We lease approximately 54,000 square feet of space at 120 Broadway, New York, New York, on the entire 14th floor and a part of the 17th floor. We pay an annual rent of $1,336,000, which will increase by the terms of the lease agreement on September 16, 2005 to $1,354,000. The expiration date of the lease is May 15, 2008, upon which date we have an option to extend the term of the lease for a single renewal term of five years. If we exercise the option for renewal, the rent will be adjusted to reflect the fair market rental value at the time of renewal.
The selected consolidated income statement data for the years ended December 31, 2004, 2003 and 2002 and the balance sheet data as of December 31, 2004 and 2003 are derived from our audited financial statements included elsewhere in this document, which have been prepared in accordance with GAAP and have been audited by Johnson Lambert & Co., our independent public accounting firm. The selected consolidated income statement data for the years ended December 31, 2001 and 2000 and the balance sheet data as of December 31, 2002, 2001 and 2000 are derived from our unaudited financial statements. These historical results are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information along with the information contained in this document, including "
OVERVIEW We provide a broad range of property and casualty insurance products as well as reinsurance through TICNY, our insurance company subsidiary. We also provide managing general underwriting, claims administration and reinsurance intermediary services through TRM, our insurance services subsidiary.
In our insurance segment, TICNY provides commercial and personal lines insurance policies to businesses and individuals. TICNY's commercial lines products include commercial multiple-peril (provides both property and liability insurance), monoline general liability (insures bodily injury or property damage liability), commercial umbrella, monoline property (insures buildings, contents or business income), workers' compensation and commercial automobile policies. Its personal lines products consist of homeowners, dwelling and other liability policies. In our reinsurance segment, TICNY assumes reinsurance directly from the insurance companies for which TRM produces insurance premiums (which we refer to as TRM's "issuing companies") or indirectly from reinsurers that provide reinsurance coverage directly to these issuing companies. In our insurance services segment, TRM generates commission income from its managing general agency by producing premiums on behalf of its issuing companies and generates fees by providing claims administration and reinsurance intermediary services.
On October 20, 2004, the Company sold 13,000,000 shares in its IPO at $8.50 per share. On the same date, the Company also effected a concurrent private placement of 500,000 shares of its common stock to an affiliate of Friedman, Billings, Ramsey & Co., Inc., the lead underwriter for the Company's IPO, at a price of $8.50 per share. On November 10, 2004 the underwriters exercised their 30-day over-allotment option after the Company's IPO. Pursuant to this exercise, the underwriters purchased 629,007 additional shares of common stock from the Company and 1,320,993 shares of common stock from selling shareholders. The Company received net cash proceeds of $107,845,000 from the offering and concurrent private placement after the underwriting discounts, commissions and offering expenses. The total costs of the IPO and private placement were $12,252,000 of which $8,407,000 was for the underwriters discount, and $3,845,000 was for all other costs. Costs of the IPO have been reflected as a reduction in Paid-in-Capital.
MARKETPLACE CONDITIONS AND TRENDS The property and casualty insurance industry is affected by naturally occurring industry cycles known as "hard" and "soft" markets. Since we began operations in 1990 and continuing into 2000, we operated in a soft market cycle, generally considered an adverse industry cycle in the property and casualty insurance industry. A soft market cycle is characterized by intense competition that results in inadequate pricing, expanded coverage terms and increased commissions paid to distribution sources in order to compete for business. We believe that a hard market began sometime in late 2000. A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing, reduced coverage terms and lower commissions paid to acquire business. While we sustained minimal losses from the September 11, 2001 terrorist attacks, the hard market conditions were significantly intensified after this event.
TICNY's gross premiums written in 2004, 2003 and 2002 were $177.8 million, $134.5 million and $106.7 million, respectively. After significant pricing increases and reunderwriting that began in 2001, TRM's underlying business also became profitable in 2003 and the premiums produced by TRM in 2004, 2003 and 2002 were $53.4 million, $39.5 million and $24.3 million, respectively.
Ceding commission revenues. We earn ceding commission revenues on the gross premiums written that we cede to reinsurers.
Direct commission revenues and fees. Direct commission revenues and fees consist of commissions earned by TRM on premiums produced by its managing general agency and fees earned from its claims administration and reinsurance intermediary services. It also includes policy billing fees that we earn in the course of collecting premiums from our policyholders. This fee is charged primarily on small policies written through our insurance segment.
o Interest expense. We pay interest on our loans, on subordinated debentures and on segregated assets placed in trust accounts on a "funds withheld" basis in order to collateralize reinsurance recoverables.
o Income taxes. We pay Federal, state and local income taxes and other taxes.
o Change in leverage ratios. In 2003, our gross leverage ratio (the ratio of gross premiums written to statutory surplus) was 3.79. For the first nine months in 2004 the annualized gross leverage ratio was 4.10. Our net leverage ratio (the ratio of net premiums written to statutory surplus) was 0.82 in 2003 and an annualized 1.08 on an annualized basis for the first nine months of 2004. The difference between the gross and net leverage ratio, 2.97 in 2003 and 3.02 for the first nine months of 2004, represents ceded premiums in relation to our surplus and is sometimes called the ceded leverage ratio. With the increased capitalization of our insurance company, we plan to target a gross leverage ratio of approximately 1.5 to 2.0, a net leverage ratio of approximately 1.25 to 1.50 and a ceded leverage ratio of up to 0.50 during 2005. The actual gross, net and ceded leverage ratios may vary from the target leverage ratios during that period, and even more significantly thereafter depending upon many factors that affect our rating with various organizations and capital adequacy requirements imposed by insurance regulatory authorities. These factors include but are not limited to the amount of statutory surplus, premium growth, quality and terms of reinsurance (especially regarding collateralization of reinsurance recoverables) and line of business mix.
o Increased net premiums written. By increasing our net leverage ratio from 0.82 in 2003 and 1.08 on an annualized basis for the first nine months in 2004 to approximately 1.25 to 1.50 in 2005 with the increased surplus in our insurance company, we would increase our underwriting profit from net premiums written if our underwriting results continue to be favorable. The underwriting profit from the increased net premiums written, however, will not be recognized immediately, but over time as net premiums written are earned.
o Reduced reliance on TRM's issuing companies. In 2003 and for the first nine months of 2004, premiums produced by TRM represented approximately 23.0% and 21.8%, respectively, of our gross premiums written by TICNY and premiums produced by TRM. The increase in TICNY's statutory surplus will enable us to reduce our reliance on TRM's issuing companies. TICNY will be able to write directly more of the business that TRM has placed with its issuing companies and therefore reduce the fees retained by TRM's issuing companies for writing this business. As a result, we expect that TRM's premiums produced as a percentage of our gross premiums written by TICNY and premiums produced by TRM will be approximately 10% to 15%. Additionally, TICNY will be able to lower its expense ratio by writing the policies with larger premium per policy than TRM currently produces, since these larger policies entail lower direct commission expense (13.9% in 2004 and for TRM's business compared with 16.6% for TICNY's business) as well as lower underwriting cost relative to the size of the policy. However, we plan to continue to utilize TRM's issuing companies to underwrite specific products in certain market segments, especially in territories outside of New York, and to increase our ability to produce premiums in excess of the premiums that TICNY can generate utilizing its own statutory surplus. By doing so, we plan to continue to generate commissions through our managing general agency and other related fees in our insurance services operation to improve our return on equity. In 2003 and 2004 our insurance services pre-tax income was 6.7% and 3.5% of our net premiums earned. With the increased capitalization of our insurance company, we expect our insurance services pre-tax income to decline to approximately 1% to 2% of our net premiums earned.
o Increased investment income. TICNY's increase in statutory surplus and in net premiums written will allow us to increase our invested assets. We expect our investment income to increase as our invested assets grow. Since loss and loss adjustment expense reserves are paid out over a number of years, we expect to realize the benefit from increased invested assets over several years.
o Improved ability to increase assumed reinsurance premiums. The increase in TICNY's statutory surplus and the improvement in its rating will enable TICNY to increase its assumed reinsurance from other insurance companies, especially TRM's issuing companies. Due to its limited statutory surplus and rating, TICNY often had relied on other reinsurers to directly reinsure TRM's issuing companies and then cede a modest amount of the assumed premiums to TICNY. As a result, while the underwriting result of the business written through TRM and of the assumed premiums improved significantly in 2003 and 2004, TICNY had not been able to assume a meaningful participation on this business due to statutory surplus constraints.
Loss ratio. The loss ratio is the ratio of losses and loss adjustment expenses incurred to premiums earned and measures the underwriting profitability of a company's insurance business. We measure our loss ratio on a gross (before reinsurance), and net basis (after reinsurance) as well as the loss ratio on the ceded portion (the difference between gross and net premium) for our insurance and reinsurance segments. We use the gross loss ratio as measures of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. We use the ceded loss ratio to measure the experience on the premiums that we cede to reinsurers, including the premiums ceded under our quota share treaties. Beginning in 2001, the loss ratio on such ceded business has determined the ceding commission rate that we earn on ceded premiums. Our net loss ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our consolidated financial statements. In addition, we use accident year and calendar year loss ratios to measure our underwriting profitability. An accident year loss ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premium earned during that year. A calendar year loss ratio and measures losses and loss adjustment expense for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of premiums earned during that year.
Net income and return on average equity. We use net income to measure our profits and return on average equity and to measure our effectiveness in utilizing our shareholders' equity to generate net income on a consolidated basis. In determining return on average equity for a given year, net income is divided by the average of shareholders' equity for that year. As the IPO was completed in fourth quarter of 2004, the 2004 full year return on equity was calculated by dividing net income by an average shareholders' equity for the year.
CRITICAL ACCOUNTING POLICIES In preparing our consolidated financial statements, management is required to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses and the related disclosures as of the date of the financial statements. Certain of these estimates result from judgments that can be subjective and complex. Consequently, actual results may differ, perhaps substantially, from the estimates.
Loss and loss adjustment expense reserves. Loss and loss adjustment expense reserves represent our best estimate at a particular point in time of the ultimate unpaid cost of all losses and loss adjustment expenses incurred, including settlement and administration of losses, based on facts and circumstances then known and including losses that have been incurred but not yet been reported. The process of establishing the liability for unpaid losses and loss adjustment expenses is complex, requiring the use of informed estimates and judgments. Actuarial methodologies are employed to assist in establishing these estimates and include judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level, possible changes in the law and other external factors that are often beyond our control. The amount of loss and loss adjustment expense reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and loss adjustment expense reserves for unreported claims are determined using historical information by line of insurance as adjusted to current conditions.
Ceding commissions earned. We have historically relied on quota share, excess of loss and catastrophe reinsurance to manage our regulatory capital requirements and limit our exposure to loss. Generally, we have ceded a significant portion of our insurance premiums to unaffiliated reinsurers in order to maintain our net leverage ratio at our desired target level.
Impairment of invested assets. Impairment of investment securities results in a charge to income when a market decline below cost is deemed to be other than temporary. We regularly review our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other than temporary declines in the fair value of investments. In general, we focus our attention on those securities whose fair value was less than 80% of their amortized cost or cost, as appropriate, for six or more consecutive months. In evaluating potential impairment, we consider, among other criteria: the current fair value compared to amortized cost or cost, as appropriate; the length of time the security's fair value has been below amortized cost or cost; our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in value; specific credit issues related to the issuer; and current economic conditions. Other than temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment. There were no other than temporary declines in the fair value of our fixed maturity securities recorded during 2004, 2003 and 2002. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in our consolidated financial statements. See "Item 1.--Investments" and "Note 2. Investments" for additional detail regarding our investment portfolio at December 31, 2004, including disclosures regarding other than temporary declines in investment value.
Intangible assets and potential impairment. The costs of a group of assets acquired in a transaction is allocated to the individual assets including identifiable intangible assets based on their relative fair values. Identifiable intangible assets with a finite useful life are amortized over the period which the asset is expected to contribute directly or indirectly to the future cash flows of the Company. Identifiable intangible assets with finite useful lives are tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. An impairment loss is recognized if the carrying value of an intangible asset is not recoverable and its carrying amount exceeds its fair value. No impairment losses were recognized in 2004, 2003 and 2002. Significant changes in the factors we consider when evaluating our intangible assets for impairment losses could result in a significant change in impairment losses reported in our consolidated financial statements. See "Item 1.--OneBeacon Renewal Rights Transaction" and "Note 6. Intangible Assets".
Our results of operations are discussed below in two parts. The first part discusses the consolidated results of operations. The second part discusses the results of the two underwriting segments: insurance and reinsurance segments, followed by the results of operations of our insurance services segment.
Premiums earned. Net premiums earned in 2004 increased by 98.6% to $45.6 million compared to $22.9 million in 2003. The increase in net premiums earned was due to the overall increase of 32.2% in gross premiums written in 2004 and to our decision to cede less business in 2004 than 2003. See "Item 7.-Insurance Segment Results of Operations" and "Item 7.-Reinsurance Segment Results of Operations" for a discussion of premiums and total commissions and fee income.
Net investment income and realized gains. Net investment income in 2004 increased by 123.6% to $5.1 million compared to $2.3 million in 2003. This increase resulted from the growth in invested assets provided by operations, net proceeds from subordinated debentures underlying trust preferred securities issued in 2003 for $20.6 million, net proceeds of $107.8 million from the October 2004 IPO and concurrent private placement and an increase of $29.2 million in funds withheld as collateral for reinsurance recoverables. This was offset in part by a decrease in the yield on fixed maturity investments. Invested assets grew $171.1 million from $57.3 million at December 31, 2003 to $228.4 million at December 31, 2004. The yield for our fixed income investments held at December 31, 2004 was 3.9% compared to 5.0% for assets held at December 31, 2003. On a tax equivalent basis, the yield was 4.4% for 2004 and 5.3% for 2003. The decrease in yield in 2004 resulted primarily from a lower available interest rates and an increased allocation to tax exempt securities.
Losses and loss adjustment expenses. Gross loss and loss adjustment expenses and the gross loss ratio for both the insurance and reinsurance segments combined in 2004 were $84.2 million and 55.2%, respectively, compared to $74.2 million and 60.8%, respectively, in 2003. The net loss ratio for the combined segments was 59.4% in 2004 and 65.7% in 2003. The improvement in the net loss ratio in 2004 compared to 2003 was due primarily to an increase in net premiums earned that reduced the effect of excess and catastrophe reinsurance premiums on the net loss ratio and to favorable development from prior years' reserves of $199,000. See "Item 7.-Insurance Segment Results of Operations" and "Item 7.-Reinsurance Segment Results of Operations."
Income tax expense. Our income tax expense in 2004 was $5.7 million compared to $3.4 million in 2003. The increased income tax in 2004 was due primarily to an increase in income before income taxes. The effective income tax rate was 38.7% in 2004 compared to 34.9% in 2003. The effective tax rates were affected by TRM's pre-tax profits which are subject to state income taxes. See "Note 11. Income Taxes".
Net income and return on average equity. Net income and return on average equity in 2004 were $9.0 million and 23.7%, respectively, compared to $6.3 million and 56.8%, respectively, in 2003, which represents a 43.8% increase in net income. Although net income was significantly higher in 2004 than in 2003, the lower return on average equity resulted from the significant increase in average shareholders' equity as the IPO was completed in the fourth quarter of 2004. For the year, the return was calculated by dividing net income of $9.0 million by an average shareholders' equity of $38.1 million.
Operating expenses. Total operating expenses increased by 33.1% to $48.5 million in 2003 from $36.5 million in 2002. The increases were primarily due to increases in underwriting expenses related to expansion of the volume of premiums written by TICNY and premiums produced by TRM, offset in part by expense efficiencies resulting from continued realization of economies of scale.
Income tax expense. Our income tax expense was $3.4 million in 2003 compared with $4.1 million in 2002. The decrease in income taxes in 2003 was primarily due to a change in the New York State tax laws in that year that shifted a portion of the state income tax to premium taxes. This change lowered income taxes and increased expenses in our insurance segment in 2003 as premium taxes are treated as an expense rather than as tax. The effective Federal tax rate was approximately 30.4% in 2003 and 21.5% in 2002. The effective Federal tax rate was lower than the statutory Federal rate of 34% in 2002 and 2003 due to tax-exempt income and certain tax credits. See "Note 11. Income Taxes".
Insurance Segment Results of Operations 2004 Compared to 2003 Gross premiums. Gross premiums written in 2004 increased by 32.2% to $176.2 million from $133.3 million in 2003. Gross premiums earned increased similarly by 25.4% to $151.2 million in 2004 compared to $120.5 million in 2003. These increases are attributable to a 12.3% growth in policy count and to a 16.8% increase in average premium size resulting primarily from rate increases and other pricing actions.
Ceded premiums. Ceded premiums written in 2004 decreased by 24.4% to $79.6 million compared with $105.3 million in 2003. Although gross written premiums increased in 2004, ceded written premiums declined due to our decision to lower the ceding percentage under our quota share reinsurance agreements. For the first nine months of 2003, the ceding percentage under our quota share reinsurance agreement was 70% and beginning October 1, 2003 was 80%. The effective quota share ceding percentage was 77.2% for 2003. For the first nine months of 2004, the ceding percentage under our quota share reinsurance agreement was 60% and beginning October 1, 2004 was 25%. The effective quota share ceding percentage was 41.6% in 2004 that also included a $13.1 million reduction to ceded written premiums from the retention of the unearned premium at December 31, 2004 that would have been ceded to Converium Re North America. Following the downgrade of Converium Reinsurance (North America) Inc.'s rating and decision by its parent to place that company into runoff in September 2004, we terminated and novated Converium's participation under its 2004 quota share treaty and decided to retain the ceded unearned premiums that would have been ceded to Converium absent the termination. Excluding the $13.1 million that we retained, the effective quota share ceding percentage would have been 49.1% in 2004. See "Note 5. Reinsurance-Converium" and "Item 1.-Reinsurance-2004 Reinsurance Program" for a further discussion. Despite the reduction in ceded premiums written, ceded premiums earned increased by 8.8% in 2004 resulting from the effect of earning ceded premiums that were written in 2003 and during the first nine months of 2004 under higher quota share ceding percentages as explained above.
Insurance Segment Results of Operations 2003 Compared to 2002 Gross premiums. Gross premiums written increased by 26.6% to $133.3 million in 2003 from $105.3 million in 2002. Gross premiums earned increased by 42.6% to $120.5 million in 2003 compared with $84.5 million in 2002. These increases were due in part to the growth in policy count, which was 9.0% in 2003, and to an increase in average premium size of 14.5% in 2003 resulting from rate increases and other pricing actions.
Gross premiums written increased in 2003 in all lines of business, but especially in commercial package (31%), workers' compensation (39%) and commercial automobile (41%).
The growth rate for premiums earned was higher than for premiums written because of significant premium growth in the second half of 2002 as a follow-on effect of the Empire renewal rights transaction. See "Item 1.-Business Segments-Insurance Segment Products-Other Liability". Much of the premiums written in 2002 were earned in 2003 instead of 2002, causing premiums earned to increase significantly in 2003 as premiums written in the later part of 2002 became earned in 2003.
Net premiums. In 2003, net premiums written increased by 4.2% to $28.0 million from $26.8 million in 2002. Net premiums earned decreased by 11.8% in 2003 to $22.4 million from $25.4 million in 2002. Net premiums earned declined in 2003 despite the increase in the net premiums written as a result of an increase in the percentage of premiums ceded in the last three months of 2003, when we entered into a new reinsurance agreement to replace our reinsurance agreement with PMA Reinsurance Company ("PMA"), which we commuted on September 30, 2003 after PMA's rating was downgraded by A.M. Best. As a result of the commutation, direct losses and loss adjustment expenses that would have been ceded and recorded as reinsurance recoverable from PMA during the nine months ended September 30, 2003 were retained by us and settled in full by payment from PMA. Accordingly, the effect of the commutation of such losses and loss adjustment expense reserves increased our net reserves by $2.7 million. See "Item 1.--Reinsurance--2003 Reinsurance Program". The percentage of premiums ceded for 2003 increased to 81.5% from 70.0% in 2002. The increase in net premiums earned in 2002 resulted from a 151.9% increase in gross premiums earned and a decrease in the percentage of premiums ceded to 70.0% from 83.5% in 2001.
Underwriting expenses and underwriting expense ratio. Underwriting expenses, which include direct commission expenses and other underwriting expenses, were $37.0 million in 2003 compared with $26.6 million in 2002. Our gross expense ratio in this segment was 30.2% in 2003 compared with 31.0% in 2002.
The net underwriting expenses and underwriting expense ratio were $1.1 million and 4.9%, respectively, in 2003 compared with $4.8 million and 18.9%, respectively, in 2002. These net underwriting expenses reflect the reduction of our gross expenses by the ceding commission revenues of $35.3 million in 2003 and $21.4 million in 2002. In addition, these net underwriting expenses are net of underwriting expense reimbursements that were made by TRM pursuant to an expense sharing agreement between TRM and TICNY. See "Item 1.-Insurance Services Segment Results of Operations" for the amounts of underwriting expense reimbursements.
Reinsurance Segment Results of Operations 2004 Compared to 2003 Gross premiums. Gross written premiums written increased by 31.3% to $1.6 million in 2004 as compared to $1.2 million in 2003. The increase was due to an increase in the premiums produced by TRM's issuing companies as well as higher rates charged on reinsurance assumed from these issuing companies. In 2003 our reinsurance assumed was converted from a pro rata reinsurance basis to an excess of loss basis, which significantly reduced the amount of premiums assumed although treaties written in 2002 still contributed somewhat to gross earned premiums in 2003.
Underwriting expenses and underwriting expense ratios. Underwriting expenses for the reinsurance segment are comprised of ceding commission expense paid to TRM's issuing companies and other third-party reinsurers to acquire the ceded premium and this segment's allocated share of our other underwriting expenses. Gross underwriting expenses in 2004 increased to $248,000 as compared to $211,000 in 2003 primarily as a result of the increase in gross premiums written which is the basis of the other underwriting expense allocation to this segment. Our net underwriting expense ratio increased to 21.8% in 2004 compared to a negative 14.4% in 2003. The negative underwriting expense ratio in 2003 resulted from ceding commission revenue earned in 2003 on premiums ceded under our 2002 quota share treaty, which exceeded the underwriting expenses incurred.
Underwriting profit and combined ratio. The underwriting profit from assumed reinsurance in 2004 was $1.6 million compared to $0.3 million in 2003. The net combined ratio was a negative 39.1% in 2004 compared to 50.3% in 2003. The net combined ratio in 2004 was the result of the negative net loss ratio as explained above.
Underwriting profit/losses and combined ratio. The underwriting profit from assumed reinsurance, which reflects our underwriting results on a net basis after the effect of ceded reinsurance, was $287,000 in 2003 compared with an underwriting loss of $939,000 in 2002. The net combined ratio was 50.3% in 2003 compared with 244.0% in 2002. The underwriting profit in 2003 resulted from the absence of adverse loss development, favorable net accident year loss ratio and a negative net underwriting expense ratio due to the minimal expenses, which were further reduced by the effect of ceding commission revenue.
Claims expense reimbursement. The amount of reimbursement by TRM for claims administration pursuant to the terms of the expense sharing agreement in 2004 was $4.0 million compared with $3.6 million in 2003 due to an increase in the number of claims handled.
Insurance Services Segment Results of Operations 2003 Compared to 2002 Total revenues for the insurance services segment were $12.8 million in 2003, compared with $12.4 million in 2002, as an increase in reinsurance commission revenue was offset by decreases in claims administration revenue and reinsurance intermediary fees.
The amount of this reimbursement for underwriting expenses was $2.2 million in 2003 compared with $1.6 million in 2002. Claims expenses reimbursed by TRM were $3.6 million in 2003 compared with $4.4 million in 2002.
Our insurance services pre-tax income for TRM was $1.5 million in 2003, compared with $3.1 million in 2002.
INVESTMENTS We classify our investments in fixed maturity securities as available for sale and report these securities at their estimated fair values based on quoted market prices or a recognized pricing service. Changes in unrealized gains and losses on these securities are reported as a separate component of comprehensive net income, and accumulated unrealized gains and losses are reported as a component of accumulated other comprehensive net income in stockholders' equity. Realized gains and losses are charged or credited to income in the period in which they are realized.
The aggregate fair market value of our invested assets as of December 31, 2004 was $228.4 million. As of that date, our fixed maturity securities had a fair market value of $224.5 million and amortized cost of $223.6 million. The equity securities had a fair value of $2.5 million and a cost of $1.8 million. The Company's common trust securities - statutory business trusts had a fair value and equity value of $1.4 million.
The following table provides a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of December 31, 2004 and December 31, 2003.
SOURCES AND USES OF FUNDS We are organized as a holding company with two operating company subsidiaries, TICNY and TRM. The holding company's principal liquidity needs include interest on debt, income taxes and stockholder dividends. The holding company's principal sources of liquidity include dividends from TICNY and TRM and other permitted payments from our subsidiaries, as well as financing through borrowings and sales of securities.
Pursuant to a Tax Allocation Agreement, dated as of January 1, 2001, by and among Tower, TICNY and TRM, we compute and pay Federal income taxes on a consolidated basis. At the end of each consolidated return year, TICNY and TRM each must compute and pay to Tower its share of the Federal income tax liability primarily based on separate return calculations. The tax allocation agreement with TICNY and TRM allows Tower to make certain Code elections in the consolidated Federal tax return. In the event such Code elections are made, any benefit or liability is accrued or paid by TICNY and TRM. If a unitary or combined state income tax return is filed, each entity's share of the liability is based on the methodology required or established by state income tax law or, if none, the percentage of each entity's separate income or tax divided by the total separate income or tax reported on the return. During 2004, TICNY paid $4.1 million and TRM paid $0.8 million to Tower under this agreement.
Cash flows from financing activities for 2004 of $125.7 million included $107.8 million of net proceeds from the IPO and concurrent private placement in the fourth quarter of 2004 and $26.0 million in net proceeds from the issuance of subordinated debentures in connection with offerings of trust preferred securities in December, 2004. In 2004, we repaid $5.6 million of notes payable and redeemed all of our Series A cumulative redeemable preferred shares for $3.0 million. Additionally, the Company collected its employee notes receivable balance of $1.4 million before December 31, 2004. The Company paid stockholder dividends of $1.2 million and $1.8 million in 2004 and 2003, respectively.
Comparison of Years Ended December 31, 2003 and 2002 Net cash provided by operating activities was $22.7 million for the year ended December 31, 2003, a 120.6% increase from $10.3 million for 2002, which was a 38.5% decrease from $16.8 million for 2001. The increase in net cash provided by operations in 2003 resulted from an increase in premiums produced by TRM, improved underwriting profitability in our insurance segment and the retention, as funds withheld, of amounts due to reinsurers to provide collateral for reinsurance recoverables. Additionally, operating cash flow increased due to the commutation of the reinsurance contract with PMA Reinsurance Company and increased investment income from a larger investment portfolio.
Net cash used by investing activities was $19.0 million for the year ended December 31, 2003, compared to $19.0 million for 2002.
Cash flows from financing activities in 2003 included $6.0 million from the issuance of notes payable under a credit agreement in February and December and $20.0 million net proceeds from the issuance of subordinated debentures in connection with offerings of trust preferred securities in May and September. In 2003, we repaid $413,000 of notes payable and contributed $17.1 million to TICNY (of which $10.0 million was used to repay a $10.0 million surplus note). The Company paid stockholder dividends of $1.8 million in 2003 and repurchased 92,567 shares of our common stock for an aggregate purchase price of $514,260.
LIQUIDITY We maintain sufficient liquidity to pay claims, operating expenses and meet our other obligations. We held $55.2 million and $30.3 million of cash and cash equivalents at December 31, 2004 and 2003, respectively, which included $34.9 and $9.4 million, respectively, which were of short-term duration of less than ninety days and were recorded as cash equivalents on the balance sheet. We monitor our expected claims payment needs and maintain a sufficient portion of our invested assets in cash and cash equivalents to enable us to fund our claims payments without having to sell longer-duration investments. As of December 31, 2004, cash and cash equivalents greatly exceeded the estimated $13.4 million of loss reserves as of that date that we expected to pay within the next year. As necessary, we adjust our holdings of short-term investments and cash and cash equivalents to provide sufficient liquidity to respond to changes in the anticipated pattern of claims payments. See "Item 1.--Investments".
COMMITMENTS The following table summarizes information about contractual obligations and commercial commitments. The minimum payments under these agreements as of December 31, 2004 were as follows:
In 2003, we formed two statutory business trusts and we own all of the common trust securities of each trust. The trusts issued $20.0 million of trust preferred securities in private placements and invested the proceeds thereof and the proceeds from the sale of common trust securities in exchange for $20.6 million of junior subordinated debentures issued by our holding company. In December 2004, we formed two additional statutory business trusts and we own all of the common securities of each of those trusts. The trusts issued $26 million of trust preferred securities in a private placement and invested the proceeds thereof and the proceeds from the sale of common trust securities in exchange for $26.8 million of junior subordinated debentures issued by our holding company. All of the debentures have stated maturities of thirty years. We have the option to call any or all of the securities at par beginning five years from the date of issuance. The interest rate on $10.3 million of the subordinated debentures issued in May 2003 will float quarterly for changes in the three month London Interbank Offered Rate ("LIBOR") plus 4.1% and may not exceed 12.5% prior to the first call date of May 15, 2008. The interest rate on $10.3 million of subordinated debentures issued in September 2003 is a combination fixed and floating rate with a fixed rate of 7.5% during the no call period of five years after which the interest rate will float quarterly for changes in the three month LIBOR interest rate plus 4%. The interest rate on $13.4 million of subordinated debentures issued on December 17, 2004 is fixed at 7.4% for the first five years after which the interest rate will float quarterly for changes in the three month LIBOR interest rate plus 3.4%. The interest rate on $13.4 million of subordinated debentures issued on December 21, 2004 will float based on the three month LIBOR interest rate plus 3.4%. Under the terms for all of the trust preferred securities, an event of default may occur upon:
o non-payment of interest on the trust preferred securities, unless such non-payment is due to a valid extension of an interest payment period;
o non-payment of all or any part of the principal of the trust preferred securities;
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 85
We have audited the accompanying consolidated balance sheets of Tower Group, Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2003 and the related consolidated statements of income and comprehensive net income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
The consolidated financial statements include the accounts of Tower Group, Inc. ("Tower") and its wholly-owned subsidiaries, Tower Insurance Company of New York ("TICNY"), and Tower Risk Management Corporation ("TRM") (collectively "the Company"). The Company's stock is traded on the NASDAQ National Market under the symbol "TWGP".
On June 22, 2004 the Company's Board of Directors approved a 1.8:1 stock split, the maintaining of a par value of $0.01 after the split and the amendment and restatement of the Company's Certificate of Incorporation which among other things, combined the Class A and Class B common stock into one class of common stock and increased the authorized common stock to 40,000,000 shares. These actions became effective on October 20, 2004, which is the effective date of the Company's IPO. All consolidated financial statements and per share amounts have been retroactively adjusted for the above stock split and maintaining the par value at $0.01 per share.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). All significant intercompany transactions have been eliminated in consolidation. Certain 2003 amounts have been reclassified to conform to the 2004 presentation.
The Company accounts for reinsurance in accordance with Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"). Management believes the Company's reinsurance arrangements qualify for reinsurance accounting in accordance with SFAS 113. Management has evaluated its reinsurance arrangements and determined that insurance risk is transferred to the reinsurers. Reinsurance agreements have been determined to be short-duration prospective contracts and, accordingly, the costs of the reinsurance are recognized over the life of the contract in a manner consistent with the earning of premiums on the underlying policies subject to the reinsurance contract.
In preparing financial statements, management makes estimates of amounts receivable from reinsurers estimated to be uncollectible based on an assessment of factors including an assessment of the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. The Company recorded no allowance for uncollectible reinsurance at December 31, 2004 and 2003 and did not expense any uncollectible reinsurance during 2004, 2003 and 2002. Significant uncertainties are inherent in the assessment of the creditworthiness of reinsurers and estimates of any uncollectible amounts due from reinsurers. Any change in the ability of the Company's reinsurers to meet their contractual obligations could have a detrimental impact on the consolidated financial statements and TICNY's ability to meet its regulatory capital and surplus requirements.
Direct commission revenue from the Company's managing general underwriting services, which is the largest component of insurance services revenue, is generally recognized and earned as insurance policies are placed with TRM's issuing companies. Fees from reinsurance intermediary services are earned when TICNY or TRM's issuing companies cede premiums to reinsurers. Claims administration fees are earned as services are performed. See "Note 17. Segment Information" for a further description of the components of insurance services revenue.
Fixed-maturity securities and equity securities are reported at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders' equity. Short-term investments are carried at cost, which approximates fair value. Realized gains and losses are determined on the specific identification method.
The costs of a group of assets acquired in a transaction is allocated to the individual assets including identifiable intangible assets based on their relative fair values. Identifiable intangible assets with a finite useful life are amortized over the period which the asset is expected to contribute directly or indirectly to the future cash flows of the Company. Identifiable intangible assets with finite useful lives are tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. An impairment loss is recognized if the carrying value of an intangible asset is not recoverable and its carrying amount exceeds its fair value. No impairment losses were recognized in 2004, 2003 and 2002.
The Company accounts for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock-Based Compensation" ("APB 25"). Under APB 25, because the exercise price of the Company's employee stock options is equal to the estimated market price of the underlying stock at the date of the grant, no compensation expense is recognized. The effect of applying Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148") requires pro-forma disclosure of EPS for the impact on the financial statements as if the stock options were expensed. See "Note 1. Summary of Significant Accounting Policies-Recent Accounting Developments".
The Company accounts for restricted stock shares awarded at fair value at the dated awarded as a charge to Unearned Compensation - Restricted Stock, included as a separate component of Stockholders' Equity, and a credit to Common Stock and Paid-in-Capital. The fair value of the shares will amortize ratably over their one to five year vesting period as a charge to compensation expense and a reduction to Unearned Compensation - Restricted Stock in Stockholders' Equity.
In accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share", the Company measures earnings per share at two levels: basic earnings per share and diluted earnings per share. Basic per share data is calculated by dividing income (loss) allocable to common stockholders by the weighted average number of shares outstanding during the year excluding issued but unvested restricted stock shares. Diluted per share data is calculated by dividing income (loss) allocable to common stockholders by the weighted average number of shares outstanding during the year, as adjusted for the potentially dilutive effects of stock options, warrants, unvested restricted stock and/or convertible preferred stock, unless common equivalent shares are antidilutive.
In March 2004, the FASB issued EITF Issue No. 03-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments, which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF Issue No. 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. The FASB has delayed the application of the accounting provisions until 2005 but requires new disclosures for annual periods ending after June 15, 2004. Management does not expect the adoption of this new accounting pronouncement to have a material impact on the Company's financial statement upon adoption.
A summary of the amortized cost and fair value of the Company's investments in fixed-maturity securities at December 31, 2004 by contractual maturity is shown below (in 000's):
AMORTIZED FAIR COST VALUE ----------- ----------- YEARS TO MATURITY: One or less $ 8,224 $ 8,243 After one through five 54,705 54,924 After five through ten 91,361 92,094 After ten 5,156 5,103 Mortgage-backed securities 64,116 64,159 ----------- ----------- TOTAL $ 223,562 $ 224,523 =========== ===========
2004 2003 2002 ------ ------ ------ Income: Fixed-maturity securities $4,868 $2,190 $1,762 Equity securities 48 39 41 Short-term investments and cash 294 121 190 Interest on notes receivable from related parties 46 54 47 Dividends on common trust securities 52 -- -- ------ ------ ------ TOTAL 5,308 2,404 2,040
Expenses: Investment expenses 238 136 107 ------ ------ ------ NET INVESTMENT INCOME $5,070 $2,268 $1,933 ====== ====== ======
As of December 31, 2004, 81 securities accounted for the gross unrealized losses, all of which are deemed to be temporary. Significant factors influencing Management's determination that unrealized losses were temporary included the mild severity of the unrealized losses in relation to each securities cost and the nature of the investments and management's intent and ability to retain the investment for a period of time sufficient to allow for anticipated recovery in value.
GROSS LIABILITY REINSURANCE RECOVERABLES --------------- ------------------------ DECEMBER 31, 2004: Case-basis reserves $ 76,793 $ 55,273 IBNR reserves 51,929 36,500 Recoverable on paid losses -- 9,400 -------- -------- TOTAL $128,722 $101,173 ======== ========
DECEMBER 31, 2003: Case-basis reserves $ 61,622 $ 45,544 IBNR reserves 37,853 29,570 Recoverable on paid losses -- 9,646 -------- -------- TOTAL $ 99,475 $ 84,760 ======== ========
2004 2003 2002 --------- --------- --------- Balance at January 1, $ 99,475 $ 65,688 $ 37,637 Less reinsurance recoverables (75,114) (50,212) (29,017) --------- --------- --------- 24,361 15,476 8,620 Incurred related to: Current year 27,259 14,996 13,416 Prior years (199) 75 2,940 --------- --------- --------- TOTAL INCURRED 27,060 15,071 16,356 --------- --------- --------- Paid related to: Current year 6,991 2,084 6,585 Prior years 7,481 4,102 2,915 --------- --------- --------- TOTAL PAID 14,472 6,186 9,500 --------- --------- --------- Net balance at December 31, 36,949 24,361 15,476 Add reinsurance recoverables 91,773 75,114 50,212 --------- --------- --------- BALANCE AT DECEMBER 31, $ 128,722 $ 99,475 $ 65,688 ========= ========= =========
For 2004, 2003 and 2002 the incurred loss and loss adjustment expenses attributable to insured events of prior years decreased by $199,000 and increased by $75,000 and $2,940,000, respectively, as a result of re-estimation of loss and loss adjustment expenses. No additional premiums or return premiums have been accrued as a result of these prior year effects.
NOTE 4 - DEFERRED ACQUISITION COSTS AND DEFERRED CEDING COMMISSION REVENUE
Acquisition costs incurred and policy-related ceding commission revenue are deferred and amortized to income on property and casualty business as follows (in 000's):
The structure of the Company's reinsurance program enables the Company to reflect significant reductions in premiums written and earned and also provides income as a result of ceding commissions earned pursuant to reinsurance contracts. This structure has enabled the Company to significantly grow its premium volume while maintaining regulatory capital and other financial ratios generally within expected ranges used for regulatory oversight purposes. The Company's participation in reinsurance arrangements does not relieve the Company from its obligations to policyholders.
To reduce TICNY's credit exposure to reinsurance, quota share reinsurance agreements effective October 1, 2003 and January 1, 2004 were placed on a "funds withheld" basis. Under these agreements TICNY places the collected ceded premiums written, net of commissions and the reinsurers margin, in segregated trusts for the benefit of TICNY and the reinsurers. TICNY may withdraw funds for loss and loss adjustment expense payments and commission adjustments. Segregated assets in trust accounts amounted to $53,888,000 and $24,943,000 at December 31, 2004 and 2003 and are included in invested assets. The Company is obliged under the reinsurance agreements to credit reinsurers with a 2.5% annual effective yield on the monthly balance in the funds held under reinsurance agreements liability accounts. The amounts credited for 2004 and 2003 were $1,069,000 and $523,000, respectively, and have been recorded as interest expense.
In January 2003, the Company entered into an excess of loss reinsurance agreement with PXRE Barbados Ltd. ("PXRE Barbados"), an affiliate of PXRE, and remitted $10,000,000 as deposit premium to PXRE Barbados as called for by the contract. This excess of loss agreement inured solely to the benefit of PXRE in connection with its participation in the 2003 quota share agreement with the Company. Effective September 30, 2003, the Company and PXRE Barbados commuted the excess of loss agreement. As a result of the commutation of the agreement, the Company recorded $1,537,000 in ceding commission revenue.
The Company entered into a borrowing arrangement during 2002 with PXRE Barbados, for $10,000,000. See "Note 8. Debt". The terms and conditions of the note were structured to comply with the New York Insurance Law, which permitted TICNY to reflect this note as surplus as regards policyholders for statutory accounting purposes as of December 31, 2002.
The Company has determined that two intangible assets were acquired in this transaction: renewal rights and new agent contractual relationships, both of which were determined to be intangible assets with a finite useful life. The renewal rights were recorded at $1,250,000 and will be amortized over ten years in proportion to anticipated renewal premiums to be written during this time period. The new agent contractual relationships have been recorded at $3,750,000 and will be amortized over twenty years on a straight-line basis. During 2004, the Company recorded amortization expense of $22,000 on the intangible assets.
ACCUMULATED INITIAL BALANCE AMORTIZATION NET --------------- ------------ ------- DECEMBER 31, 2004: Renewal rights $ 1,250 $ (6) $ 1,244 Agency force 3,750 (16) 3,734 ------- ----- ------- $ 5,000 $ (22) $ 4,978 ======= ===== =======
ACCUMULATED COST DEPRECIATION NET ------- ------- ------- DECEMBER 31, 2004: Furniture $ 626 $ (298) $ 328 Leasehold improvements 1,123 (649) 474 Computer equipment 4,954 (3,716) 1,238 Software 5,705 (2,325) 3,380 ------- ------- ------- Net fixed assets $12,408 $(6,988) $ 5,420 ======= ======= ======= DECEMBER 31, 2003: Furniture $ 614 $ (223) $ 391 Leasehold improvements 1,114 (498) 616 Computer equipment 4,008 (3,063) 945 Software 3,308 (1,220) 2,088 ------- ------- ------- Net fixed assets $ 9,044 $(5,004) $ 4,040 ======= ======= =======
Total interest expense incurred for all subordinated debentures, including amortization of deferred origination costs, was $1,461,000 and $559,000, respectively for the years ended December 31, 2004 and 2003.
In 2002, the Company, through its investment manager, executed a securities repurchase agreement with J.P. Morgan Securities, Inc. At December 31, 2002, the Company owed approximately $3,000,000 under this repurchase agreement, which was collateralized by certain mortgage-backed securities owned by the Company. During 2003 and 2002, the Company incurred interest totaling $23,000 and $43,000, respectively, relating to its repurchase obligations. This facility is still open as of December 31, 2004.
The 60,000 shares of the Company's Series A Cumulative Redeemable Preferred Stock ("the preferred stock"), $0.01 par value were held by Am Re. The preferred stock carried a rate of 10.5% per annum with dividends payable quarterly and in arrears, and was redeemable in advance of the mandatory redemption dates at the option of the Company. The preferred stock did not have rights to vote with the holders of common stock. In January 2004, the Company redeemed 30,000 of the outstanding shares of the preferred stock for $1,500,000 and the remaining 30,000 shares were redeemed by the Company in October 2004 for $1,500,000 plus accrued interest.
Aggregate scheduled maturities of the subordinated debentures at December 31, 2004 are (in 000's):
The roll forward of shares of common stock (adjusted to reflect 1.8:1 stock split) is as follows (in 000's):
See "Note 1. Summary of Significant Accounting Policies" and "Note 8. Debt". The preferred stock dividends for the first six months of 2003 (prior to the adoption of FAS 150) were $157,500 and for the twelve months ending December 31, 2002 were $315,000. The preferred stock dividends were recorded as a reduction to stockholders' equity.
The Company issued 946,642 additional shares of common stock immediately prior to its IPO as a result of the exercise in full of Am Re's warrant to purchase 1,049,999 shares of common stock at an exercise price of $0.76 per share, pursuant to a cashless exercise provision, and based upon the IPO price of $8.50 per share.
On September 29, 2004 the Company's Board of Directors authorized the issuance of 68,832 restricted Common Stock to various employees under the 2004 Long Term-Equity Compensation Plan. The fair value of the restricted shares was $585,000. The restricted shares vest ratably over five years from the date of grant. During the vesting period, the recipients have voting rights and will receive dividends but the shares may not be sold, assigned, transferred, exchanged, pledged or otherwise encumbered.
On November 10, 2004 the Company's Board of Directors authorized the issuance of 7,072 restricted Common Stock to all non-employee directors. The fair value of the restricted shares was $70,000 at the grant date. These shares vest March 31, 2005.
The following table provides an analysis of stock option activity during the three years ended December 31, 2004.
Options outstanding and exercisable as of December 31, 2004 are shown on the following schedule:
Deferred tax liability: Deferred acquisition costs net of deferred ceding commission revenue 6,559 195 Depreciation and Amortization 952 -- Unrealized appreciation of securities 664 540 Other 19 -- ------- ------- Total deferred tax liabilities 8,194 735 ------- ------- Net deferred income tax (liability)/asset $(1,587) $ 2,033 ======= =======
In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. No valuation allowance against deferred tax assets has been established, as the Company believes it is more likely than not the deferred tax assets will be realized.
The Company maintains a defined contribution Employee Pretax Savings Plan (401(k) Plan) for its employees. The Company contributes 50% of each participant's contribution up to 8% of the participant's compensation. The Company incurred approximately $461,000, $332,000 and $319,000 of expense in 2004, 2003 and 2002, respectively, related to this plan.
The Company sponsored a nonqualified deferred compensation plan ("the Plan") for the Chairman of the Board, President and Chief Executive Officer of the Company. As of December 31, 2002, the Company has granted the maximum amount allowed under the Plan, $1,000,000. Amounts contributed to the Plan earn interest at the rate of 7% per year. During 2004, 2003 and 2002, the Company recognized deferred compensation expense of $44,000, $85,000 and $79,000, respectively. On May 5, 2004 the Board of TRM approved the payment of the entire deferred compensation balance and terminated the plan.
The Company entered lease agreements for office space and equipment. The Company's future minimum lease payments are as follows ($'s in 000's):
2005 $ 1,412 2006 1,375 2007 1,375 2008 520 --------- Total $ 4,682 =========
TICNY is subject to assessments in New York for various purposes, including the provision of funds necessary to fund the operations of the New York Insurance Department, the New York Property/Casualty Insurance Security Fund, which pays covered claims under certain policies provided by impaired, insolvent or failed insurance companies and various funds administered by the New York Workers' Compensation Board which pays covered claims under certain policies provided by impaired, insolvent or failed insurance companies The Company was assessed approximately $435,000, $340,000 and $280,000 in 2004, 2003 and 2002, respectively, for its proportional share of the total assessment for the Property/Casualty Security Fund and approximately $556,000, $312,000 and $129,000 in 2004, 2003 and 2002, respectively, for its proportional share of the operating expenses of the New York Insurance Department. Property casualty insurance company insolvencies or failures may result in additional security fund assessments to the Company at some future date. At this time the Company is unable to estimate the possible amounts, if any, of such assessments. Accordingly, the Company is unable to determine the impact, if any, such assessments may have on financial position or results of operations of the Company. The Company is permitted to assess premium surcharges on workers' compensation policies that are based on statutorily enacted rates. However, assessments by the various workers' compensation funds have recently exceeded the permitted surcharges resulting in additional expenses of $1,143,000, $0 and $0 in 2004, 2003 and 2002, respectively. As of December 31, 2004 the liability for the various workers' compensation funds, which includes amounts assessed on workers' compensation policies was $1,839,000. This amount is expected to be paid over an eighteen month period ending June 30, 2006.
o Policy acquisition costs are charged to operations in the year such costs are incurred, rather than being deferred and amortized as premiums are earned over the terms of the policies.
o Ceding commission revenues are earned when ceded premiums are written rather than being deferred and amortized as the underlying ceded premiums are earned over the term of the reinsurance agreements.
EQUITY AND FIXED INCOME INVESTMENTS: Fair value disclosures for investments are included in "Note 2. Investments".
AGENTS' BALANCES RECEIVABLE, ASSUMED PREMIUMS RECEIVABLE, RECEIVABLE-CLAIMS PAID BY AGENCY: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values.
LONG-TERM DEBT - CIT: The carrying values reported in the accompanying balance sheets for these financial instruments approximate fair value. Fair value was estimated using projected cash flows, discounted at rates currently being offered for similar notes.
SERIES A CUMULATIVE REDEEMABLE PREFERRED STOCK: The carrying values reported in the accompanying balance sheets for these financial instruments approximate fair value. Fair value was estimated using projected cash flows, discounted at rates currently being offered for similar securities.
In the insurance segment, TICNY provides commercial and personal lines insurance policies to businesses and individuals. TICNY's commercial lines products include commercial multiple-peril, monoline general liability, commercial umbrella, monoline property, workers' compensation and commercial automobile policies. Its personal lines products consist of homeowners, dwelling and other liability policies.
In the reinsurance segment, TICNY assumes reinsurance directly from TRM's issuing companies or indirectly from reinsurers that provide reinsurance coverage directly to the issuing companies. TICNY assumes, as a reinsurer, a modest amount of the risk on the premiums that TRM's managing general agency produces.
In the insurance services segment, TRM generates commission revenue from its managing general agency by producing premiums on behalf of its issuing companies and generates fees by providing claims administration and reinsurance intermediary services. Placing risks through TRM's issuing companies allows the Company to underwrite larger policies and gain exposure to market segments that are unavailable to TICNY due to its rating, financial size and geographical licensing limitations. TRM does not assume any risk on business produced by it. All of the risk is ceded by the issuing companies to a variety of reinsurers pursuant to reinsurance programs arranged by TRM's reinsurance intermediary working with outside reinsurance intermediaries. Through its issuing companies, TRM's managing general agency offers commercial package, monoline general liability, monoline property, commercial automobile and commercial umbrella products.
2004 2003 2002 -------- -------- -------- Revenue Insurance segment $ 85,081 $ 58,221 $ 47,131 Reinsurance segment 1,137 870 1,125 Insurance services segment 16,389 12,830 12,428 -------- -------- -------- Total segment revenues 102,607 71,921 60,684 Investment income 5,070 2,268 1,933 Realized capital gains 13 493 95 -------- -------- -------- Consolidated revenues $107,690 $ 74,682 $ 62,712 ======== ======== ========
The following table reconciles the results of our individual segments to consolidated income before taxes (in 000's):
2004 2003 2002 -------- -------- -------- Insurance segment underwriting profit $ 9,524 $ 6,567 $ 5,769 Reinsurance segment underwriting profit (loss) 1,582 287 (939) -------- -------- -------- Total underwriting profit (loss) 11,106 6,854 4,830 Insurance services segment pretax income (loss) 1,951 1,541 3,060 Net investment income 5,070 2,268 1,933 Net realized investment gains 13 493 95 Corporate expenses (289) (40) (28) Interest expense (3,128) (1,462) (122) -------- -------- -------- Income before taxes $ 14,723 $ 9,654 $ 9,768 ======== ======== ========
NALIC will be initially capitalized with part of the $26,000,000 raised by Tower Group, Inc. through two trust preferred offerings in December, 2004. See "Note 8. Debt". According to the terms of the agreement, all liabilities and assets of NALIC (which will be renamed) will be transferred to a liquidating trust prior to closing with the exception of its charter and insurance licenses. The transaction is subject to court approval in Massachusetts and is expected to close in March or April of 2005.