The Company does not own, directly or indirectly, any real estate. The Company subleases office space for day-to-day operations in the following cities:
Total shareholders’ equity of $279.5 million, or $31.56 per diluted share
After tax charges of $3.4 million for the write off of inefficient computer software
After tax charges of $1.1 million for expenses relating to an investment in an asset management company that was not consummated
Net realized investment losses after taxes for the year ended December 31, 2007 were $4.5 million, or $49 per diluted share, compared with $262,000, or $.03 per diluted share, for 2006. The realized investment losses in 2007 primarily relate to write-downs to the Company’s investments in residential mortgage backed securities that consist of “Alt A” mortgages.
Gross premiums written of $228.4 million decreased by 5% for the year ended December 31, 2007 compared to the same period of 2006. However, net premiums written of $167.9 million increased by 8% for the year ended December 31, 2007 over the same period of 2006, and net premiums earned of $166.1 million for the year ended of 2007 increased by 9% compared with the same period last year.
Effective January 1, 2007, the Company maintained its $5 million per risk and $6 million per occurrence net loss retention in the ocean marine line that was in existence during 2006; however, the Company could incur an additional loss amount, as large as $5 million, depending upon the gross loss to the Company in excess of $5 million. The 80% quota share reinsurance protection for the Company’s energy business, which commenced in 2006, also remained in effect for 2007. The Company terminated its relationship with one of its agents writing cargo business in 2007. As a result of this termination, both gross and net written premiums in the ocean marine class are expected to decline in 2008 when compared to 2007.
Net losses and loss adjustment expenses incurred as a percentage of net premiums earned (the loss ratio) were 54.1% for the year ended December 31, 2007 as compared to 56.7% for 2006. The Company reported lower loss ratios in the other liability line of business in 2007 when compared to 2006 primarily as a result of the novation of substantially all of the excess workers’ compensation policies written in conjunction with our prior producer of those policies. The novation reduced the overall loss ratio by 3.7 percentage points in 2007. The ocean marine loss ratio was down slightly in 2007 when compared to 2006 as a result of favorable loss reserve development that was off set partially by a large cargo claim. The inland marine/fire loss ratio decreased in 2007, reflecting lower severity losses in the fire and the surety classes.
Net realized investment losses were $6.9 million for the year ended December 31, 2007 as compared to $403,000 for the year ended December 31, 2006. These amounts result from the sale of fixed income investments as well as write-downs from other-than-temporary declines in the fair value of securities, which amounted to $6.7 million and $371,000 for the years ended December 31, 2007 and 2006, respectively. The write-downs in 2007 primarily relate to the Company’s investments in super senior residential mortgage backed securities that consist of “Alt A” mortgages. The decision to write down such securities was based upon the likelihood that we may not hold such securities until the fair value decline is recovered.
Total income tax expense as a percentage of income before taxes for year ended December 31, 2007 was 33.7% as compared to 33.5% for 2006. The percentage for the 2006-year includes a $500,000 reduction in taxes resulting from the resolution of tax uncertainties for the Company’s former subsidiary, MMO UK, which was sold in 2005. The 2007-year includes larger benefits resulting from greater investments in municipal bonds and preferred stocks.
Reserve for unearned premiums increased to $87.6 million as of December 31, 2007 from $93.6 million as of December 31, 2006 primarily as a result of the decrease in gross premiums written in the ocean marine line of business and the excess workers’ compensation class.
Ocean marine gross premiums written in 2006 decreased by 1%, primarily reflecting a volume decrease in the hull class of business due to a reduction in unprofitable accounts. Volume decreases were also recorded in the rig class, as a result of the Company’s tighter monitoring of the overall concentration of rig exposures in the Gulf of Mexico. These decreases in production were partially offset by an increase in marine liability production. Substantial rate increases were achieved in the energy class in 2006 followed by smaller increases in rates in certain marine liability policies. However, rates in the other classes of marine business were generally flat to slightly declining when compared to 2005.
Ocean marine net premiums written and net premiums earned for year ended December 31, 2006 increased by 7% and 9% respectively, when compared to 2005. Net written and earned premiums in 2005 were reduced by $14.8 million in reinstatement reinsurance premiums as a result of losses sustained from hurricanes Katrina and Rita. This compares to additional reinstatement reinsurance costs recorded in 2006 on hurricanes Katrina and Rita of $1.1 million
Other liability gross premiums written, net premiums written and net premiums earned for the year ended December 31, 2006 rose by 65%, 32% and 18%, respectively, when compared to 2005. In prior years, the Company issued excess workers’ compensation insurance policies on behalf of certain self-insured workers’ compensation trusts. Specifically, in 2005 the Company wrote a $500,000 layer in excess of each trust’s self insured retention of $500,000 and the gross premiums written were reinsured under a 50% quota share reinsurance treaty. In 2006, the Company provided gross statutory limits on the renewals of its existing inforce book of excess workers’ compensation policies to these trusts. In addition, the Company expanded the number of trusts it issued policies to under an agreement with another agent. Accordingly, the reinsurance structure was changed in 2006 to accommodate the increase in gross limits. A general excess of loss treaty was secured in order to protect the Company on any one risk. The resulting net retention was then subject to a 70% quota share reinsurance treaty. As a result of the change in underwriting and reinsurance structures, the gross, ceded and net premiums written increased substantially in this class of business in 2006 when compared to 2005. Gross and net premiums written in the excess workers’ compensation class increased to $41.7 million and $11.5 million, respectively, in 2006 from $6.3 million and $3.1 million, respectively, in 2005. Net premiums earned increased to $11.6 million in 2006 compared to $6.6 million in 2005. Volume increases from existing classes (professional liability and contractors’ liability) were also achieved in 2006 when compared to 2005. Premium rates in these classes during 2006 were flat to down slightly when compared to 2005.
Net losses and loss adjustment expenses incurred as a percentage of net premiums earned (the loss ratio) were 56.7% for the year ended December 31, 2006 as compared to 68.6% for 2005. The higher loss ratio in 2005 was largely attributable to losses sustained in the ocean marine line from hurricanes Katrina and Rita, which added 11.2% to the year ended December 31, 2005 overall loss ratio. The ocean marine loss ratio further improved in 2006 as a result of the non-renewal of certain unprofitable hull business. The Company reported lower loss ratios in the other liability lines of business for 2006 when compared to 2005 as a result of lower ratios for the current accident year losses. The inland marine/fire loss ratio increased for 2006, reflecting larger severity losses in the fire and the surety class.
The Company decreased net loss reserves by approximately $7.7 million in 2006 from the 2005-year end net unpaid loss reserve amount of $289 million as a result of favorable loss reserve development. This compared to $13 million of favorable loss reserve development recorded in 2005.
The Company reported favorable development of prior year loss reserves of $7.7 million in 2006 primarily as a result of favorable reported loss trends arising from the ocean marine line of business in the 2005 and 2004 accident years due in part to lower settlements of case reserve estimates, higher than expected receipts of salvage and subrogation recoveries and a lower emergence of actual versus expected losses. Partially offsetting this benefit was adverse development in the 2005 and 2004 accident years in the commercial auto class as a result of higher than initially anticipated loss ratios. 2004 was the first full year of writing commercial auto premium. The Company also reported overall favorable development in its other liability line as a result of shorter than expected loss development tail on its contractors’ class. The inland marine/fire segment also reported adverse loss development partially due to higher than expected loss ratios in one of the Company’s program businesses, which was not renewed in 2006, as well as a higher than initially expected loss ratio in its surety class due to a large shock loss.
The $13.2 million decrease in 2005 primarily reflected the recognition of favorable development in the ocean marine line of business, particularly in the 2001 to 2003 accident years. The Company’s net loss retention per risk, or occurrence, increased substantially in the ocean marine line during the 2001-2003 accident years from previous years. Our net loss retentions in the ocean marine line of business for the 1998, 1999 and 2000 years were $50,000, $50,000 and $100,000, respectively. This compared to net loss retentions in the ocean marine line of business for the 2001, 2002 and 2003 years of $1.5 million, $2 million and $2 million, respectively. The Company estimated higher IBNR amounts in the 2001 to 2003 accident years to correspond to the larger net loss retentions. Our subsequent analysis of our 2004 actual loss development, however, indicated a trend, which continued in 2005, that the actual loss emergence for the larger net retention years of 2001 to 2003 was not developing as we had originally anticipated. These results compared favorably with those obtained through a statistical evaluation of losses using the Bornheutter-Ferguson, paid and incurred methods. The other liability line also reported favorable development in years prior to 2002 resulting from a lower than expected emergence of losses attributable to a shorter loss reporting tail than originally estimated. Further contributing to the increase was the favorable development of aircraft loss reserves largely attributable to the 2001 accident year. The favorable loss development in 2005 was partially offset by net adverse loss development resulting from provisions made for insolvent, financially impaired reinsurers and commuted reinsurance contracts, partly as a result of an increase in ceded incurred losses relating to a few specific asbestos claims.
Policy acquisition costs as a percentage of net premiums earned (the acquisition cost ratio) for the years ended December 31, 2006 and 2005 were 20.6% and 22.7%, respectively. The acquisition cost ratio reported in 2005 is higher primarily due to the ocean marine line and the impact of reinsurance reinstatement costs arising from hurricane losses. The 2006 ocean marine acquisition cost ratio was favorably impacted by ceded override commissions in the energy quota share reinsurance agreement, which became effective in 2006.
General and administrative expenses increased by 16% for the year ended December 31, 2006 when compared to 2005. Larger expenses were incurred in 2006 to service the growth in the Company’s business operations, including higher personnel and administrative expenses as well as larger consulting expenses resulting from the implementation of new computer systems.
As of December 31, 2006 and 2005 investments in limited partnerships amounted to approximately $182.3 million and $139.6 million, respectively. The equity method of accounting was used to account for the Company’s limited partnership hedge fund investments. Under the equity method, the Company records all changes in the underlying value of the limited partnership hedge funds to results of operations. Net investment income for 2006 and 2005 reflected approximately $16.5 million and $17.6 million, respectively, derived from limited partnership hedge fund investments.
Other liabilities declined to $30.2 million at December 31, 2006 from $33.8 million at December 31, 2005 primarily as a result of payments for amounts owed to the MMO pool member companies, which was partially offset by higher federal income taxes payable.
Property, improvements and equipments, net increased to $9.9 million at December 31, 2006 from $8.3 million at December 31, 2005 primarily as a result of capitalized expenses for computer software.
The Company monitors cash and short-term investments in order to have an adequate level of funds available to satisfy claims and expenses as they become due. As of December 31, 2007, the Company’s assets included approximately $205.1 million in cash and short-term investments. In addition, the fixed maturities available for sale includes approximately $135 million in high investment grade floating rate residential mortgage backed securities. Cash and total investments increased from $664.9 million at December 31, 2006 to $701.1 million at December 31, 2007, principally as a result of collections of reinsurance recoverables on hurricane losses and lower net paid losses. Receivables for securities sold amounted to $22.9 million and $18.8 million as of December 31, 2007 and 2006, respectively. Payable for securities purchased amounted to $28.7 million and $0 at December 31, 2007 and 2006, respectively. The level of cash and short-term investments of $205.1 million at December 31, 2007 reflected the Company’s high liquidity position.
Cash flows used in operating activities were $106.4 million for the year ended December 31, 2007. This compared to cash flows provided by operating activities of $110.6 million for the year ended December 31, 2006 and cash flows used in operating activities $64.0 million for the year ended December 31, 2005. Cash flows from operating activities are significantly impacted by changes in the Company’s trading portfolio. Any securities purchased by the Company in its trading portfolio would be reflected as a use of cash from operating activities and any securities sold from its trading portfolio would be reflected as a source of cash from operating activities. Trading portfolio activities of $116.2 million and $110.6 million adversely affected cash flows for the years ended December 31, 2007 and 2005, respectively, while trading portfolio activities of $109.8 million favorably affected cash flows for the year ended December 31, 2006. Trading portfolio activities include the purchase and sale of CDO/CLO securities, commercial middle market debt, preferred stocks and U.S. Treasury securities. As the Company’s trading portfolio balance may fluctuate significantly from period to period, cash flows from operating activities may also be significantly impacted by such trading activities.
Cash flows from operating activities were favorably impacted, other than trading activities, for each of the years ended December 31, 2007, 2006 and 2005. Cash flows were favorably impacted in 2007, principally as a result of collections of reinsurance recoverables on hurricane losses and lower net paid losses, which were partially offset by payments of quota share reinsurance premiums; in 2006, by collections of premiums from a large increase in other liability premiums, which were mostly offset by a greater amount of paid losses and reinstatement reinsurance premiums, due in part to hurricane losses and partly due to payments on asbestos related losses; and, in 2005 were favorably affected by increased cash collections on premium and other receivables.
Cash flows used in financing activities were $2.8 million and $27.3 million for the years ended December 31, 2007 and 2005, respectively. The repurchase of treasury stock accounted for most of the use of cash flows in each of 2007 and 2005. Cash flows provided by financing activities were $1.1 million for the year ended December 31, 2006.
On March 22, 2006, the Company entered into an agreement (the “Letter Agreement”) to amend the Option Certificate granted under a Securities Purchase Agreement, dated January 31, 2003, by and between the Company and Conning Capital Partners VI, L.P. (“CCP”). The Amended and Restated Option Certificate dated as of March 22, 2006 by and between the Company and CCP (“Amended and Restated Option”) decreased the number of shares of Company common stock that may be issued upon the exercise of the Amended and Restated Option from 400,000 to 300,000 and extended the term from January 31, 2008 to December 31, 2010.
Specific related party transactions and their impact on results of operations are disclosed in Note 17 of the Company’s financial statements. The Company adheres to investment guidelines set by management and approved by the Finance Committee of the Board of Directors. See “Investment Policy.”
Within this limitation, the maximum amount which could be paid to the Company out of the domestic insurance companies’ surplus was approximately $20.3 million as of December 31, 2007.
New York Marine and Gotham collectively paid ordinary dividends of $14,475,000, $13,225,000 and $8,500,000 in 2007, 2006 and 2005, respectively.
In 2003, the Company acquired an interest in substantially all of a limited partnership hedge fund, (now known as Tricadia), that invests in collateralized debt obligations (“CDO”) securities, Credit Related Structured Product (CRS) securities and other structured product securities that are structured, managed or advised by a Mariner affiliated company. In 2003, the Company made an investment of $11.0 million in Tricadia. Additional investments of $4.65 million, $2.7 million, $0 and $6.25 million were made in 2004, 2005, 2006 and 2007, respectively. The Company is committed to providing an additional $15.4 million, or a total of approximately $40 million, in capital to Tricadia.
The following table presents the Company’s contractual obligations as of December 31, 2007:
Unpaid losses and loss adjustment expenses are based on individual case estimates for losses reported. A provision is also included, based on actuarial estimates utilizing historical trends in the frequency and severity of paid and reported claims, for losses incurred but not reported, salvage and subrogation recoveries and for loss adjustment expenses. Unpaid losses with respect to asbestos/environmental risks are difficult for management to estimate and require considerable judgment due to the uncertainty regarding the significant issues surrounding such claims. For a further discussion concerning asbestos/environmental reserves see “Reserves.” Unpaid losses and loss adjustment expenses amounted to $556.5 million and $579.2 million at December 31, 2007 and 2006, respectively. Unpaid losses and loss adjustment expenses, net of reinsurance amounted to $306.4 million and $292.9 million at December 31, 2007 and 2006, respectively. Management believes that both the gross and net unpaid loss reserve estimates as of December 31, 2007 have been reasonably estimated. Management continually reviews and updates the estimates for unpaid losses and any changes resulting therefrom are reflected in operating results currently. The potential for future adverse or favorable loss development is highly uncertain and subject to a variety of factors including, but not limited to, court decisions, legislative actions and inflation.
The allowance for doubtful accounts is based on management’s review of amounts due from insolvent or financially impaired companies. Allowances are estimated for both premium receivables and reinsurance receivables. Management continually reviews and updates such estimates for any changes in the financial status of companies. For a further discussion concerning reinsurance receivables see “Reinsurance Ceded.” The allowance for doubtful accounts on reinsurance receivables amounted to $14.1 million and $13.9 million at December 31, 2007 and 2006, respectively. The allowance for doubtful accounts on premiums and other receivables each amounted to $300,000 as of December 31, 2007 and 2006, respectively.
Impairment of investments, included in realized investment gains or losses, results from declines in the fair value of investments which are considered by management to be other-than-temporary. Management reviews investments for impairment based upon specific criteria that include the duration and extent of declines in fair value of the security below its cost or amortized cost. The Company performs a qualitative and quantitative review of all securities in a loss position in order to determine if any impairment is considered to be other-than-temporary. With respect to fixed income investments, declines in fair value of less than 10% are normally considered to be temporary, unless the fixed income security has been downgraded at least two levels by a major rating agency. Additionally, the Company reviews those securities held for six months or more, with fair value declines of greater than 10% at the end of each reporting period. The Company also reviews all securities with any rating agency declines during the reporting period. As a result of this review, the Company will record an impairment charge to earnings if the fair value decline is greater than 20%, if the fixed income security has been downgraded at least two levels by a major rating agency, or if the fair value decline is greater than 10% and the security has been downgraded one level by a major rating agency. This review includes considering the effect of rising interest rates and the Company’s intent and ability to hold impaired securities in the foreseeable future to recoup any losses. In addition to subjecting its securities to the objective tests of percent declines in fair value and downgrades by major rating agencies, when it determines whether declines in the fair value of its securities are other than temporary, the Company also considers the facts and circumstances that may have caused the declines in the value of such securities. As to any specific security, it may consider general market conditions, changes in interest rates, adverse changes in the regulatory environment of the issuer, the duration for which the Company has the intent and the ability to hold the security for the length of any forecasted recovery. Approximately $6.7 million and $371,000 were charged to results from operations for 2007 and 2006, respectively, resulting from fair value declines considered to be other-than-temporary. The write-downs in 2007 primarily relate to the Company’s investments in residential mortgage backed securities that consist of “Alt A” mortgages. Gross unrealized gains and losses on fixed maturity investments available for sale amounted to approximately $486,000 and $175,000, respectively, at December 31, 2007. As of December 31, 2007, there were unrealized losses consecutively for twelve months or longer on fixed income securities available for sale amounting to $174,000. The Company believes these unrealized losses to be temporary and result from changes in market conditions, including interest rates or sector spreads. There were no unrealized gains or losses on equity securities at December 31, 2007 and 2006, respectively.