Upon completion of the Merger, each issued share of the Company’s common stock (other than shares held by the Company or by any of its subsidiaries, which will be cancelled, and other than shares as to which the holders have validly exercised appraisal rights) will be converted into the right to receive $33.00 in cash, without interest, plus (subject to certain contingencies) an additional amount per share equal to a pro rated portion of the Company’s current regular dividends that have not been paid through the time of the closing.
Results of operations for 2006 and 2005 reflect the effects of the Services Agreement and the Reinsurance Pooling Agreement among the Company, its wholly-owned insurance subsidiary, MNH, and Mutual, effective January 1, 2003. The Services Agreement calls for Mutual to provide underwriting, administrative, claims and investment services to the Company and MNH. The Reinsurance Pooling Agreement provides for the pooling, or sharing, of insurance business traditionally written by Mutual and MNH on or after the effective date. MNH’s share of pooled (combined Mutual and MNH) premiums earned and losses and loss adjustment expenses (LAE) for 2006 and 2005 in accordance with the Reinsurance Pooling Agreement was 25% and 30%, respectively. The Reinsurance Pooling Agreement pertains to premiums earned and incurred losses and LAE. Direct premiums written by MNH or Mutual are not pooled. MNH’s share of pooled premiums will be 25% in 2007.
Total combined Mutual and MNH or “group-wide” direct premiums written (DWP) for the year ended December 31, 2006 were $198,258,000, an increase of $3,030,000, or 2%, from $195,228,000 in 2005. The Company’s pro-forma share of combined DWP in 2006, in accordance with the Reinsurance Pooling Agreement, was $49,565,000 compared to $58,569,000 in 2005. The table below shows a comparison of DWP by major category in 2006 and 2005:
The 11% (or $4,688,000) decrease in group-wide voluntary personal DWP resulted from a 20% decrease in private passenger automobile (PPA) DWP and a 1% decrease in homeowners DWP. The decrease in PPA DWP is the result of the companies’ decision, implemented in 2001, not to write new policies in certain jurisdictions and to increased availability of this product from other competitors. As a result, voluntary PPA policies in force at December 31, 2006 were 12,173, a decrease of 2,467 or 17%, from 14,640 at December 31, 2005.
The monoline commercial umbrella program (the Umbrella Program) resulted in $15,060,000 of DWP in 2006 compared to $19,688,000 in 2005. This decrease of $4,628,000 or 24% resulted from increased competition from property casualty companies that have expanded their underwriting appetite to include commercial umbrella policies written in conjunction with the underlying property and liability policies. The Umbrella Program is marketed exclusively through one independent agent and approximately 95% of the premiums from Umbrella Program Policies are reinsured with an “A” rated national reinsurer through a quota share reinsurance treaty.
The 59% decrease in group-wide involuntary DWP resulted primarily from a decrease in assignments from the New York Automobile Insurance Plan (NYAIP). DWP related to policies assigned from the NYAIP decreased 67% to $764,000 from $2,329,000 for 2005. The NYAIP provides coverage for individuals who are unable to obtain auto insurance in the voluntary market. Assignments from the NYAIP vary depending upon a company’s PPA market share and the size of the NYAIP. The Company is unable to predict the volume of future assignments from the NYAIP.
In order to minimize the adverse impact of assignments from the NYAIP, the Company purchased territorial credits from an unaffiliated company pursuant to Section 6.A.7. of the NYAIP Manual. The credits against NYAIP assignments were generated by the other insurance company for writing PPA business in certain localities in New York with PPA market availability problems. The other insurance company, by nature of its concentration in PPA business in “credit” territories, generated more credits than it required to offset its NYAIP assignments. The purchased credits reduced the Company’s share of the NYAIP. The purchased credits decreased direct premiums written related to NYAIP assignments during 2006 and 2005 by approximately $971,000 and $1,200,000, respectively.
Group-wide pooled net premiums written for 2006 were $167,697,000, an increase of $3,395,000, or 2%, from $164,302,000 for 2005. This increase resulted from the 2% increase in group-wide DWP. The Company’s share of pooled net premiums written in 2006 in accordance with the Reinsurance Pooling Agreement was $37,740,000, a decrease of $7,395,000, or 16%, from $45,135,000 in 2005. This decrease resulted primarily from the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
Total revenues for 2006 were $49,540,000, a decrease of $7,885,000 or 14%, from $57,425,000 in 2005.
Net investment income was $7,938,000, an increase of $205,000, or 3%, from $7,733,000 in 2005 primarily due to a 19 basis point (5%) increase in average portfolio yield somewhat offset by a 3% decrease in average portfolio assets.
Net losses and LAE were $22,147,000 for 2006, a decrease of $4,261,000, or 16%, from $26,408,000 for 2005. The decrease in net losses and LAE was due to the 16% decrease in net premiums earned. The calendar year loss and LAE ratio was 53.8% in 2006 and in 2005. The loss and LAE ratio for the current accident year was 63.9% in 2006 compared to 60.5% in 2005, an increase of 3.4 percentage points. This increase resulted from increased costs of reinsurance and market pricing pressure as well as a snow and ice storm in Western New York State during October 2006 that added approximately .9 percentage points to the 2006 accident year loss and LAE ratio. There were no similar storms in 2005.
The Company made no changes to the key assumptions used in evaluating the adequacy of its reserves for losses and LAE during 2006. A reasonable possibility exists in any year that relatively minor fluctuations in the estimate of reserves for losses and LAE may have a significant impact on the Company’s net income. This is due primarily to the size of the Company’s reserves for losses and LAE ($104,914,000 at December 31, 2006) relative to its net income.
Total combined Mutual and MNH or “group-wide” DWP for the year ended December 31, 2005 were $195,228,000, an increase of $4,090,000, or 2%, from $191,138,000 in 2004. The Company’s pro- forma share of combined DWP in 2005, in accordance with the Reinsurance Pooling Agreement, was
The 20% (or $10,037,000) decrease in group-wide voluntary personal DWP resulted from a 30% decrease in private passenger automobile DWP and a 1% decrease in homeowners DWP. The decrease in PPA DWP is the result of the companies’ decision, implemented in 2001, not to write new policies in certain jurisdictions and from the approval of the companies’ plan to withdraw from the New Jersey PPA market by the New Jersey Department of Banking and Insurance, which was effective in June 2003 and was completed in May 2005. As a result, voluntary PPA policies in force at December 31, 2005 were 14,640, a decrease of 5,291 or 27%, from 19,931 at December 31, 2004.
In order to minimize the adverse impact of assignments from the NYAIP, the Company purchased territorial credits from an unaffiliated company pursuant to Section 6.A.7. of the NYAIP Manual. The purchased credits decreased DWP related to NYAIP assignments during 2005 and 2004 by approximately $1,200,000 and $2,351,000, respectively.
There were no net investment gains or losses in 2005 compared to $221,000 ($.07 per fully diluted share after taxes) of net investment losses in 2004. The 2004 amount included an aggregate $700,000 of investment losses related to an other-than-temporary impairment in the value of two investment securities owned by the Company at December 31, 2004.
Other revenues were $571,000 in 2005, a decrease of $151,000, or 21%, from $722,000 in 2004, primarily due to the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
The Company recorded decreases to its estimate of losses and LAE related to prior accident years of $3,303,000 and $843,000 in 2005 and 2004, respectively, a difference of $2,460,000. These decreases in losses and LAE relating to prior accident years reduced the loss and LAE ratio in 2005 and 2004 by 6.7 and 1.5 percentage points, respectively. The reserve development for each product and for each accident year during 2005 was within the range of reasonably likely reserves by product as of December 31, 2004. It is not appropriate to predict future increases or decreases in the estimate of losses and LAE for prior accident years from past experience. See “Critical Accounting Policies and Estimates” for a further discussion of the
The Company’s reduction in its estimate of losses and LAE related to prior accident years represented less than 3% of the recorded reserve for losses and LAE at December 31, 2004 and is within a reasonable range of loss reserve volatility for the products being underwritten.
The ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned increased to 43.9% for 2005 from 40.5% for 2004. A $2,081,000 or 14% decrease in the amortization of deferred acquisition costs was partly offset by a $520,000 or 6% increase in other underwriting expenses. Other underwriting expenses included $3,320,000 (6.8 percentage points of the expense ratio) of retrospective commission expense related to the Reinsurance Pooling Agreement, which provides for retrospective commission income or expense based on actual experience compared to a targeted loss and LAE ratio. The commission is owed to Mutual based on a decrease during 2005 in the estimated
The incurred loss development method is based on the assumption that the past relative adequacy of case reserves is consistent with the current relative adequacy of case reserves. Because incurred losses include payments and case reserves, a larger volume of data is considered in the estimate of ultimate losses. As a result, incurred loss data patterns may be less erratic than paid loss data patterns, particularly for coverages on which claims are reported relatively quickly but have a long payout pattern. Because this method assumes that the relative adequacy of case reserves has been consistent, changes in claims handling procedures or the occurrence or absence of large losses may cause estimates to be erratic.
This method multiplies the estimated number of ultimate claims by a selected ultimate average loss for each accident year to produce ultimate loss estimates. If loss development methods produce erratic or unreliable estimates, this method can provide more stable estimates, consistent with recent loss history. This method may produce erratic results if there has been a change in the way claims are counted or in the mix of types of loss. The occurrence or absence of large losses can also distort the average loss estimate.
Estimated ultimate losses and LAE and the resulting reserve for losses and LAE are determined based on the results of the methods described above along with the following considerations:
How results of paid and incurred development methods compare to results of paid and incurred BF methods.
the reasonableness of ultimate loss & ALAE ratios and ultimate severities
The product categories shown in this table are those used by the Company in its loss reserving process. The Company’s reserve for unpaid losses and LAE in the table that follows are segregated by product type as defined in the Company’s Annual Statement filed with insurance department regulators.
Despite the many factors considered in the reserving process, it is reasonably probable that actual payments for losses and LAE will differ from those contemplated in the Company’s reserves. Such fluctuations could have a significant impact on the Company’s net income. This is primarily due to the size of the Company’s reserves for losses and LAE ($104,914,000 at December 31, 2006) relative to its net income.
The following table presents the liability for the reserve for unpaid losses and LAE separated into case reserves, reserves for IBNR losses and reserves for LAE by major product:
The Company’s investment committee, comprised of the Chief Operating Officer, the Chief Investment Officer and the Chief Financial Officer, meets monthly and monitors the Company’s investment portfolio for declines in value that are other-than-temporary. This assessment requires significant judgment. The investment committee considers the nature of the investment, the severity and length of the decline in fair value, events specific to the issuer including valuation modeling, overall market conditions, and the Company’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. When a decline in the fair value of a security is determined to be other-than-temporary, the Company adjusts the cost basis of that security to fair value and records a charge to earnings. Future increases in fair value, and future decreases in fair value if not other-than-temporary, are included in other comprehensive income.
In developing its investment strategy the Company determines a level of cash and short-term investments which, when combined with expected cash flow, is estimated to be adequate to meet expected cash obligations. Due to declining written premiums however, the Company’s operating activities have resulted in a use of cash each year since 2001. Net cash used in operations was $4,350,000 in 2006.
At December 31, 2006, the Company owned 124 investment securities, of which 105 were in an unrealized loss position. As of December 31, 2006 all of the Company’s fixed maturity investments were exchange traded or are readily marketable and are supported by the broker/dealer community. The total potential impact on the Company’s future earnings if the unrealized losses associated with its investment portfolio at December 31, 2006 were to become other-than-temporary would be $2,991,000, or $1,974,000 after taxes.
The Company designates newly acquired fixed maturity investments as available for sale and carries these investments at fair value. Unrealized gains and losses related to these investments are recorded as accumulated other comprehensive income within stockholders’ equity.
At December 31, 2006, $80,518,000, or 51.3%, of the Company’s fixed maturity portfolio was invested in mortgage-backed and other asset-backed securities. The Company invests in a variety of collateralized mortgage obligation (“CMO”) products but has not invested in the derivative type of CMO products such as interest only, principal only or inverse floating rate securities. All of the Company’s CMO investments have a secondary market and their effect on the Company’s liquidity does not differ significantly from that of other fixed maturity investments.
The Company has arranged for a $2,000,000 unsecured credit facility from a bank. Any borrowings under this facility are payable on demand and carry an interest rate which can be fixed or variable and is negotiated at the time of each advance. This facility is available for general working capital purposes and for repurchases of the Company’s common stock. No amounts were outstanding related to this facility at December 31, 2006.
As a holding company, the Company is dependent upon cash dividends from MNH to meet its obligations and to pay any cash dividends. MNH is subject to New Hampshire insurance laws which place certain restrictions on its ability to pay dividends without the prior approval of state regulatory authorities. These restrictions limit dividends to those that, when added to all other dividends paid within the preceding twelve months, would not exceed 10% of the insurer’s policyholders’ surplus as of the preceding December 31st. The maximum amount of dividends that MNH could pay during any twelve month period ending in 2007 without the prior approval of the New Hampshire Insurance Commissioner is $7,167,000. MNH paid $1,000,000, $2,000,000 and $750,000 of dividends to the Company in August 2006, January 2007 and March 2007, respectively. The Company paid aggregate quarterly cash dividends to its common stockholders of $1.00 per share in 2006, which amounted to $2,147,000.
strategy that would allow MNH to meet this 3 to 1 regulatory guideline. MNH’s ratio of net premiums written to statutory surplus for 2006 was .5 to 1.
At December 31, 2006, the Company had no contractual obligations related to long-term debt, capital leases, operating leases, purchase obligations or other long-term liabilities reflected on its balance sheet.
The Company does not expect these pronouncements to have any material impact on its financial statements.
MNH, like many other property and casualty insurance companies, is subject to environmental damage claims asserted by or against its insureds. Management of the Company is of the opinion that based on various court decisions throughout the country, certain of these claims should not be recoverable under the terms of MNH’s insurance policies because of either specific or general coverage exclusions contained in the policies. However, there is no assurance that the courts will agree with MNH’s position in every case, nor can there be assurance that material claims will not be asserted under policies which a court will find do not explicitly or implicitly exclude claims for environmental damages. Management, however, is not aware of any pending claim or group of claims which would result in a liability that would have a material adverse effect on the financial condition of the Company or MNH.
The Company’s and MNH’s business and day-to-day operations are closely aligned with those of Mutual. This is the result of a combination of factors. Mutual has had a historical ownership interest in the Company and MNH. Prior to November 1986 MNH was a wholly-owned subsidiary of Mutual. Following the Company’s initial public offering in November 1986 and until a secondary stock offering in July 1993 the Company was a majority-owned subsidiary of Mutual. At December 31, 2006 Mutual owned 11.9% of the Company’s common stock. Under the Services Agreement, Mutual provides the Company and MNH with all facilities and personnel to operate their business. The officers of the Company and MNH are employees of Mutual whose services are provided to, and paid for by, the Company and MNH through the Services Agreement. Also, the operation of MNH’s insurance business, which offers substantially the same products as Mutual through the same independent insurance agents, creates a very close relationship among the companies.
“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:
With the exception of historical information, the matters and statements discussed, made or incorporated by reference in this Annual Report on Form 10-K constitute forward-looking statements and are discussed, made or incorporated by reference, as the case may be, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements relating to the Company’s plans, strategies, objectives, expectations and intentions. Words such as “believes,” “forecasts,” “intends,” “possible,” “expects,” “anticipates,” “estimates,” or “plans,” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve certain assumptions, risks and uncertainties that include, but are not limited to, those associated with factors affecting the property-casualty insurance industry generally, including price competition, the Company’s dependence on state insurance departments for approval of rate increases, size and frequency of claims, escalating damage awards, natural disasters, fluctuations in interest rates and general business conditions; the Company’s dependence on investment income; the geographic