The following financial discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto, which can be found on subsequent pages of this report.
While 2003 was a profitable year for the property and casualty insurance industry, we anticipate that when all the industry data is reported, 2004 will have been more profitable than 2003. Improvement in 2004 operating results should result in a decrease in the industry’s statutory combined ratio, which is a key performance measure for property and casualty insurers. Please refer to a later section of this report entitled “Non-GAAP Financial Measures” for a more detailed definition of statutory combined ratio. A.M. Best Company, a leading insurance industry rating agency and data provider, estimates the 2004 industry-wide statutory combined ratio to be 97.6 percent, as compared with a statutory combined ratio of 100.1 percent in 2003. The impact of pricing increases that occurred over the past three years has contributed to the improved results for the industry.
Specific events or issues that occurred or existed during 2004 that had or could have a significant impact upon the insurance industry include pricing of insurance products, the investment environment, continued concern by A.M. Best Company and other industry observers that the insurance industry is under-reserved for asbestos and environmental exposures, the occurrence of four hurricanes during the third quarter of 2004, the occurrence of the Indonesian tsunami in December 2004, court decisions related to the collapse of the World Trade Center on September 11, 2001 and investigations conducted by the New York Attorney General, the Securities and Exchange Commission and others into various industry practices.
During 2004, the property and casualty insurance industry continued to see pricing increases that contributed to an increase in premiums earned. We believe that the industry-wide premium rate increases that were implemented in 2004 had declined from the levels of pricing increases implemented during recent years. We discuss the impact of pricing in our lines of business later in this report in a section titled “Property and Casualty Insurance Segment”. At the end of 2004, market indicators suggest that the industry is experiencing a softening of the market. A soft market generally results in decreases in pricing, as well as more liberal insurance policy terms and conditions. Historically, during this market phase some insurers will accept inadequate prices in an attempt to gain market share. In previous soft markets, we resisted irrational price reductions, and we will continue to do so. Looking into 2005, we intend to continue to charge adequate prices for our property and casualty products given current market conditions. We believe that this will result in decreased prices in some of our lines of business in order to retain and obtain desireable accounts.
Interest rates have a major impact on the profitability of our life insurance segment’s annuity products. The income that we derive from annuities is primarily dependent on the spread achieved between the return on investments and the interest credited to annuity holders. We are disciplined in setting the crediting rates offered on our annuity products in order to achieve targeted interest rate spreads on these products. We have been willing to accept lower levels of sales on these products when market conditions make these targeted spreads more difficult to achieve. Beginning January 1, 2004, we re-entered the annuity sales market after a six-month suspension of our annuity sales. We implemented the suspension due to the negative spread we were experiencing. Beginning in 2004, we believed that suitable investment vehicles were more readily available, leading to more appropriate opportunities to invest our cash. To further enhance our profitability, during 2004 we also implemented cost reduction measures. In 2005, we will continue to strive to meet our targeted interest rate spreads through the monitoring of investment rates and the monitoring and adjustment of crediting rates. We will also look to improve profitability through increased sales levels and cost control measures.
We believe that the recovery in the investment environment will continue into 2005. We expect increasing interest rates and cash flows from underwriting operations in 2005 to result in higher net investment income. However, increases in interest rates could negatively impact our stockholder’s equity, as higher rates will lead to a decrease in the fair value of our fixed maturity securities and the related unrealized appreciation recognized in stockholders’ equity.
On December 26, 2004, an earthquake in the Indian Ocean generated a tsunami that devastated the shores of Indonesia, Sri Lanka, South India and Thailand. Industry sources estimate that the United States property and casualty insurance industry will incur less than $4.0 billion in losses related to the this catastrophe. We believe that we may have immaterial assumed reinsurance loss exposure related to the tsunami event. We have not received notification of losses from any of our assumed reinsurance brokers, and we have not recorded a reserve for losses for this particular catastrophe.
Our independent agencies are eligible to receive a profit-sharing commission from us when certain premium thresholds are met and when loss results are more favorable than predetermined thresholds. We determine the premium and loss thresholds and communicate them to our independent agents. We estimate the cost of these commissions and charge them to other underwriting expenses when the expense is incurred. We paid approximately $90.6 million in commissions to our independent agents in 2004. Approximately $18.8 million, or 21 percent of total commissions paid, was in the form of profit-sharing commissions. We have similar arrangements in effect for 2005 and expect to pay profit-sharing commissions for 2005 in approximately the same proportion to total commissions as we paid in 2004. We believe that our commission agreements comply with applicable law.
We also assume insurance business from other insurance companies. Assumed premiums written decreased slightly between the past two years, with $11.3 million recorded in 2004 compared with $12.9 million recorded in 2003.
The Terrorism Risk Insurance Act of 2002 helped facilitate the creation of a market for insurance that covers commercial losses caused by acts of terrorism. The Act requires us to offer coverage for certified acts of terrorism on all polices issued or renewed through December 31, 2005. Under the Act, the Federal government would share with primary and surplus lines insurers the costs of any insured losses caused by certified acts of terrorism. The Act defines a “certified” act of terrorism as “an act that is certified by the Secretary of the Treasury as resulting in aggregate losses in excess of $5.0 million, is a violent act or dangerous to human life, property or infrastructure, and is committed by an individual(s) acting on behalf of any foreign person or interest as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion.” The Act is not intended to provide a permanent solution. Therefore, the stipulated duration of the Federal government’s cost-sharing obligations would terminate at the end of 2005. It is unclear at this time whether or not the Act, or a modified version, will be extended beyond December 31, 2005.
In 2004, we incurred losses and settlement expenses of $256.2 million, of which $294.8 million was attributable to losses that occurred in 2004. In 2004, we recorded a $38.6 million offset to losses incurred related to the net savings realized in 2004 on the settlement of losses that occurred prior to 2004. The net savings, also referred to as loss redundancy, resulted from settling or re-estimating claims for less than reserved at December 31, 2003. We experienced loss redundancy in each of our lines of business, with the exception of other liability. The adverse development in our other liability line of business was impacted by construction defect losses and related legal costs.
Our reserving process, which contributed to favorable development of losses in 2004 and 2003, is presented under “Critical Accounting Policies” later in this discussion. Our workers’ compensation and other liability lines of business are considered long-tail lines of business due to the length of time that may elapse before claims are finally settled. Therefore, we may not know our final development on individual claims for many years. Our estimates for losses, particularly in these long-tail lines, are dependent upon many factors, such as our estimate of the severity of the claim, the legal environment, inflation and medical costs. We consider all of these factors, as well as others, in estimating our loss reserves. As conditions or trends with respect to these factors change, we change our estimate for loss reserves accordingly.
In 2004, we recorded $19.2 million in catastrophe losses, compared with $17.6 million in 2003. A series of four hurricanes that made landfall in the southern United States contributed $12.6 million of the catastrophe losses in 2004.
The net loss ratio in our commercial lines of business improved from 59.6 percent in 2003 to 56.3 percent in 2004. Pricing increases occurring in 2003 and 2004 contributed to the growth in commercial lines premiums earned, which increased by $31.6 million or 9 percent. During 2003 we achieved double-digit premium rate increases in many of our commercial lines and in many of the states where we write commercial accounts. During 2004 the average premium rate increases in these lines were in the high single-digit range.
Our assumed reinsurance line of business improved in 2004, ending the year with a net loss ratio of 46.8 percent, compared with 95.4 percent in 2003. We attribute the improvement to a reduction in run-off losses related to assumed contracts that expired in 2000, that we did not renew. In 2004, we maintained the same assumed reinsurance contracts as in 2003. Assumed losses decreased by $5.2 million between 2003 and 2004. We continue to have exposure, primarily with respect to catastrophe coverage related to the run-off business, as well as to the small number of assumed reinsurance contracts that we have continued to underwrite. We believe that as of December 31, 2004, our loss reserves established for the assumed reinsurance business are appropriate.
Pre-tax income recorded by the life insurance segment for 2004 was $16.4 million, compared with $13.0 million for 2003. The increase in income was attributable primarily to an increase in net premiums earned and a decrease in net realized investment losses. The increase in net premiums earned was the result of marketing initiatives pursued in the last year, which have led to increased sales of single premium whole life and term products. The decrease in net realized investment losses was primarily due to investment write-downs of $.3 million in 2004 versus investment write-downs of $5.5 million in 2003. Net investment income earned in 2004 increased by $1.2 million, or 1.5 percent, to $82.5 million.
Net premiums earned by the life insurance segment in 2004 totaled $35.4 million, compared with $29.6 million in 2003. Annuity deposits collected are not reported as net premiums earned. Annuity deposits are invested and recorded as future policy benefits. Revenues for fixed annuity products consist of policy surrender charges and investment income earned. In 2004, annuity deposits were $50.8 million, compared with $69.1 million in 2003. These annuity deposit results are much lower than the results we had been able to achieve prior to the temporary suspension of the sale of all fixed annuity business that went into effect on June 30, 2003. We temporarily suspended the sale of fixed annuities in consideration of the difficulty we had in finding investment vehicles suitable in duration and quality to fit our asset-liability matching needs. The difficulty in finding suitable investment vehicles resulted in the accumulation of significant amounts of cash, which improved our liquidity, but also resulted in negative spreads on new business. As a result of the improving investment environment, we re-entered the fixed annuity marketplace in most of our licensed states effective January 1, 2004. Since our re-entry into the fixed annuity marketplace our annuity deposit levels have gradually recovered, but they have not yet returned to pre-suspension levels.
In 2004 we credited interest of $56.4 million to our fixed annuity and universal life policyholder accounts, compared with $56.5 million in 2003. We establish our interest crediting rates based upon current market conditions and maintain a “spread” by crediting rates on our policyholder account balances that are less than the ratio of net investment income to average invested assets. Our fixed annuity products expose us to the risk that changes in interest rates could reduce our spread and the rate of return that we are able to earn on our investments.
As of December 31, 2004, we have recorded net unrealized gains, after-tax, of $103.7 million, compared with net unrealized gains, after-tax, of $90.6 million at December 31, 2003. The growth was driven by the increase in the fair value of our equity security portfolio. Included within the 2004 net unrealized gain were unrealized losses of $4.1 million on our fixed maturity portfolio and $1.3 million on our equity portfolio. We believe that the unrealized losses related to our fixed maturity portfolio resulted primarily from changes in interest rates, not from changes in the credit quality of the issuers of these securities. We consider the unrealized losses to be temporary, and we have the intent and ability to hold our fixed maturity securities for a period of time that is sufficient to allow for the recovery in fair value that we expect to occur. We also believe that the unrealized losses on our equity portfolio are temporary. As of December 31, 2004, the largest unrealized loss, after-tax, on any single investment security was $0.9 million.
Unrealized losses do not affect net income and earnings per common share but do reduce comprehensive net income, stockholders’ equity and book value. Unrealized losses subsequently identified as other-than-temporary impairments are recorded as a component of net realized gains and losses. We recorded net realized gains on securities of $4.1 million in 2004, compared with net realized losses of $1.7 million in 2003. The 2004 and 2003 amounts recognized included other-than-temporary impairments of $.3 million and $6.4 million, respectively. See “Critical Accounting Policies” for a presentation of our impairment policy.
As of December 31, 2004, we have a deferred tax asset for net operating loss carryforwards totaling $21.9 million, all of which were acquired as part of our purchase of American Indemnity Financial Corporation. These net operating loss carryforwards expire from 2005 to 2018. We are required to establish a valuation allowance for any portion of the gross deferred tax asset that we believe may not be realized. At December 31, 2004, we recorded a valuation allowance of $7.8 million, of which $7.3 million relates to these net operating loss carryforwards that can only be used to offset future income of the property and casualty insurance segment. As we have determined that the benefit of these net operating losses can be realized, the related reduction in the deferred tax asset valuation allowance has been recorded as a reduction to our intangible asset relating to agency relationships. These adjustments have resulted in the elimination of the carrying value of the intangible asset related to the acquisition of American Indemnity Financial Corporation. The remainder of these adjustments will be recognized through our consolidated statements of income as a reduction to current tax expense.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
In 2003, we reported net income of $55.6 million, or $2.53 per share (after providing for the dividend on convertible preferred stock), which included net realized investment losses (before tax) of $1.7 million. Net income in 2002 was $20.8 million, or $.88 per share (after providing for the dividend on convertible preferred stock), which included net realized investment losses (before tax) of $13.8 million. Diluted earnings were $2.36 per share and $.88 per share for 2003 and 2002, respectively.
Total revenues increased by $62.4 million to $573.3 million in 2003, when compared with 2002. Net premiums earned increased by $47.3 million to $464.6 million, an increase of 11 percent. In 2003, we recorded other-than-temporary investment impairments of $6.4 million in 2003, compared with $13.3 million in 2002.
Losses and settlement expenses decreased by $7.3 million or 2 percent, between 2002 and 2003. While losses and settlement expenses increased between years in some of our lines of business, significant improvement in our fire and allied lines business led to the overall improvement between years. Good weather in 2003 contributed to this improvement, as did a number of underwriting initiatives that we undertook during the year.
Our property and casualty insurance segment compared favorably with the property and casualty industry. Our statutory combined ratio was 93.1 percent in 2003, compared with 101.9 percent in 2002. Like the industry as a whole, our underwriting profitability benefited from the premium rate increases that began in 2001, and continued in 2002 and 2003. We attributed the reduction in losses and settlement expenses, which was concentrated in our fire and allied lines of business, to a decrease in loss frequency and continued adherence to disciplined underwriting standards.
Our reinsurance contracts limit or exclude coverage for losses sustained as a result of terrorist activities. The Terrorism Risk Insurance Act of 2002 defines a “certified” act of terrorism as “an act that is certified by the Secretary of the Treasury as resulting in aggregate losses in excess of $5.0 million, is a violent act or dangerous to human life, property or infrastructure, and is committed by an individual(s) acting on behalf of any foreign person or interest as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion.” As of December 31, 2003, the Act required us to offer coverage for certified acts of terrorism on all polices issued or renewed through December 31, 2004.
In 2003, we incurred losses and settlement expenses of $271.6 million, of which $283.9 million was attributable to losses that occurred in 2003. In 2003 we recorded a $12.3 million offset to losses incurred related to a loss redundancy realized in 2003 on the settlement of losses that occurred prior to 2003. We experienced loss redundancy in each of our lines of business, with the exception of other liability and workers’ compensation.
The adverse development in our other liability line of business was due to several large claims that were reported to us in 2003. These claims, for which we did not have adequate reserves established at December 31, 2002, occurred in years prior to 2003. This line of business was negatively affected by the emergence of construction defect losses, as well as higher than anticipated legal costs. The adverse development in our workers’ compensation line of business was due to an increase in our reserves for older accident years. The adverse development in the other liability and workers’ compensation lines of business was more than offset by the loss redundancy in all of our other lines of business.
Our surety products guarantee the performance and payment of our bondholders. Our contract bonds protect owners from failure to perform on the part of our principals. Also, material suppliers and subcontractors are protected from nonpayment by our contractors. Our fidelity products generally provide coverage against loss of money or other property due to the fraud or dishonesty of employees. In 2003, we began the discontinuation of fidelity bonds, as the majority of this type of coverage had left the surety industry and was provided by the insurance industry. Our fidelity book of business had been reduced to a level where we could no longer afford to implement needed automation updates, keep trained staff and maintain current policy forms.
We wrote the majority of our personal lines business in Iowa, Louisiana, and Texas. In 2003, to improve our underwriting results, we successfully completed the consolidation of our personal lines business to our home office in Cedar Rapids, Iowa. In addition to improving underwriting results, we believed this move would enable us to provide more consistent and efficient service to our agents and policyholders.
In our assumed reinsurance line of business, we recorded a loss ratio of 95.4 percent in 2003, compared with 81.5 percent in 2002. Our assumed premiums earned were significantly reduced between 2001 and 2003, due to the run-off of several assumed reinsurance contracts. This lower premium volume, coupled with losses incurred related to the run-off contracts, had contributed to the deterioration. We continued to have exposure, primarily catastrophe coverages, related to the assumed reinsurance contracts written prior to 2001, as well as to the small number of assumed reinsurance contracts that we had continued to underwrite. We believed that as of December 31, 2003, our loss reserves established for the assumed reinsurance business were appropriate. We anticipated that we would decrease the assumed loss reserves each year as the non-renewed assumed reinsurance contracts continue to run off and the losses are paid out.
In 2003, we credited interest of $56.5 million to our fixed annuity and universal life policyholder accounts, compared with $51.7 million in 2002. We establish our interest crediting rates based upon current market conditions and maintain a “spread” by crediting rates on our policyholder account balances that are less than the ratio of net investment income to average invested assets. We decreased interest-crediting rates during 2003 and 2002 for new deposits. The increase in our expense for interest on policyholders’ accounts in 2003 was primarily a result of the interest credited on existing account balances. Our fixed annuity products expose us to the risk that changes in interest rates could reduce our spread and the rate of return that we are able to earn on our investments. Because of the poor performance of the market during 2003, our spread had been reduced due to the decreased rate of return earned on funds invested in 2003. We had significant amounts of annuities up for renewal beginning in 2004. Because of market conditions and the resulting low interest rates, many of these annuities may not have been renewed. Because there are significant annuities at risk for non-renewal, our financial results could be significantly and negatively affected.
Unrealized losses do not impact net income and earnings per common share but do reduce comprehensive net income, stockholders’ equity and book value. Unrealized losses subsequently identified as other-than-temporary impairments are recorded as a component of net realized losses. We recorded net realized losses on securities of $1.7 million in 2003, compared with net realized losses of $13.8 million in 2002. The net realized loss that we recognized in 2003 and 2002 included other-than-temporary impairments of $6.4 million and $13.3 million, respectively. See “Critical Accounting Policies” later in this discussion for a presentation of our impairment policy.
Our effective federal income tax rate of 30.4 percent was less than the applicable federal tax rate of 35.0 percent due primarily to our portfolio of tax-exempt securities. Our effective rate was 20.2 percent in 2002. The increasing effective rate was driven primarily by an increase in taxable income.
At December 31, 2004 our invested assets, comprised primarily of fixed maturity securities, increased $132.2 million, or 7.2 percent, from December 31, 2003. The increase in invested assets we have experienced this year is attributable to improvements in the investment environment. As interest rates have increased, we have realized an increase in the suitable investment opportunities available to us. As a result, we have purchased investments during the year at a rate exceeding sales, calls and maturities of investments. The increase in invested assets resulting from the increase in investment activity during the year was accompanied by an increase in the unrealized appreciation recognized on our investment portfolio. The net unrealized gain from these investments is reported net of tax as a separate component of accumulated other comprehensive income. The changes in our total reported invested asset balance are summarized by the following table:
At December 31, 2004, $1,633.6 million, or 94.3 percent, of our fixed maturities were classified as available-for-sale, compared with $1,519.4 million, or 92.0 percent, at December 31, 2003. Our trading securities consist primarily of convertible redeemable preferred securities, which are recorded at fair value, with any changes in fair value recognized in earnings. Our remaining fixed maturities are classified as held-to-maturity and are reported at amortized cost. As of December 31, 2004, 91.3 percent of our fixed maturities were investment grade, as defined by the National Association of Insurance Commissioners’ Securities Valuation Office, and had ratings of Class 1 or Class 2.
We have significant cash flows from sales of investments and scheduled and unscheduled investment security maturities, redemptions and prepayments. These cash flows, which totaled $317.1 million in 2004 and $286.3 million in 2003, were sufficient for our cash flow needs in both years. If our operating and investment cash flows had not been sufficient to support our operations, we have short-term investments that we could utilize for this purpose. We may also borrow up to $20 million on a bank line of credit. Under the terms of our credit agreement, interest on outstanding notes is payable at the lender’s prevailing prime rate, minus 1.0 percent. We did not utilize our line of credit during 2004 or 2003.
We invest funds available for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. At December 31, 2004 our cash and cash equivalents included $31.4 million related to these money market accounts, compared with $91.7 million at December 31, 2003.
Under the insurance laws of the states and jurisdictions where our insurance subsidiaries and affiliate are domiciled, an insurer is restricted with respect to the timing or the amount of dividends it may pay without prior approval by regulatory authorities. In 2004 and 2003 United Fire did not receive dividends from its insurance subsidiaries and affiliate.
Redeemable preferred stock totaling $65.8 million consists of 2,759,600 shares of 6.375 percent Convertible Preferred Stock, Series A, issued at $25 per share in May 2002. Dividends paid and accrued on our preferred stock in 2004 totaled $4.4 million. Our preferred stock is discussed further in Note 11 of the Notes to Consolidated Financial Statements.
In most cases, quoted market prices are used in determining the fair value of fixed maturities, equity securities and short-term investments. Where quoted market prices were unavailable, the estimate is based upon estimated realizable value. Other long-term investments, consisting primarily of holdings in limited partnership funds, are valued by the various fund managers. Unrealized appreciation or depreciation of investments carried at fair value is excluded from net income and credited or charged, net of applicable deferred income taxes, directly to a component of accumulated other comprehensive income in stockholders’ equity.
We continually monitor the difference between our cost basis and the estimated fair value of our investments. Our accounting policy for impairment recognition requires other-than-temporary impairment charges to be recorded when we determine that it is more likely than not that we will be unable to collect all amounts due according to the contractual terms of the fixed maturity security or that the anticipated recovery in market value of the equity security will not occur in a reasonable amount of time. Impairment charges on investments are recorded based on the fair value of the investments at the measurement date and are included in net realized gains and losses. Factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which the fair value has been less than cost; the financial conditions and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery. As of December 31, 2004, we had a number of securities where fair value was less than our cost. The total unrealized depreciation on these securities totaled $5.6 million at December 31, 2004, compared with $7.9 million at December 31, 2003. Our rationale for not recording other-than-temporary impairments on these securities is discussed in Note 2 of the Notes to Consolidated Financial Statements.
We record a deferred asset for our life insurance segment’s policy acquisition costs. We defer and amortize policy acquisition costs, with interest, on traditional life insurance policies, over the anticipated premium-paying period of the related policies in relation to anticipated premium income on those policies.
The estimate of these reserves is subjective and complex and requires us to make estimates about the future payout of claims, which is inherently uncertain. When we establish and adjust reserves, we do so based on our knowledge of the circumstances and facts of claims. Upon notice of a claim, we establish a case reserve for losses based on the claims information reported to us at that time. Subsequently, we conduct an investigation of each reported claim, which allows us to more fully understand the factors contributing to the loss and our potential exposure. This investigation may extend over a long period of time. As our investigations of claims develop and as our claims personnel identify trends in claims activity, we refine and adjust our estimates of case reserves. To evaluate and refine our overall reserving process, we track and monitor all claims until they are settled and paid in full and all salvage and subrogation claims are resolved.
Assuming that we have liability for all claims, even though the issue of liability may in some cases be resolved in our favor;
Promoting claims management services to encourage return-to-work programs, case management by nurses for serious injuries and management of medical provider services and billings; and
At December 31, 2004 our reserves for gross losses and settlement expenses increased by $37.9 million to $464.9 million, from $427.0 million at December 31, 2003. We increased our gross loss and settlement reserves for the other liability line of business by $17.2 million, and we increased our gross reserves for our workers’ compensation business by $7.8 million. In all of our other lines of business, we decreased our gross reserves for losses and loss adjustment expenses. Other liability and workers’ compensation lines of business are considered long-tail lines of business due to the length of time that may elapse before claims are finally settled. Therefore, we may not know our final development on individual claims for many years. Our estimates for losses, particularly in these long-tail lines, are dependent upon many factors, such as our estimate of the severity of the claim, the legal environment, inflation and medical costs. We consider all of these and other factors in estimating our loss reserves. As conditions or trends with respect to these factors change, we change our estimate for loss reserves accordingly.
Included in the other liability line of business are gross reserves for asbestos and other environmental losses and settlement expenses. At December 31, 2004, we established $3.0 million in asbestos and environmental loss reserves, compared with $3.3 million at December 31, 2003. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss adjustment expense reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves.
Future Policy Benefits and Losses, Claims and Settlement Expenses-Life Insurance Segment
Several of the factors that are utilized to determine the benefit plans’ projected benefit obligation and expense are dependent upon future events, such as how long the employee and any survivors live, how many years of service the employee is expected to render and the employee’s future level of compensation. Accordingly, the effects of such future factors are estimated. The selection of benefit plan estimates, primarily the discount rate and the expected long-term rate of return on pension plan assets, can have a significant impact on the estimated projected benefit obligation and benefit expense, and thus on the consolidated results of operations.
State regulators have the authority to approve or deny our premium rates to ensure that they are not excessive and are not discriminatory. Because of this regulatory constraint, it is sometimes difficult to receive an adequate premium rate on our products, which can result in unsatisfactory underwriting results.
Despite strict oversight by state insurance regulators, insurance companies occasionally become insolvent. Each of our insurance companies is required to participate in state guaranty fund associations, the purpose of which is to protect the policyholders of insolvent insurance companies. The guaranty fund associations assess solvent insurers to pay the claims of insolvent insurers. The assessments are based proportionately upon each solvent insurance company’s share of written premiums in the applicable state. Most of the state guaranty fund associations allow solvent insurers to recoup the assessments paid via the utilization of rate increases, surcharges or premium tax credits. However, there is no assurance that we will ultimately recover these assessments. At December 31, 2004, we have accrued $.1 million for state guaranty fund assessments.
Our insurance companies are subject to state laws and regulations that require investment portfolio diversification and that limit the amount of investment in certain categories. Non-compliance may cause non-conforming investments to be non-admitted in measuring statutory surplus and, in some instances, may require us to sell the non-conforming securities.
The National Association of Insurance Commissioners annually calculates a number of financial ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. A “usual range” of results for each ratio is used as a benchmark. Departure from the “usual range” on four or more of the ratios could lead to inquiries from individual state insurance departments as to certain aspects of a company’s business. None of our insurance companies had four or more ratios outside the “usual range” at December 31, 2004. In addition to the financial ratios, we are also required to calculate a minimum capital requirement for each of our insurance companies based on individual company insurance risk factors. These “risk-based capital” results are used to identify companies that require regulatory attention or the initiation of regulatory action. At December 31, 2004, all of our insurance companies had capital well in excess of the required levels.
Our life insurance subsidiary has received an “A-” (Excellent) rating from A.M. Best Company. According to A.M. Best Company, companies rated “A” and “A-” have “an excellent ability to meet their ongoing obligations to policyholders.” A.M. Best Company assigned a “bbb” rating to our convertible preferred stock issue.
Standard & Poor’s issued an “A” rating to United Fire & Casualty Company, Addison Insurance Company, Lafayette Insurance Company, United Fire & Indemnity Company, United Fire Lloyds, and United Life Insurance Company. According to Standard & Poor’s, an insurer rated “A” has “strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings.” A Standard & Poor’s Insurer Financial Strength Rating is Standard & Poor’s current opinion of the creditworthiness of an insurer with respect to its ability to pay under its insurance policies and contracts in accordance with their terms. Standard & Poor’s assigned a “BBB+” rating to our convertible preferred stock issue.
We believe that investor understanding of our financial performance is enhanced by disclosure of certain non-GAAP financial measures. The non-GAAP financial measures we utilize in this report are net premiums written, catastrophe losses and statutory combined ratio. These are statutory financial measures prepared in accordance with statutory accounting rules as prescribed by the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual.
Net premiums written: Net premiums written is a statutory accounting measure representing the amount of premiums charged for policies issued during the period. These premiums are reported as revenue as they are earned over the underlying policy period. Net premiums written applicable to the unexpired term of a policy are recorded as unearned premium. We evaluate net premiums written as a measure of business production for the period under review.
Catastrophe losses: A catastrophe loss is a single incident or series of closely related incidents causing severe insured losses. Catastrophes are by their nature unpredictable. The frequency and severity of catastrophic losses we experience in any year impacts our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance segment, we evaluate performance both including and excluding catastrophe losses. We define catastrophes to include events that cause $25.0 million or more in industry-wide, direct-insured losses to property and that affect a significant number of insureds and insurers. This is the same definition utilized by the Insurance Services Office, a supplier of property and casualty statistical data. At United Fire, we also include in our catastrophe totals those events we believe are, or will be, material to our operations, either in amount or in number of claims made. A portion of these losses may be recoverable under our catastrophe reinsurance agreements. These amounts totaled $3.9 million and $4.0 million for the years ended December 31, 2004 and 2003, respectively.
Statutory combined ratio: The combined ratio is a commonly used financial measure of underwriting performance. A combined ratio below 100 percent indicates a profitable book of business. The combined ratio is the sum of two separately calculated ratios, the loss and loss adjustment expense ratio (referred to as the “net loss ratio”) and the underwriting expense ratio (the “expense ratio”). When prepared in accordance with GAAP the net loss ratio is calculated by dividing the sum of losses and loss adjustment expenses by net premium earned. The expense ratio is calculated by dividing non-deferred underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. When prepared in accordance with statutory accounting principles, the net loss ratio is calculated by dividing the sum of losses and loss adjustment expenses by net premium earned. The expense ratio is calculated by dividing underwriting expenses by net premiums written.
(3) All share and per share amounts reflect the retroactive effects of our December 15, 2004 one-for-one stock dividend.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial statement categories that are most dependent on management estimates and assumptions include investments, deferred policy acquisition costs and future policy benefits and losses, claims and settlement expenses.
On whole life and term insurance (traditional business), premiums are reported as earned when due, and benefits and expenses are associated with premium income in order to result in the recognition of profits over the lives of the related contracts. On universal life and annuity policies (nontraditional business), income and expenses are reported when charged and credited to policyholder account balances in order to result in the recognition of profits over the lives of the related contracts. We accomplish this by means of a provision for future policy benefits and the deferral and subsequent amortization of life policy acquisition costs. We do not write variable annuities or variable insurance products.
The costs of acquiring new life business, principally commissions and certain variable underwriting, agency and policy issue expenses, have been deferred. These costs are amortized to income over the premium paying period of the related traditional policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of nontraditional policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. Policy acquisition costs deferred in 2004, 2003 and 2002 were $7,780,000, $12,526,000 and $20,402,000, respectively. Amortization of deferred policy acquisition costs in 2004, 2003 and 2002 totaled $12,384,000, $8,453,000 and $8,905,000, respectively. The expected premium revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining future policy benefits. For nontraditional policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs for revisions to estimated gross profits is reflected in earnings in the period such estimated gross profits are revised.
Liabilities for future policy benefits for traditional products are computed by the net level premium method using interest assumptions ranging from 4.5 percent to 8.0 percent and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Accident and health reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Liabilities for universal life and investment contracts are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon future anticipated cash flows using statutory mortality and interest rates, which produce results that are not materially different from GAAP. Deferred annuity reserves are carried at the account value.
Realized gains or losses on disposition of investments are included in the computation of net income. Cost of investments sold is determined by the specific identification method. Changes in unrealized appreciation and depreciation with respect to available-for-sale fixed maturities and equity securities are reported as a separate component of accumulated other comprehensive income, less applicable income taxes.
We are a defendant in legal actions arising from normal business activities. Management, after consultation with legal counsel, is of the opinion that any liability resulting from these actions will not have a material impact on our financial condition and operating results.
Statement of Financial Accounting Standard No. 123(R) “Share-Based Payment” replaces Statement No. 123 and supercedes Opinion No. 25. Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005. The pro forma disclosures previously allowed under Statement No. 123 no longer will be an alternative to financial statement recognition. The transition methods for adoption include the modified-prospective and modified-retroactive methods. Under the modified-retroactive method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified-prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock that exist upon the adoption of Statement 123(R). We are currently evaluating the requirements of Statement 123(R) and expect that the adoption of Statement 123(R) will not have a material impact on our Consolidated Financial Statements.
Proceeds from sales of available-for-sale securities during 2004, 2003 and 2002 were $11,541,000, $26,367,000 and $9,125,000, respectively. Gross gains of $4,222,000, $4,855,000 and $1,682,000 were realized on those sales in 2004, 2003 and 2002, respectively. Gross losses of $3,053,000, $7,513,000 and $15,040,000 were realized on those sales in 2004, 2003 and 2002, respectively.
A summary of realized investment gains (losses) resulting from sales, calls and other-than-temporary impairments and a summary of net changes in unrealized investment appreciation (depreciation), less applicable income taxes, is as follows.
We occasionally write covered call options on our equity security portfolio to generate additional portfolio income. We do not use these or any other investment instruments for hedging purposes. Covered call options are recorded at fair value and are included in accrued expenses and other liabilities. Any income, gains or losses, including the change in the fair value of the covered call options, is recognized currently in earnings and included in realized investment gains and losses. There were no open covered call options at December 31, 2004 and 2003.
In most cases, quoted market prices were used to determine the fair value of fixed maturities, equity securities and short-term investments. Where quoted market prices do not exist, fair value is based upon estimated realizable value.
The estimated fair value of mortgage loans is based upon discounted cash flows utilizing the market rate of interest for similar loans in effect at the valuation date. Other long-term investments, consisting primarily of holdings in limited partnership funds, are valued by the various fund managers. In management’s opinion, these values represent fair value at December 31, 2004 and 2003.
The fair value of the liabilities for annuity products that are in a benefit payment phase, guaranteed investment contracts and structured settlements is based on a discount rate of 5.75 percent and 6.00 percent at December 31, 2004 and 2003, respectively. The fair value of annuities currently in an accumulation phase is based on the net cash surrender value.
A summary of the carrying value and estimated fair value of our financial instruments at December 31, 2004 and 2003 is as follows.
We maintain a $20,000,000 bank line of credit. Under the terms of the agreement, interest on outstanding notes is payable at the lender’s prevailing prime rate minus 1.0 percent. There were no loan balances outstanding at December 31, 2004 and 2003, nor did we borrow against this line of credit in 2004, 2003 and 2002.
Reinsurance is a contract by which one insurer, called the reinsurer, agrees to cover, under certain defined circumstances, a portion of the losses incurred by a primary insurer if a claim is made under a policy issued by the primary insurer. We have several programs that provide reinsurance coverage. This reinsurance coverage limits the risk of loss that we retain by reinsuring direct risks in excess of our retention limits. For our property and casualty lines of business, our retention was $2,000,000 for losses that pertain to 2004, $1,500,000 for losses that pertain to 2003, $1,250,000 for losses that pertain to 2002, $1,000,000 for losses that pertain to years 1995 through 2001 and $750,000 or less for losses that pertain to years prior to 1995. In addition, we reinsure personal and commercial umbrella policy losses in excess of $1,000,000 up to $5,000,000, and we reinsure surety policy losses in excess of $1,250,000 up to $5,000,000, 90 percent of losses in excess of $5,000,000 up to $15,000,000 and 80 percent of losses in excess of $15,000,000 up to $20,000,000. We also have reinsurance that limits the total direct loss we may incur from a single catastrophe. The catastrophe reinsurance program provides coverage of 95 percent of $95,000,000 for losses in excess of our retention of $10,000,000 for a catastrophic event.
Written premiums ceded were $28,191,000, $31,380,000 and $35,251,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Earned premiums ceded were $28,674,000, $34,289,000 and $32,787,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Ceded loss and loss adjustment expenses incurred were $5,464,000, $440,000 and $4,812,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The ceding of reinsurance does not legally discharge us from primary liability under our policies, and we must pay the loss if the reinsurer fails to meet its obligations. We believe all reinsurance receivables due from reinsurers are collectable and realizable. There are no concentrations of credit risk associated with our reinsurance.
Our property and casualty companies also assume portions of their insurance business from other insurance companies. During the second quarter of 2000, we began to significantly reduce our writing of assumed reinsurance business. Most of our reinsurance business expired on or before December 31, 2000, and we continue to limit our exposure through the selective renewal of our remaining reinsurance contracts. We continue to have exposure related to the assumed reinsurance contracts that we have elected to continue to write and those that are in run-off status. Written premiums assumed for the years ended December 31, 2004, 2003 and 2002 were $11,338,000, $12,860,000 and $10,766,000, respectively. Assumed premiums earned for the years ended December 31, 2004, 2003 and 2002 were $11,467,000 $12,822,000 and $11,024,000, respectively. Assumed loss and loss adjustment expenses incurred were $7,002,000, $12,238,000 and $6,818,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
In 2002, the life insurance segment began assuming portions of credit life and accident and health insurance business from other insurance companies. Assumed premiums written for the years ended December 31, 2004, 2003 and 2002 were $284,000, $560,000 and $423,000, respectively. Assumed premiums earned for the years ended December 31, 2004, 2003 and 2002 were $436,000, $309,000 and $87,000, respectively. Assumed losses incurred were $157,000, $102,000 and $12,000 for the years ended December 31, 2004, 2003 and 2002, respectively. During 2004, we ceased the assumption of insurance business from other insurance companies. We continue to have exposure related to our assumed reinsurance contracts that are in a run-off status.
The table below provides an analysis of changes in our property and casualty loss and loss adjustment expense reserves for 2004, 2003 and 2002 (net of reinsurance amounts). Changes in reserves are reported in the consolidated statement of income for the year when the changes are made. The favorable development resulted from a re-estimation of loss reserves recorded at December 31 of the prior year. The significant improvement in the development of our reserves during 2004 is primarily attributable to both the payment of claims in amounts other than the amounts reserved and from changes in loss reserves due to additional information on individual claims that we received after the reserves for those claims had been established.
The table below provides an analysis of changes in our life and accident and health policy claim liabilities (net of reinsurance amounts) for 2004, 2003 and 2002. United Life Insurance Company’s reserve for life claims is based on the contractual terms of the underlying policies. The reserve for accident and health claims is determined actuarially using morbidity assumptions relative to each claim. Changes in assumptions for such things as environmental hazards and legal actions, as well as changes in actual experience, could cause these estimates to change in the near term.
Statutory capital and surplus in regards to policyholders at December 31, 2004, 2003 and 2002 and net income for the years then ended are as follows.
The State of Iowa Insurance Department governs the amount of dividends that we may pay to stockholders without prior approval by the department. Based on these restrictions, we are allowed to make a maximum of $66,693,000 in dividend distributions to stockholders in 2005 without prior approval. Dividend payments by the insurance subsidiaries to United Fire are subject to similar restrictions in the states in which they are domiciled. We received no dividends from our subsidiaries in 2004, 2003 or 2002.
A reconciliation of income tax expense (computed at the applicable federal tax rate of 35 percent in 2004, 2003 and 2002, respectively) to the amount recorded in the Consolidated Financial Statements is as follows.
The significant components of the net deferred tax liability at December 31, 2004 and 2003, are as follows.
As of December 31, 2004, we have a deferred tax asset for net operating loss carryforwards totaling $21,910,000, all of which were acquired as part of our purchase of American Indemnity Financial Corporation. These net operating loss carryforwards expire from 2009 through 2018, of which carryforwards of $10,955,000 expire from 2009 through 2011. We are required to establish a valuation allowance for any portion of the gross deferred tax asset that we believe may not be realized. At December 31, 2004, we recorded a valuation allowance of $7,844,000, of which $7,291,000 relates to these net operating loss carryforwards that can only be used to offset future income of the property and casualty insurance segment. As we have determined that the benefit of these net operating losses can be realized, the related reduction in the deferred tax asset valuation allowance has been recorded as a reduction to our intangible asset relating to agency relationships. These adjustments have resulted in the elimination of the carrying value of the intangible asset related to the acquisition of American Indemnity Financial Corporation. The remainder of these adjustments will be recognized through our consolidated statements of income as a reduction to current tax expense.
Under prior federal income tax law, one-half of the excess of a life insurance company’s income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as “Policyholders’ Surplus.” At December 31, 2004, we had approximately $2,121,000 of untaxed “Policyholders’ Surplus” on which no payment of federal income taxes will be required unless it is distributed as a dividend, or under other specified conditions. The American Jobs Creation Act, passed on October 11, 2004 suspended the tax on distributions from the Policyholder Surplus Account of stock life insurance companies for tax years beginning after December 31, 2004 and before January 1, 2007. The Act also reversed the order of accounts from which distributions are deemed to occur during this time. Distributions occurring during 2005 and 2006 will be deemed to come first from Policyholder Surplus Accounts, then from Shareholder Surplus Accounts and then from other accounts. This provision would allow us to distribute the amount in our Policyholder Surplus account during 2005 and 2006 without being required to pay the related federal income tax.
We offer a health and dental benefit plan to all of our eligible employees and retirees. The plan is composed of two programs: (1) the Self-Funded Retiree Health and Dental Benefit plan and (2) the Self-Funded Employee Health and Dental Benefit Plan. The plan provides health and dental benefits to our employees who are regularly scheduled to work for 24 or more hours per week and their covered dependents. Retired employees and their covered dependents are entitled to health and dental benefits, provided the retired employees have attained at least age 55 and have continuously participated in the employee plan for at least 10 consecutive years immediately prior to retirement. The plan’s contract administrators are responsible for making medical and dental care benefit payments. The plan requires participants to submit claims for reimbursement or payment to the plan administrator within 365 days after the end of the calendar year in which the charges were incurred. The plan’s benefit obligation relates primarily to our postretirement benefit program.
The following actuarial assumptions were used at December 31 to determine the reported plan benefit obligations.
The following table provides a reconciliation of the changes in both plans’ benefit obligations and fair value of plan assets and a statement of the plan’s funded status for 2004 and 2003.
The following table provides the components of net periodic benefit cost for the plans for 2004, 2003 and 2002.
The “Medicare Prescription Drug, Improvement and Modernization Act of 2003” became effective December 8, 2003. In accordance with Financial Accounting Standards Board Staff Position 106-2, the above measures of the postretirement benefit obligation and net periodic postretirement benefit cost have been adjusted for the provisions of this Act. For further discussion of this Act refer to Note 1.
For measurement purposes, a 10.0 percent annual rate of increase in the per capita cost of covered health care benefits is assumed for 2005. The rate is assumed to decrease gradually each year to a rate of 5.25 percent for 2010 and remain at that level thereafter. For dental claims, a 4.75 percent annual rate of increase was assumed for 2005 and thereafter.
We also have an employee stock ownership plan for the benefit of eligible employees and their beneficiaries. All employees are eligible to participate in the plan upon completion of one year of service, meeting the hourly requirements with United Fire and attaining age 21. Contributions to this plan are made at our discretion. These contributions are based upon a percentage of total payroll and are allocated to participants on the basis of compensation. We make contributions in stock or cash, which the trustee uses to acquire shares of United Fire stock to allocate to participants’ accounts. As of December 31, 2004, 2003 and 2002, the Employee Stock Ownership Plan owned 250,922, 252,412 and 252,432 shares of United Fire stock, respectively. Shares owned by the Employee Stock Ownership Plan are included in shares issued and outstanding for purposes of calculating earnings per share, and dividends paid on the shares are charged to retained earnings. We made contributions to the plan of $30,000, $300,000 and $90,000 in 2004, 2003 and 2002, respectively.
The analysis below details the activity of our stock option plan for the years ended December 31, 2004, 2003 and 2002. Information on the options outstanding at December 31, 2004 is also presented. All information presented reflects the retroactive effects of our December 15, 2004 one-for-one stock dividend.
The weighted-average grant date fair value of the options granted under the plan has been estimated using the Black-Scholes option pricing model with the following weighted average assumptions.
On May 6, 2002, we issued 2,760,000 shares of 6.375 percent convertible preferred stock, Series A at $25 per share. In connection with the preferred stock issuance, we collected net proceeds of $64,884,000. The preferred shares are non-voting. Dividends on the preferred stock are cumulative from the date of original issuance and are payable on March 15, June 15, September 15 and December 15 of each year, beginning on June 15, 2002. During 2004 and 2003, we paid and accrued dividends of $4,399,000 on our preferred stock, compared with $2,871,000 in 2002. The preferred stock has a liquidation preference and redemption price of $25 per share.
We have two reportable business segments in our operations: property and casualty insurance and life insurance. The property and casualty insurance segment has three domestic locations from which it conducts its business. All offices target a similar customer base, market the same products and use the same marketing strategies, and are therefore aggregated. The life insurance segment operates from our home office. The accounting policies of the segments are the same as those described in Note 1. We evaluate the two segments on both a statutory basis and GAAP basis. We analyze results based on profitability (i.e. loss ratios), expenses and return on equity. Because we sell all insurance domestically, we have no revenues allocable to foreign operations.
(1) “Fire and allied lines” in this table includes fire, allied lines, homeowners, commercial multiple peril and inland marine.
We determine the dilutive effect of our convertible preferred stock using the “if-converted” method. Under this method, we add to the denominator of the earnings per share calculation a number determined by multiplying the number of convertible preferred shares by the appropriate conversion rate. We also add the amount of preferred dividends and accretions back to the numerator of the earnings per share equation due to the assumed conversion of all the convertible preferred stock to common stock at the beginning of the reporting period. If the effect of the if-converted method is anti-dilutive, the effect on diluted earnings per share of our convertible preferred stock is disregarded. This was the case in our 2002 diluted earnings per share calculation. The preferred stock had a dilutive effect in both 2003 and 2004.
We determine the dilutive effect of our stock options outstanding using the “treasury stock” method. Under this method, we assume the exercise of all of the outstanding options whose exercise price is less than the weighted-average fair market value of our stock during the period. This method also assumes that the proceeds from the hypothetical stock option exercises are used to repurchase shares of common stock at the weighted-average fair market value of the stock during the period. The net of the assumed options exercised and assumed common shares repurchased represents the number of potentially dilutive common shares, which we add to the denominator of the earnings per share calculation. The components of basic and diluted earnings per share are displayed in the following table. All share and per share amounts reflect the retroactive effects of our December 15, 2004 one-for-one stock dividend.
We have audited the accompanying consolidated balance sheets of United Fire & Casualty Company as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index to Supplementary Schedules at Item 8. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
The management of United Fire & Casualty Company is responsible for establishing and maintaining adequate internal control over financial reporting. United Fire & Casualty Company’s internal control over financial reporting is a process designed under the supervision of its Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of its financial statements for external purposes in accordance with U.S. GAAP.
As of December 31, 2004, United Fire & Casualty Company’s management assessed the effectiveness of internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the assessment, United Fire & Casualty Company’s management determined that effective internal control over financial reporting is maintained as of December 31, 2004, based on those criteria.
Ernst & Young LLP, the independent registered public accounting firm that audited the consolidated financial statements of United Fire & Casualty Company included in this Annual Report on Form 10-K, has issued an attestation report on management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2004. The report, which expresses unqualified opinions on management’s assessment and on the effectiveness of United Fire & Casualty Company’s internal control over financial reporting as of December 31, 2004, is included in this Item under the heading “Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.”
We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that United Fire & Casualty Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). United Fire & Casualty Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
In our opinion, management’s assessment that United Fire & Casualty Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, United Fire & Casualty Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balances sheets of United Fire & Casualty Company as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004, and our report dated February 28, 2005, expressed an unqualified opinion thereon.
All other schedules have been omitted as not required, not applicable, not deemed material or because the information is included in the Consolidated Financial Statements.