As of February 7, 2008, we leased 11,868 square feet in Columbus, Ohio for our headquarters pursuant to a lease that commenced on January 1, 2001 and expires on December 31, 2008. The lease provides for monthly rent of $13,230.
A discussion of our sale of American Legal Publishing Corporation is set forth in Item 1 above under the caption “Sale of Affiliate” and is incorporated herein by reference.
Highlands has entered into settlement agreements with the New Jersey Attorney General for its New Jersey bail bond obligations and with the U.S. Department of Homeland Security for its federal immigration bond obligations (collectively, the “Settlement Agreements”). The Settlement Agreements cover both past and future losses for bonds issued by Highlands. Highlands has also provided loss information to the Company with respect to potential losses for bail bonds issued in states other than New Jersey. As of December 31, 2007, the Company is reserving to its best estimate of Highlands losses based on the Settlement Agreements and the most recent loss information received from Highlands. As of December 31, 2007 and 2006, the Company’s total loss and LAE reserves for Highlands was approximately $4.8 million and $4.0 million, respectively.
We believe there is potential for the Company to mitigate its ultimate liability to Highlands through the arbitration proceeding with Highlands; however, because of the subjective nature inherent in assessing the final outcome of this arbitration, management cannot estimate the probability of an adverse or favorable outcome as of December 31, 2007. In addition, while outside counsel believes we have legal defenses under the reinsurance
Discontinued bond program losses and LAE were $0.7 million and $1.8 million for 2007 and 2006, respectively. The loss in 2007 was primarily attributable to an increase in reported losses from Highlands which was partially offset by a decrease in reported losses from Harco. The loss in 2006 was primarily attributable to the Harco Final Order combined with an increase in reported losses from Harco.
In October 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”). SOP 05-1 provides accounting guidance for deferred policy acquisition costs associated with internal replacements of insurance and investment contracts other than those already described in Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of SOP 05-1 became
effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The adoption of SOP 05-1 did not have an effect on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits all entities to choose to measure and report many financial instruments and certain other items at fair value at specified election dates. If such an election is made, any unrealized gains and losses on items for which the fair value option has been elected are required to be reported in earnings at each subsequent reporting date. In addition, SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Company is required to adopt the provisions of SFAS No. 159 for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 is not expected to have a material impact on the Company’s consolidated financial statements.
During 2001, the Company began issuing insurance policies which guarantee the performance obligations of two automobile service contract providers (the “Providers”). The Providers are owned by a common parent. The Company has issued insurance policies covering business produced by the Providers in five states. Our insurance policies guarantee the fulfillment of the Providers’ obligations under the service contracts. Under the program, the Providers maintain the reserves and related assets and are responsible for the claims administration. The Company is obligated to pay a claim only if a Provider fails to do so. Under a reinsurance arrangement, the Company cedes 100% of this business to another insurance carrier. In addition, the Company obtained collateral from the Providers in the form of a $4.3 million letter of credit to secure our obligations under the program. On February 15, 2007, one
A discussion of our ongoing SEC investigation is set forth in Item 1 above under the caption “Regulation-Ongoing SEC Investigation,” and is incorporated herein by reference.
The following table sets forth period-to-period changes in selected financial data:
Net premiums earned for GAP decreased 1.7%, or $192,727, to $11,047,793 in 2007 from $11,240,520 a year ago primarily due to the Transferred Business which was partially offset by an increase in pricing and lending volumes for certain for certain financial institution customers.
Investment Income. Net investment income increased 1.4%, or $52,587, to $3,897,651 in 2007 from $3,845,064 a year ago. This improvement was primarily due to higher yields.
Net realized gains (losses) on investments decreased 2,299.1%, or $1,281,012, to $(1,225,293) in 2007 from $55,719 a year ago primarily due to an increase in impairment charges. Impairment charges included in net realized gains (losses) on investments during 2007 and 2006 were $1,243,126 and $7,310, respectively. The increase in impairment charges during 2007 was primarily due to the following: (1) $506,134 in impairment charges for equity securities of five financial institutions whose fair values were adversely affected by exposure to subprime mortgage
For more information concerning other-than-temporary impairments, see “Critical Accounting Policies-Other-Than-Temporary Impairments of Investments” below.
CPI losses and LAE decreased 55.7%, or $298,892, to $237,475 in 2007 from $536,367 a year ago consistent with the decline in business.
UC losses and LAE increased 70.0%, or $381,852, to $927,147 in 2007 from $545,295 a year ago. The increase was primarily due to growth in the business combined with favorable loss development in the prior year.
WIP losses and LAE decreased 47.1%, or $211,703, to $238,194 in 2007 from $449,897 a year ago primarily due to release of reserves related to the 2004 year as the Company records loss and LAE reserves for WIP using an expected loss ratio reserving method, which is based on a certain percentage of net premiums earned over trailing thirty six months.
Commissions, Other Insurance Operating Expenses and General and Administrative Expenses. Commission expense declined 23.1%, or $2,787,340, to $9,253,714 in 2007 from $12,041,054 a year ago primarily due to a decrease in ULI commissions associated with the Cancelled Account and Transferred Business combined with an
GAAP Combined Ratio. For 2007, the combined ratio decreased to 92.2% from 97.9% a year ago. The loss ratio increased to 53.9% for 2007 from 53.2% a year ago. Excluding the discontinued bond program, the Company’s loss ratio was 52.3% in 2007 compared to 49.6% a year ago. The increase in the loss ratio for 2007 versus a year ago was primarily attributable to our ULI product line as a result of prior year favorable loss development combined with the Cancelled Account. The expense ratio decreased to 38.3% for 2007 compared to 44.7% a year ago. This improvement was primarily due to the decrease in the commission expense from the Cancelled Account combined with lower legal expenses associated with the discontinued bond program arbitrations, which were partially offset by an increase in legal expenses for the SEC investigation.
We believe the national economy remains unstable. National automobile sale volumes were down in 2007. During 2007, many of our automobile lender service customers experienced a decline in lending volume which resulted in a decline in premium volume for the Company. If this trend continues, we could experience a premium decline in 2008 as well.
Effective January 1, 2007, the Company entered into a producer-owned reinsurance arrangement with a new CPI customer whereby 100% of that customer’s premiums (along with the associated risk) were ceded to its PORC. For this program, the CPI coverage is voluntary and is primarily for tractors and residential/commercial mowers as opposed to automobiles. The Company receives a ceding commission based on a percentage of the premiums ceded. For this reinsurance arrangement, the Company has obtained collateral in the form of funds held and a letter of credit to secure its obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and the Company has immediate access to such collateral if necessary. If this customer’s premium volume for 2008 is comparable to 2007, this program should reduce our commission expense by approximately $0.8 million during fiscal year 2008 compared to $0.3 million in 2007. As of December 31, 2007, the Company had approximately $1.0 million of deferred ceded commissions for this program that will be earned over approximately four years.
The Company believes that there has been a stabilization of benefit charge levels in our UC product customer base; however, if unemployment levels rise for our customers, we could experience lower management fees and/or increased losses for our UC products. Furthermore, any developments on the discontinued bond program, including Harco and Highlands loss development and Highlands arbitration, could have a material impact on our results of operations and/or financial condition.
During 2006, the Company experienced a high level of legal costs associated with the discontinued bond program arbitrations. As previously disclosed, the Company concluded three of the arbitration proceedings during 2006 and only the Highlands arbitration remains pending. Because there was little activity in the Highlands arbitration during 2007, the Company incurred minimal legal costs in 2007 for the Highlands arbitration. The Company anticipates it will continue to incur legal costs during fiscal year 2008 for the Highlands arbitration; however, it is uncertain how much activity there will be in 2008 for the Highlands arbitration. As a result, the Company cannot predict with reasonable certainty the amount of legal costs that will be incurred during fiscal year 2008 for the Highlands arbitration; however, it is possible that the amount of such legal costs could be material to our results of operations if the arbitration proceeding takes place in 2008. See “Overview-Discontinued Bond Program” above and “Discontinued Bond Program” in Note 15 to the Consolidated Financial Statements for more information regarding the discontinued bond program arbitrations.
interest rates could decrease or increase the fair value of the Company’s fixed income investment portfolio. The fair value of our fixed income investment portfolio could also be impacted by rating actions and financial uncertainty associated with insurance companies that guarantee the obligations of our bonds. During 2007, the Company recorded approximately $1.2 million of impairments in its investment portfolio. Additional impairments within the Company’s investment portfolio during fiscal year 2008 are possible if current economic and financial conditions worsen.
Liquidity and capital resources demonstrate the Company’s ability to generate sufficient cash flows from its operations and borrow funds at competitive rates to meet operating and growth needs. As of December 31, 2007, the Company’s capital structure consists of trust preferred debt issued to affiliates and shareholders’ equity and is summarized in the following table:
In December 2002, we organized BIC Statutory Trust I (“BIC Trust I”), a Connecticut special purpose business trust, which issued $8,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust I also issued $248,000 of floating rate common securities to Bancinsurance. In September 2003, we organized BIC Statutory Trust II (“BIC Trust II”), a Delaware special purpose business trust, which issued $7,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust II also issued $217,000 of floating rate common securities to Bancinsurance. BIC Trust I and BIC Trust II (collectively, the “Trusts”) were formed for the sole purpose of issuing and selling the floating rate trust preferred capital securities and investing the proceeds from such securities in junior subordinated debentures of the Company. In connection with the issuance of the trust preferred capital securities, the Company issued junior subordinated debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC Trust II, respectively. The floating rate trust preferred capital securities and the junior subordinated debentures have substantially the same terms and conditions. The Company has fully and unconditionally guaranteed the obligations of the Trusts with respect to the floating rate trust preferred capital securities. The Trusts distribute the interest received from the Company on the junior subordinated debentures to the holders of their floating rate trust preferred capital securities to fulfill their dividend obligations with respect to such trust preferred securities. BIC Trust I’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred basis points (9.13% and 9.37% at December 31, 2007 and 2006, respectively), are redeemable at par on or after December 4, 2007 and mature on December 4, 2032. BIC Trust II’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred and five basis points (8.88% and 9.41% at December 31, 2007 and 2006, respectively), are redeemable at par on or after September 30, 2008 and mature on September 30, 2033. The proceeds from the junior subordinated debentures were used for general corporate purposes and provided additional financial flexibility to the Company. The terms of the junior subordinated debentures contain various covenants. As of December 31, 2007, the Company was in compliance with all such covenants.
Because of the nature of the risks we insure on a direct basis, losses and LAE emanating from the insurance policies that we issue are generally characterized by relatively short settlement periods and quick development of ultimate losses compared to claims emanating from other types of insurance products. Therefore, we believe we can estimate our cash needs to meet our policy obligations and utilize cash flows from operations and cash and short-term investments to meet these obligations. The Company considers the relationship between the duration of our policy obligations and our expected cash flows from operations in determining our cash and short-term investment position. We maintain a level of cash and liquid short-term investments which we believe will be adequate to meet our anticipated cash needs without being required to liquidate intermediate-term and long-term investments.
As discussed in “Overview-Discontinued Bond Program” above and in “Discontinued Bond Program” in Note 15 to the Consolidated Financial Statements, discontinued bond program loss and LAE reserves were $6.7 million at December 31, 2007. Ultimate payment on the discontinued bond program may result in an increase in cash outflows from operations and may impact our financial condition by reducing our invested assets. We consider the discontinued bond program liabilities and related Highlands arbitration as we manage our assets and liabilities. In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed-income investments with the expected payout of our liabilities for the discontinued bond program. There are no significant variations between the maturity of our investments and the expected payout of our loss and LAE reserves for the discontinued bond program.
Bancinsurance, the parent company, derives its funds principally from dividends from USA. In addition, Bancinsurance generated cash of $4.6 million (pre-tax) from the sale of ALPC in 2006. We believe the dividends from USA and the cash and investments held by Bancinsurance at December 31, 2007 are sufficient to meet its operating expenses. However, due to the inherent uncertainty associated with the SEC investigation, it is possible that Bancinsurance’s total operating costs, including the SEC investigation costs, may exceed the cash and investments held by Bancinsurance. If this occurs, Bancinsurance may need to draw on its line of credit or cause Ohio Indemnity to dividend to Bancinsurance any shortfall. If a dividend from Ohio Indemnity is required, we believe that the amount of such dividend will not exceed the annual maximum limit described below. See “Regulation-Ongoing SEC Investigation,” in Item 1 above, “Critical Accounting Policies-Guarantee Liabilities” below and Note 4 to the Consolidated Financial Statements for more information regarding the ongoing SEC investigation.
Ohio Indemnity is restricted by the insurance laws of the State of Ohio as to amounts that can be transferred to Bancinsurance in the form of dividends without the approval of The Ohio Department of Insurance (the “Department”). During 2008, the maximum amount of dividends that may be paid to Bancinsurance by Ohio Indemnity without prior approval is limited to $6,669,399.
We do not consider the impact of inflation to be material in the analysis of our overall operations.
The preparation of the consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, revenues, liabilities and expenses and related disclosures of contingent assets and liabilities. We regularly evaluate these estimates, assumptions and judgments. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates, assumptions and judgments under different assumptions or conditions. Set forth below are the critical accounting policies that we believe require significant estimates, assumptions and judgments and are critical to an understanding of our consolidated financial statements.
the financial condition and future prospects of the issuer, including any specific events that may influence the issuer’s operations and its ability to make future scheduled principal and interest payments on a timely basis;
the length of time and extent to which the estimated fair value has been less than book value;
primarily on reports received by the Company from the underlying ceding insurers. These reports are the primary basis for the Company’s reserving estimates.
For the Company’s assumed WIP program and contract and escrow surety bond programs, the Company is recording loss and LAE reserves using a loss ratio reserving methodology. The loss ratio method calculates a reserve based on expected losses in relation to premiums earned. The expected loss ratios for these programs were selected using expected loss information provided by the ceding insurer.
Historical “age-to-age” loss development factors (“LDF”) were calculated to measure the relative development for each accident year from one maturity point to the next. Based on the historical LDF, we selected age-to-age LDF that we believe are appropriate to estimate the remaining future development for each accident year. These selected factors are used to project the ultimate expected losses for each accident year. The validity of the results from using a loss development approach can be affected by many conditions, such as claim department processing changes, a shift between single and multiple payments per claim, legal changes or variations in our mix of business from year to year. Also, because the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimate losses. Therefore, ultimate values for immature accident years may be based on alternative estimation techniques, such as expected loss ratio method, or some combination of acceptable actuarial methods.
or inconsistencies in our data. We did not experience any significant change in the number of claims paid that was inconsistent with our business (other than claims related to the discontinued bond program), average claim paid or average claim reserve that would be inconsistent with the types of risks we insured in the respective years.
Loss and LAE Reserves at Year End. As of December 31, 2007 and 2006, gross loss and LAE reserves by product line were split between incurred but not reported (“IBNR”) and case reserves as follows:
During 2007, reserves for incurred losses and LAE attributable to insured events of prior years decreased by approximately $0.3 million as a result of re-estimation of unpaid losses and LAE principally on the Company’s lender service product line, which was partially offset by an increase in losses for the discontinued bond program. An analysis of this change in reserves is provided below.
As disclosed in Note 4 to the Consolidated Financial Statements, the Company accounts for guarantees in accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34” (“FIN 45”). The Company has determined that the undertaking agreements as described in Note 4 are within the scope of FIN 45. Due to the inherent uncertainties of the SEC investigation, actual future payments related to the undertaking agreements may be materially different than the FIN 45 liability as recorded at December 31, 2007. Because of the subjective nature inherent in assessing the estimated future costs associated with the undertaking agreements and because of the potential that our estimated future costs may be materially different than the Company’s actual future costs, such estimates are considered to be critical accounting estimates. See “Regulation-Ongoing SEC Investigation,” in Item 1 above, “Liquidity and Capital Resources” above and Note 4 to the Consolidated Financial Statements for more information regarding the ongoing SEC investigation.
We have audited the accompanying consolidated balance sheets of Bancinsurance Corporation and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for the two years then ended. Our audits also included the financial statement schedules listed in the index at Item 15(a). 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.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bancinsurance Corporation and subsidiaries at December 31, 2007 and 2006 and the results of their operations and their cash flows for the two years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Bancinsurance is a specialty property/casualty insurance holding company incorporated in the State of Ohio in 1970. The Company has two reportable business segments: (1) property/casualty insurance; and (2) insurance agency. Until August 31, 2006, the Company also had a municipal code publishing business segment. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described in “Sale of Affiliate” below. These segments are described in more detail below.
The Company has certain other specialty products which consist primarily of vehicle service contracts and contract and escrow surety bond products. For more information concerning one of the Company’s vehicle service contract programs, see “Automobile Service Program” in Note 15 to the Consolidated Financial Statements.
We sell our insurance products through multiple distribution channels, including three managing general agents, approximately thirty-five independent agents and direct sales.
The Purchaser was organized by Steven G. Wolf, who had served as President of ALPC since 1984 and as a director of ALPC since 2000. At the time of the transaction, Mr. Wolf and certain other employees of ALPC collectively owned a significant equity interest in the Purchaser.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” This Statement defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The Statement clarifies the rule that fair value be based on the assumptions that market participants would use when pricing an asset or liability, and establishes a fair value hierarchy that prioritizes the framework and information used to develop those assumptions. FASB Staff Position 157-2 delays the effective date of SFAS No. 157 to allow the FASB Board additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS No. 157. Under FASB Staff Position 157-2, the Company is required to adopt the provisions of SFAS No. 157 for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS No. 157 is not expected to have a material impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits all entities to choose to
measure and report many financial instruments and certain other items at fair value at specified election dates. If such an election is made, any unrealized gains and losses on items for which the fair value option has been elected are required to be reported in earnings at each subsequent reporting date. In addition, SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Company is required to adopt the provisions of SFAS No. 159 for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 is not expected to have a material impact on the Company’s consolidated financial statements.
The accompanying financial statements include the Company’s accounts and the accounts of our wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Ohio Indemnity’s insurance premiums and ceded commissions are earned over the terms of the related insurance policies and reinsurance contracts. For our ULI, GAP and voluntary CPI products, premiums and ceded commissions are earned over the contract period in proportion to the amount of insurance protection provided as the amount of insurance protection declines according to a predetermined schedule. For all other products, premiums and ceded commissions are earned pro rata over the contract period. The portion of premiums written applicable to the unexpired portion of insurance policies is recorded in the balance sheet as unearned premiums.
Pursuant to the terms of certain surety bonds issued by the Company that guarantee the payment of reimbursable unemployment compensation benefits, certain monies are held by the Company in contract funds on deposit and are used for the payment of benefit charges. The Company has agreements with cost containment service firms designed to control the unemployment compensation costs of the employers enrolled in the program. Any remaining funds after the payment of all benefit charges are shared between the Company and the cost containment firms as management fees. Management fees are recognized when earned based on the development of benefit charges. Management fees of $448,899 and $830,329 were recognized in 2007 and 2006, respectively, as a result of this arrangement.
Property, equipment and internally-developed computer software are stated at cost and depreciated using the straight-line method over the estimated useful life, ranging from three to five years. Leasehold improvements are capitalized and amortized over the remaining office lease term. Maintenance and repairs are charged directly to expense as incurred. As of December 31, 2007 and 2006, the carrying value of property, equipment, computer software and leasehold improvements, net of accumulated depreciation, was $506,756 and $636,966, respectively. These balances are presented in the accompanying balance sheets as other assets.
The amortized cost, gross unrealized gains and losses and estimated fair value of investments in held to maturity and available for sale securities were as follows:
The proceeds from sales of available for sale securities were $26,711,634 and $43,604,109 for the years ended December 31, 2007 and 2006, respectively.
As previously reported, on February 14, 2005, the Company received notification from the U.S. Securities and Exchange Commission (“SEC”) that it was conducting an informal, non-public inquiry regarding the Company. The inquiry generally concerned the chronology, events and announcements relating to Ernst & Young LLP (“E&Y”), the Company’s former independent registered public accounting firm, withdrawing its audit reports for the years 2001 through 2003 for the Company. On March 29, 2005, the Company was notified by the SEC that the informal, non-public inquiry was converted to a formal order of private investigation. On October 23, 2007, the Company and certain of its current officers (Chief Executive Officer, Chief Financial Officer and Vice President of Specialty Products) each received a “Wells Notice” (the “Notice”) from the staff of the SEC indicating that the staff is considering recommending that the SEC bring a civil action against each of them for possible violations of the federal securities laws. The Notice provides the Company and each officer the opportunity to present their positions to the staff before the staff recommends whether any action should be taken by the SEC. The Company continues to cooperate fully with the SEC and intends to continue to do so in an effort to resolve this matter.
Pursuant to separate undertaking agreements dated November 12, 2007 between the Company and each officer who received the Notice, the Company has agreed to advance reasonable legal fees and expenses incurred by each officer in connection with the ongoing SEC investigation. The undertaking agreements require each officer to repay the amounts advanced if it is ultimately determined, in accordance with Article Five of the Company’s code of regulations, that the officer did not act in good faith or in a manner he reasonably believed to be in or not opposed to the best interests of the Company with respect to the matters covered by the SEC investigation. Under the Company’s code of regulations and Ohio law, the Company may also be required to indemnify each officer in connection with the SEC investigation.
undertaking agreements beyond the $1.3 million of estimated costs to respond to the Notice. Due to the inherent uncertainties of the SEC investigation, actual future payments related to the undertaking agreements may be materially different than the estimated fair value of $1.3 million as recorded at December 31, 2007.
We routinely lease premises for use as administrative offices, vehicles and office equipment under operating leases for varying periods. Management expects that in the normal course of business, leases will be renewed or replaced by other leases. Effective January 2001, we entered into a new lease for our Columbus, Ohio office space. Under its provisions, no cash payments were due until April 1, 2002. Rent expense is recognized evenly over the lease term ending December 31, 2008. Rental expenses under operating leases were $177,839 and $251,768 for the years ended December 31, 2007 and 2006, respectively.
In December 2002, we organized BIC Statutory Trust I (“BIC Trust I”), a Connecticut special purpose business trust, which issued $8,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust I also issued $248,000 of floating rate common securities to Bancinsurance. In September 2003, we organized BIC Statutory Trust II (“BIC Trust II”), a Delaware special purpose business trust, which issued $7,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust II also issued $217,000 of floating rate common securities to Bancinsurance. BIC Trust I and BIC Trust II were formed for the sole purpose of issuing and selling the floating rate trust preferred capital securities and investing the proceeds from such securities in junior subordinated debentures of the Company. In connection with the issuance of the trust preferred capital securities, the Company issued junior subordinated debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC Trust II, respectively. The floating rate trust preferred capital securities and the junior subordinated debentures have substantially the same terms and conditions. The Company has fully and unconditionally guaranteed the obligations of BIC Trust I and BIC Trust II with respect to the floating rate trust preferred capital securities. BIC Trust I and BIC Trust II distribute the interest received from the Company on the junior subordinated debentures to the holders of their floating rate trust preferred capital securities to fulfill their dividend obligations with respect to such trust preferred securities. BIC Trust I’s floating rate trust preferred capital
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which requires the consolidation of certain entities considered to be variable interest entities (“VIEs”). An entity is considered to be a VIE when it has equity investors who lack the characteristics of having a controlling financial interest, or its capital is insufficient to permit it to finance its activities without additional subordinated financial support. Consolidation of a VIE by an investor is required when it is determined that the investor will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the VIE’s expected residual returns if they occur, or both. In accordance with FIN 46, BIC Trust I and BIC Trust II are not included in the Company’s consolidated financial statements. If they were included in the Company’s consolidated financial statements, there would be no change to net income, only changes in the presentation of the financial statements.
The difference between income taxes provided at our effective tax rate and the 34% federal statutory rate for the period ended December 31 is as follows:
The Ohio Indemnity Company Employee 401(k) and Profit Sharing Plan (the “401(k) Plan”) is available to full-time employees who meet the 401(k) Plan’s eligibility requirements. Under the 401(k) Plan, we match 100% of the qualified employee’s contribution up to 3% of salary and 50% of the qualified employee’s contribution between 3% and 5% of salary. The total cost of the matching contribution was $98,222 and $130,075 for the years ended December 31, 2007 and 2006, respectively.
required to record equity-based compensation expense for all awards granted after the date of adoption and for the nonvested portion of previously granted awards outstanding as of the date of adoption. The results for prior periods have not been restated.
The 1994 Stock Option Plan (the “1994 Stock Option Plan”) provided for the grants of options, covering up to an aggregate of 500,000 common shares, with a 100,000 common share maximum for any one participant. Key employees, officers and directors of, and consultants and advisors to, the Company were eligible to participate in the 1994 Stock Option Plan. The 1994 Stock Option Plan is administered by the Company’s Compensation Committee which determined to whom and when options were granted along with the terms and conditions of the options. Under the 1994 Stock Option Plan, options for 177,500 common shares were outstanding at December 31, 2007 and expire at various dates from 2008 to 2013 and range in option price per share from $4.063 to $6.25. Of the options for 177,500 common shares outstanding, 18,000 have been granted to our non-employee directors and 159,500 have been granted to employees. All of the options outstanding were granted to employees and directors for compensatory purposes. No new options can be granted under the 1994 Stock Option Plan and the plan remains in effect only with respect to the outstanding options.
The following table summarizes restricted stock award activity for the Company under the 2002 Plan from January 1, 2007 through December 31, 2007:
The following table summarizes all stock option activity for the Company under the Plans from January 1, 2007 through December 31, 2007:
The weighted-average grant-date fair value of options granted during the years ended December 31, 2007 and 2006 was $2.65 and $2.48, respectively. The total intrinsic value of options exercised during the years ended December 31, 2007 and 2006 was $145,235, $9,120, respectively.
The following table summarizes nonvested stock option activity for the Company under the Plans from January 1, 2007 through December 31, 2007:
The compensation expense recognized for all equity-based awards is net of forfeitures and is recognized over the awards’ respective service period. The Company recorded equity-based compensation expense for the years ended December 31, 2007 and 2006 in the amount of $339,654 and $217,958 ($224,172 and $143,852 net of tax), respectively. In accordance with SAB No. 107, the equity-based compensation expense is classified within other insurance operating expenses to correspond with the same line item as cash compensation paid to employees.
Generally, Ohio Indemnity is restricted by the insurance laws of the State of Ohio as to amounts that can be transferred to its parent in the form of dividends, loans, or advances without the approval of the Department. Under these restrictions, during 2008, dividends, loans or advances in excess of $6,669,399 will require the approval of the Department.
Under its waste surety bond program, the Company both assumes and cedes certain waste surety business under three quota share reinsurance arrangements. First, in the second quarter of 2004, the Company entered into a 50% quota share reinsurance arrangement whereby the Company assumed 50% of all waste surety bonds with liability limits up to $4.0 million from two insurance carriers. Effective January 1, 2005, the reinsurance arrangement was amended whereby the Company’s assumed participation was reduced from 50% to 25%. Effective August 1, 2006, the reinsurance arrangement was further amended whereby the Company assumed 50% of all waste surety bonds with liability limits up to $1.2 million. Second, effective August 1, 2007, the Company entered into a 5% quota share reinsurance arrangement whereby the Company assumed 5% of all waste surety bonds with liability limits over $1.2 million up to $10.0 million from one insurance carrier. Third, in addition to assuming business, the Company also writes on a direct basis waste surety bonds with liability limits up to our Treasury limit ($4.0 million as of July 1, 2007). The Company then cedes 50% of that business to an insurance carrier under a reinsurance arrangement. Under this program, the Company assumed premiums earned of $2,958,794 and $3,283,690 for the years ended December 31, 2007 and 2006, respectively. Also, the Company ceded premiums earned of $1,529,148 and $1,235,624 for the years ended December 31, 2007 and 2006, respectively.
In addition to the arrangements discussed above, the Company has other reinsurance arrangements, including two automobile lender service PORC quota share arrangements, one unemployment compensation facultative reinsurance arrangement, several quota share arrangements for certain contract and escrow surety bond business and a reinsurance arrangement for a vehicle service contract program. Under these arrangements, the Company ceded premiums earned of $1,126,594 and $708,430 for the years ended December 31, 2007 and 2006, respectively. Also, the Company assumed premiums earned of $868,771 and $60,535 for the years ended December 31, 2007 and 2006, respectively.
From 2001 until the end of the second quarter of 2004, the Company participated in a bail and immigration bond program. This program was discontinued in the second quarter of 2004. For more information concerning this program, see “Discontinued Bond Program” in Note 15 to the Consolidated Financial Statements.
We believe there is potential for the Company to mitigate its ultimate liability to Highlands through the arbitration proceeding with Highlands; however, because of the subjective nature inherent in assessing the final outcome of this arbitration, management cannot estimate the probability of an adverse or favorable outcome as of December 31, 2007. In addition, while outside counsel believes we have legal defenses under the reinsurance agreement, they are unable to assess whether an adverse outcome is probable or remote in the arbitration as of December 31, 2007. In accordance with SFAS No. 5, “Accounting for Contingencies,” the Company is reserving to its best estimate of the ultimate liability on the program at December 31, 2007 without any adjustment for a positive
Given the uncertainties of the outcome of the Highlands arbitration and Highlands receivership proceeding, uncertainties in the future loss information provided by Harco and Highlands, and the inherent volatility in assumed reinsurance, actual losses incurred for the discontinued bond program could be materially different from our estimated reserves at December 31, 2007. As a result, future loss development on the discontinued bond program could have a material effect on the Company’s results of operations and/or financial condition.
Loss and LAE Reserves. The following compares our loss and LAE reserves for the discontinued bond program at December 31, 2007 and December 31, 2006 (dollars in millions):
The increase in loss and LAE reserves to $6.7 million at December 31, 2007 from $6.4 million at December 31, 2006 was primarily due to an increase in reported losses from Highlands. This increase was partially offset by loss payments made by the Company to Harco during 2007 combined with a decrease in reported losses from Harco.
April 13, 2007, this Provider filed a voluntary petition under Chapter 11 of the Bankruptcy Code. On June 12, 2007, the Bankruptcy Court ruled that the Provider was an eligible debtor for purposes of the Bankruptcy Code. No new business is being produced by this Provider; however, the Company continues to produce business for the other Provider that is not in bankruptcy.
On August 24, 2007, the Company drew on the $4.3 million letter of credit and subsequently obtained an additional $0.5 million from the Provider that is not in bankruptcy to further secure the Company’s insurance obligations. As of December 31, 2007, the total cash held by the Company as collateral for this program consisted of approximately $4.7 million, which funds are currently invested in short term investments. The Company has estimated its liability for claims under this program to be approximately $3.0 million as of December 31, 2007. Because we believe our estimated liability for claims under this program is fully collateralized and our loss exposure is 100% reinsured, we do not believe the events described above will have a material adverse impact to the Company. However, if the Company’s actual liability for claims under this program exceeds the collateral held by the Company and if the Company is unable to collect on the reinsurance, then this program could have a material adverse effect on our business, financial condition and/or operating results.
In 1994, we entered into a Split-Dollar Insurance Agreement with a bank, as trustee, for the benefit of an officer and his spouse. The bank has acquired a second-to-die policy on the lives of the insureds, in the aggregate face amount of $2,700,000. On July 3, 2007, the officer passed away and he was survived by his spouse. At December 31, 2007 and 2006, we had loaned the trustee $1,004,372 and $932,653, respectively, under this agreement for payment of insurance premiums, which is included in loans to affiliates in the accompanying balance sheet. Amounts loaned by the Company to the trustee are to be repaid, in full, without interest, from any of the following sources: (1) cash surrender value of the underlying insurance policies; (2) death benefits; and/or (3) the sale of 15,750 common shares of the Company contributed by the officer to the trust.
The Company has the following concentrations of total revenues (concentration is defined as 10% or more of consolidated revenues) with three separate general agents within our property/casualty insurance business segment for the years ended December 31:
The carrying amount and estimated fair value of financial instruments subject to disclosure requirements were as follows at December 31:
See Note 4 to the Consolidated Financial Statements for information concerning the SEC investigation. See “Discontinued Bond Program” in Note 15 to the Consolidated Financial Statements for information concerning the Highlands arbitration.
The Company is a guarantor for performance on a $550,400 bridge loan. In addition, the Company is involved in various lawsuits and legal proceedings arising in the ordinary course of business, some of which involve claims for substantial amounts. We provide accruals for these items to the extent that we deem the losses probable and reasonably estimable. The outcome of litigation is subject to numerous uncertainties. While the ultimate resolution of these legal proceedings could be material to the Company’s results of operations in a future quarter or annual period, in the opinion of Company’s management, none would likely have a material adverse effect on the Company’s financial condition or liquidity.
were applied. Depreciation and capital expenditures are not considered material. Segment results for the years ended December 31, 2007 and 2006 are as follows:
On March 7, 2007, the Board of Directors adopted a common share repurchase program authorizing the repurchase of up to 500,000 common shares of the Company. This repurchase program expires on December 31, 2008. Through December 31, 2007, the Company had repurchased 117,348 common shares at an aggregate cost of $731,900 and at an average price per share of $6.24 under this program.