a revolving credit facility with a consortium of banks to fund the working capital needs of the Company’s premium finance operations since 1994. Under the terms of the current facility, interest is payable quarterly at a rate elected by the Company of either the base commercial rate of First Tennessee Bank, N.A., as “Agent”, or at 1.5% to 2.0% above LIBOR. The LIBOR spread at the time of the election is determined based upon the Company’s “Average Funded Debt to EBITDA Ratio” as defined in the agreement. At December 31, 2005, the weighted average rate in effect was 6.46%. Under terms of the current facility, the Company may borrow up to $190,000,000. As of December 31, 2005, the unused amount was $40,000,000. The current facility matures on June 30, 2007. The loan is principally secured by the stock of the first tier subsidiaries.
The revolving credit facility contains covenants which, among other matters 1) limit the Company’s ability to incur or guarantee indebtedness, merge, consolidate and acquire or sell assets without bank approval; 2) require the Company to satisfy certain financial ratios, including those related to net worth, debt-to-equity, and profitability; and 3) restrict the payment of cash dividends on common stock. As of December 31, 2005, the Company was in compliance with all covenants related to the credit agreement.
facility matures on June 30, 2007, with all remaining principal and interest payments being due at that time. There were no amounts outstanding under this facility as of December 31, 2005 or 2004.
The debentures are classified as debentures payable on the Company’s statements of financial position and the interest paid on these debentures is classified as interest expense in the consolidated statements of operations.
Aggregate principal payments due on debt outstanding at December 31, 2005 is as follows:
The Company assumed, under quota-share reinsurance agreements, a percentage of personal automobile insurance produced for other insurers (see Note 8). As of December 31, 2005, the Company provided an unsecured letter of credit in the amount of $4,000,000, pledged investments totaling $3,559,000, and provided reinsurance security trust accounts totaling $9,006,000 for the benefit of certain unaffiliated insurers with respect to its obligations under the assumed reinsurance agreements.
Premiums associated with personal automobile insurance produced for other insurers and related assumed premiums are as follows:
The Company and its non-life subsidiaries file a consolidated federal income tax return, while its life subsidiaries, Direct Life Insurance Company and Direct General Life Insurance Company, file separate federal income tax returns.
A summary of the status of the Company’s stock option plans as of December 31, 2005, 2004 and 2003, and changes during the years ending on these dates is as follows:
If the Company had elected to recognize stock compensation expense based on the fair value of stock options at the grant date, as prescribed by SFAS No. 123, net income available to common shareholders and basic and diluted earnings per share would have been reported as presented in the following table.
As of December 31, 2005, shares of common stock have been reserved for the following :
The Company maintains a $190,000,000 variable rate revolving credit agreement with a group of banks (Note 6), which subjects the Company to exposures from fluctuations in interest rates under the agreement. Effective August 1, 2005, the Company purchased an interest rate swap with a notional amount of $50,000,000 which has been designated as a hedge of variable cash flows associated with that portion of the revolving credit agreement. This derivative instrument requires monthly settlements whereby the Company pays a fixed rate of 4.255% and receives 30-day LIBOR rate, reset monthly. The derivative expires on August 2, 2010.
Effective November 1, 2001, the Company purchased an interest rate cap and sold an interest rate floor in a combined derivative instrument known as a zero-cost collar (derivative), which was designated as a hedge of variable cash flows associated with interest rate increases above the 30-day LIBOR rate of 5.05% on a notional amount of $50,000,000 (cap) and interest rate decreases below the 30-day LIBOR rate of 5.05% on a notional amount of $25,000,000 (floor). This derivative expired on November 1, 2005.
The Company leases various office space and equipment. Total rent expense was approximately $11,594,000, $7,786,000 and $6,248,000 in 2005, 2004 and 2003, respectively. Approximate future minimum lease
Debt Securities - Additional fair value disclosures for debt securities are included in Note 2.
On January 30, 2004, the Company acquired an inactive life insurance company for a total purchase price of $7,330,000 of which approximately $1,348,000 was attributable to the value of the licenses acquired. The assets of this life insurance company consist of debt securities and licenses to conduct life and/or accident and health insurance business in 43 states and the District of Columbia.