The Company owns two buildings and the adjacent real estate approximately two miles and eleven miles from its main office. The buildings contain approximately 3,300 and 15,000 square feet of usable space respectively, and are used primarily as off-site data storage and as a contingent back up and disaster recovery site.
Net premiums written by the Company’s U.S. insurance subsidiaries for 2008 equaled approximately 41% of the combined statutory surplus of these subsidiaries. Premium writings of 100% to 200% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
As more fully discussed in Note R to the consolidated financial statements, at December 31, 2008, $86.7 million, or 26% of shareholders’ equity, represented net assets of the Company’s insurance subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company maintains a $20 million unsecured line of credit and has $9.0 million of drawings outstanding on this line at December 31, 2008, the proceeds of which were used to purchase treasury stock.
Net losses on investments, before taxes, totaled $47.7 million in 2008 compared to a net gain on investments of $40.1 million last year. These totals include gains and losses from both direct securities trading and investments in limited partnerships. The losses in 2008 are attributable to $11.9 million in fixed maturity and equity security net direct trading losses, $33.6 million in limited partnerships net losses and $2.2 in derivative security net losses. Limited partnership ventures utilized by the Company are primarily engaged in the trading of public and private securities, including foreign securities and small venture capital activities and, to a lesser extent, real estate development. The estimated market value of limited partnership ventures investments was $59.9 million at December 31, 2008 compared to a cost basis of $47.0 million. The aggregate of the Company’s share of earnings in these entities represented a loss of 43% for 2008 versus a positive return of over 40% for 2007. The Company follows the equity method of accounting for its investments in limited partnerships. To the extent that accounting rules require the limited partnerships to include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include unrealized as well as realized gains or losses. The current year limited partnership total is composed of estimated realized gains of $3.4 million and estimated unrealized losses of $37.0 million, as reported to the Company by the general partners. Inception to date unrealized losses included in the December 31, 2008 asset valuation total $6.9 million. Adjustments attributable to “other-than-temporary impairment,” of $9.0 million during 2008 are reflected in fixed maturity and equity security net losses as stated above. Further explanation of “other-than-temporary impairment” can be found in Note B to the consolidated financial statements.
Losses and loss expenses incurred during 2008 increased $8.0 million (7%) to $115.8 million. The increase in losses incurred is due to increased current year loss activity, including $5.5 million in losses attributable to hurricanes, and lower savings on prior accident year losses, primarily from property reinsurance. Partially offsetting increases in loss and loss expenses was a $5.5 million decrease in losses from the Company’s private passenger automobile product corresponding to the decline in premium volume for that product. The 2008 consolidated loss and loss expense ratio was 63.5% compared to 60.2% for 2007. The Company’s loss and loss expense ratios for major product lines are summarized in the following table.
The fleet transportation loss ratio for 2008 was adversely impacted by increases in reported loss amounts on a handful of severe claims. Also, the loss ratio for the independent contractor product is higher in 2008 as a significant number of insured contractors altered their business structure and therefore transitioned from accident and health to workers’ compensation coverage. Factors such as fluctuations in premium volume, the levels of self-insured retentions and the Company’s higher net retention under reinsurance treaties in recent years allow for more volatility in losses. The decrease in the private passenger automobile loss ratio is due primarily to increased savings on prior years’ losses. The property reinsurance loss ratio was higher in 2008 as the result of hurricane losses, principally Hurricane Ike, which added almost 16 points to the loss ratio for this segment for the year end more than offset a decline in the unusually large amount of tornado and hail losses experienced during 2007.
The Company produced an overall savings on the handling of prior year claims during 2008 of $17.1 million. This net savings is included in the computation of loss ratios shown in the previous table, as is the $21.3 million savings produced during 2007 on prior year claims. This savings was distributed among all of the Company’s products, with the majority attributable to the Company’s large fleet transportation business, and is generally consistent with recent prior years before consideration of savings related to retrospectively-rated contracts. Because of the high limits provided by the Company to its fleet transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company’s claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company’s reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
Other operating expenses for 2008, before credits for allowances from reinsurers, increased $3.4 million (6%) to $61.7 million. This increase is due primarily to a $2.4 million increase in commission expense and an $.8 million investment in new product development. The higher commissions reflect expansion of the Company’s distribution channels to include non-affiliated agents. It should be noted that much of the Company’s expense structure is fixed, that is, expenses do not vary directly with revenue, as revenue consists principally of net premiums earned by the insurance subsidiaries. In general, only commissions to non-affiliated agents, premium taxes and other acquisition costs vary directly with premium volume and each of these factors is considered in the pricing of insurance products.
A portion of the Company’s fleet transportation business is produced by direct sales efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not incur commission expense on a consolidated basis. Instead, the expenses of the agency operations, including salaries and bonuses of salesmen, travel expenses, etc. are included in operating expenses. In general, commissions paid by the insurance subsidiaries to the parent company exceed related acquisition costs incurred in the production of the property and casualty insurance business. The ratio of net operating expenses of the insurance subsidiaries to net premiums earned was 30.9% during 2008, level with the prior year. Including the agency operations, and after elimination of inter-company commissions, the ratio of operating expenses to operating revenue (defined as total revenue less gains (losses) on investments) was 28.6% for 2008 compared with 27.7% for 2007.
Premiums assumed from other insurers and reinsurers totaled $26.4 million during 2007, an increase of $13.5 million (105%) from 2006. The property reinsurance increase resulted primarily from new business generated by the Company’s affiliation with Paladin Catastrophe Management. Protective is the exclusive market for property catastrophe business produced by Paladin which focused on soliciting coverage from insurance companies with risks throughout the U.S. Midwest and limited coastal regions excluding Florida and California in 2007.
Net gains on investments totaled $40.1 million in 2007 compared to $17.1 million last year. These totals include gains from both direct securities trading and investments in limited partnerships. The gains in 2007 are attributable to $16.8 million in equity security net gains, $23.2 million in limited partnerships net gains and $.1 in debt security net gains. During 2007, the Company disposed of numerous equity securities primarily to provide funds for a new investment program initiated after year end which will be managed by a consolidated entity in 2008. The Company’s investments in limited partnership ventures, consists primarily of securities trading which include foreign securities and small venture capital activities and, to a lesser extent, real estate development. The estimated market value of limited partnership ventures investments was $80.9 million at December 31, 2007 and the aggregate of the Company’s share of earnings in these entities represented a return of over 40% for 2007 and 25% for 2006. The Company follows the equity method of accounting for its investments in limited partnerships. To the extent that the limited partnerships include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include unrealized as well as realized gains or losses. The current year limited partnership total is composed of estimated realized income of $7.9 million and estimated unrealized income of $15.3 million, as reported to the Company by the general partners. Inception to date unrealized gains included in the December 31, 2007 asset valuation total $30.4 million. The final component of investment gains, consisting of adjustments attributable to “other-than-temporary impairment,” was not significant during 2007 or 2006 and is more fully explained in Note B to the consolidated financial statements.
reinsurance, continued low frequency of large trucking claims, and premium volume declines in the Company’s private passenger automobile product. These decreases were largely offset by $12.2 million in losses from the Company’s expansion of its property catastrophe business during 2007. The 2007 consolidated loss and loss expense ratio was 60.2% compared to 66.3% for 2006. The Company’s loss and loss expense ratios for individual product lines are summarized in the following table.
The fleet transportation loss ratio for 2007 was favorably impacted by an increase in savings on prior year losses and a continued low frequency of extremely severe accidents. Factors such as fluctuations in premium volume, the levels of self-insured retentions and the Company’s higher net retention under reinsurance treaties in recent years tend to allow for more volatility in losses. The increase in the private passenger automobile loss ratio is associated with product modifications as competitive market conditions are ongoing. The loss ratio for property reinsurance increased as the result of the Company’s expansion of catastrophe coverages to the U.S. Midwest during 2007. An unusually large number of tornado and hail losses were incurred resulting in a loss ratio of 94.5% on this book of business. The property reinsurance loss ratio for the year was 33.0%, or slightly lower than 2006 on the remainder of our property reinsurance book of business.
The Company produced an overall savings on the handling of prior year claims during 2007 of $21.3 million. This net savings is included in the computation of loss ratios shown in the table insert, as is the $16.9 million savings produced during 2006 on prior year claims. The savings is generally consistent with recent prior years before consideration of savings related to retrospectively-rated contracts. Because of the high limits provided by the Company to its large trucking fleet insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company’s claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company’s reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
In determining if and when a decline in market value below cost is other-than-temporary, we first make an objective analysis of each individual security where current market value is less than cost. For any security where the unrealized loss exceeds 20% of original or adjusted cost, and where that decline has existed for a period of at least six months, the decline is treated as an other-than-temporary impairment, without any subjective evaluation as to possible future recovery. For individual issues where the decline in value is less than 20% but the amount of the decline is considered significant, we will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other-than-temporary. In those instances, the Company also considers its intent and ability to hold investments until recovery or maturity. For any decline which is considered to be other-than-temporary, we recognize an impairment loss in the current period earnings as an investment loss. Declines which are considered to be temporary are recorded as a reduction in shareholders’ equity, net of related federal income tax credits.
this entire amount been considered other-than-temporary at December 31, 2008, investment losses would have increased by $.30 per share for the year, after tax. There would, however, have been no impact on total shareholders’ equity or book value per share since the decline in value of these securities was already recognized as a reduction to shareholders’ equity at December 31, 2008.
Amounts recoverable under the terms of reinsurance contracts comprise approximately 21% of total Company assets as of December 31, 2008. In order to be able to provide the high limits required by the Company’s fleet transportation company insureds, we share a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts. Some reinsurance contracts provide that a loss be shared among the Company and its reinsurers on a predetermined pro-rata basis (“quota-share”) while other contracts provide that the Company keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount (“excess of loss”). Some risks are covered by a combination of quota-share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by the Company’s insurance policies for fleet transportation liability and workers’ compensation, provide more variability in the estimation process than lines of business with lower coverage limits.
As with any receivable, credit risk exists in the recoverability of reinsurance. This is even more pronounced than in normal receivable situations since recoverable amounts are not generally due until the loss is settled which, in some cases, may be many years after the contract was written. If a reinsurer is unable, in the future, to meet its financial commitments under the terms of the contracts, the Company would be responsible for the reinsurer’s portion of the loss. The financial condition of each of the Company’s reinsurers is initially determined upon the execution of a given treaty and only reinsurers with the superior credit ratings available are utilized. However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period. Reviews of the current financial strength of each reinsurer are made continually and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company’s additional liability. Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit risk rather than a deficiency associated with the loss reserving process. See Notes D and L to the consolidated financial statements, for further discussion of reinsurance and concentrations of credit risk with respect to reinsurance recoverable.
The reserving process requires management to continuously monitor and evaluate the life cycle of claims based on the class of business and the nature of claims. As previously noted, our claims range from the very routine private passenger automobile “fender bender” to the highly complex and costly third party bodily injury claim involving large tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in the Company’s fleet transportation liability policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. Note C to the consolidated financial statements includes additional information relating to loss and loss adjustment expense reserve development.
Under reasonably possible scenarios, it is conceivable that the Company’s selected loss reserve estimates could be 10%, or more, redundant or deficient. As shown in the table on page 29, the majority of the Company’s reserves for losses and loss expenses, on either a gross or a net of reinsurance basis, relates to the fleet transportation product. Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for the Company’s large fleet excess product for policies subject to certain recent major reinsurance treaties (approximately $84.9 million, or approximately 27% of, carried direct reserves for fleet transportation).
The liability method is used in accounting for federal income taxes. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for deferred federal income tax was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. Net deferred tax liabilities reported at December 31, 2008 and 2007 consisted of (dollars in thousands):
Deferred tax assets at December 31, 2008, include approximately $15.6 million related to loss and loss expense reserves of which, $9.6 million relates to policy liability discounts required by the Internal Revenue Code which are perpetual in nature and, in the absence of the termination of business, will not reverse to a material degree in the foreseeable future. An additional $4.1 million relates to impairment adjustments made to investments, as required by accounting regulations. The sizable unrealized gains in the Company’s investment portfolios would allow for the recovery of this deferred tax at any time. Limited partnership investments represent $2.4 million of deferred tax assets. The balance of deferred tax assets, approximately $1.6 million, consists of various normal operating expense accruals and is not considered to be material. As a result of its analysis, management has determined that no valuation allowance is necessary at December 31, 2008.
To the extent inflation influences yields on investments, the Company is also affected. The Company’s short-term and fixed investment portfolios are structured in direct response to available interest rates over the yield curve. As available market interest rates fluctuate in response to the presence or absence of inflation, the yields on the Company’s investments are impacted. Further, as inflation affects current market rates of return, previously committed investments might increase or decline in value depending on the type and maturity of investment (see comments under Market Risk, following).
The Company operates solely within the property and casualty insurance industry and, accordingly, has significant invested assets which are exposed to various market risks. These market risks relate to interest rate fluctuations, equities market prices and, to a far lesser extent, foreign currency rate fluctuations. All of the Company’s invested assets, with the exception of investments in limited partnerships, are classified as available for sale and are listed as such in Note B to the consolidated financial statements.
market value of the Company’s equity positions at December 31, 2008 was $63.2 million or approximately 12% of invested assets. This market valuation includes $23.1 million of appreciation over the cost basis of the equity security investments. Funds invested in the equities market are not considered to be assets necessary for the Company to conduct its daily operations and, therefore, can be committed for extended periods of time. The long-term nature of the Company’s equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuations, is the primary focus.
A 10 percentage point increase or decrease in the loss factors actually utilized in the Company’s reserve determination at December 31, 2008 would increase or decrease gross loss reserves by approximately $17.2 million. On a net basis, a 10 percentage point increase in loss ratio would increase net loss reserves by approximately $7.8 million whereas a 10 percentage point decrease would decrease net loss reserves by approximately $9.4 million. Similarly, a 20 percentage point increase or decrease would increase or decrease gross loss reserves by approximately $34.3 million. On a net basis, a 20 percentage point increase in loss ratio would increase net loss reserves by approximately $15.5 million whereas a 20 percentage point decrease would decrease net loss reserves by approximately $20.4 million with the difference attributable to minimums and maximums included in the various reinsurance contracts.
The table below sets forth the amounts of the Company’s contractual obligations at December 31, 2008.
Borrowings are made under a line of credit with a current expiration of May, 2011.
Goodwill and Other Intangible Assets: Goodwill is not amortized. It is instead tested for impairment in accordance with Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets, at the reporting-unit level. Goodwill is tested annually (during the fourth quarter) or more often if events or circumstances, such as adverse changes in the business climate, indicate there may be impairment. Intangible assets determined to have indefinite lives are not amortized but instead are tested for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the fair value of the indefinite-lived intangible asset to its carrying amount. Other acquired intangible assets determined to have finite lives, such as customer relationships and employment agreements, are amortized over their estimated useful lives in a manner that best reflects the economic benefits of the intangible asset. In addition, impairment testing is performed on these amortizing intangible assets if impairment indicators are noted.
Reinsurance: Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other insurers have been reported as a reduction of premium earned. Amounts applicable to reinsurance ceded for unearned premium and claim loss reserves have been reported as reinsurance recoverable assets. Certain reinsurance contracts provide for additional or return premiums and commissions based upon profits or losses to the reinsurer over prescribed periods. Estimates of additional or return premiums and commissions are adjusted quarterly to recognize actual loss experience to date as well as projected loss experience applicable to the various contract periods. Estimates of reinstatement premiums on property reinsurance contracts covering catastrophic events are recorded concurrently with the related loss.
The Company accounts for foreign and domestic property reinsurance using the periodic method. Under the periodic method, premiums from foreign property reinsurance are recognized as revenue ratably over the contract term, and claims, including an estimate of claims incurred but not reported, are recognized as they occur.
Federal Income Taxes: A consolidated federal income tax return is filed by the Company and includes all wholly owned subsidiaries.
Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities based on enacted tax rates and laws. The deferred tax benefits of the deferred tax assets are recognized to the extent realization of such benefits is more likely than not. Deferred income tax expense or benefit generally represents the net change in deferred income tax assets and liabilities during the year. Current income tax expense represents the tax consequences of revenues and expenses currently taxable or deductible on various income tax returns for the year reported.
Earnings Per Share: Diluted earnings per share of common stock are based on the average number of shares of Class A and Class B common stock outstanding during the year, adjusted for the dilutive effect, if any, of options outstanding. Basic earnings per share are presented exclusive of the effect of options outstanding. See Note K - Earnings Per Share.
Note: Recovery in market value of an investment which has previously been adjusted for other-than-temporary impairment is treated as an unrealized gain until the investment is disposed of.
There is no primary or secondary market for the Company’s investments in limited partnerships and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. The Company has commitments to contribute an additional $2,500 to various limited partnerships as of December 31, 2008.
The Company has invested a total of $24,000 in three limited partnerships, with an aggregate estimated market value of $29,878 at December 31, 2008, that are managed by organizations in which two directors of the Company are executive officers, directors and owners. The Company’s ownership interest in these limited partnerships ranges from 3% to 24%. These limited partnerships added $28,502, net of fees, to investment losses in 2008, and $19,177 and $7,942, net of fees, to investment gains in 2007 and 2006, respectively. During 2008, 2007 and 2006, the Company has recorded management fees of $781, $765 and $604, respectively, and performance-based fees of $0, $4,902 and $1,587, respectively, to these organizations for management of these limited partnerships. The Company has been informed that the fee rates applied to its investments in these limited partnerships are the same as, or lower than, the fee rates charged to unaffiliated customers for similar investments.
The Company utilized the services of a broker-dealer firm of which a director of the Company is an executive officer and owner. This broker-dealer serves as agent for purchases and sales of securities and manages an equity securities portfolio and fixed maturity portfolio with market values of approximately $1,865 and $17,467, respectively, at December 31, 2008. The Company has been informed that commission and management rates charged by this broker-dealer to the Company are commensurate with rates charged to non-affiliated customers for similar investments. Total commissions and fees earned by the broker-dealer and affiliates on these transactions and for advice and consulting were approximately $171, $170 and $148 during 2008, 2007 and 2006, respectively.
Short-term investments at December 31, 2008 include $3,000 in foreign time certificates of deposit.
The Company’s limited partnerships include one significant investment accounted for using the equity method. This limited partnership investment’s value as of December 31, 2008 and 2007 was $18,761 and $44,716, respectively. At December 31, 2008, the Company’s estimated ownership interest in this limited partnership investment was less than 4%.
The Company’s share of earnings from this limited partnership investment was as follows for the years ended December 31:
Activity in the reserves for losses and loss expenses is summarized as follows. All amounts are shown net of reinsurance, unless otherwise indicated for the years ended December 31:
The Company has not changed its original estimate for the loss sustained as a result of the terrorist attacks of September 11, 2001. Therefore, there is no impact on the loss developments shown in the above table except for payments against the original established reserves. The Company has paid $11.1 million to date and carries a remaining reserve of $8.9 million at December 31, 2008.
Net losses and loss expenses incurred for 2008, 2007 and 2006 have been reduced by ceded reinsurance recoveries of approximately $53,398, $4,981 and $14,026, respectively. The increase in 2008 recoveries is a result of the Company having reached its annual aggregate deductible on one of its reinsurance treaties. Ceded reinsurance premiums and loss recoveries for catastrophe reinsurance contracts were not material.
Cash flows related to federal income taxes paid, net of refunds received, for 2008, 2007 and 2006 were $11,186, $14,502 and $16,097, respectively.
The Company maintains two stock option plans which are described below. Compensation cost charged against income for those plans was $0, $0, and $20, for 2008, 2007, and 2006, respectively.
Under the Employee Option Plan (the Employee Plan), which is shareholder approved, the Company has reserved 1,125,000 shares of Class B common stock for the granting of discounted and market value options to employees. Approximately 259,000 shares of Class B common stock are available for future grants. No options were granted to employees during the three year period ended December 31, 2008 and no options remained outstanding at December 31, 2008 and 2007. Additionally, there were no option exercises during 2008. During 2007 and 2006, all options were exercised at $20.60 per share. The total intrinsic value of options exercised during 2007 and 2006 was $722 and $1,684, respectively. No options were outstanding or exercised during 2008.
Cash received from option exercise under all share-based payment arrangements for the years ended December 31, 2007 and 2006 was $2,211, and 6,804, respectively. The federal tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $253 and $759, respectively, for the years ended December 31, 2007 and 2006. Under the terms of the Employee Plan, $253 and $589, respectively, of tax benefits realized were passed on to employees in the form of cash for the years ended December 31, 2007 and 2006.
During 2002 and 2001, the Company offered loans to certain employees for the sole purpose of purchasing the Company’s Class B common stock in the open market. Principal and interest totaling $2,199 and $2,228 relating to such loans was outstanding at December 31, 2008 and 2007, respectively. Loans carry interest rates ranging from 4.75% to 6%, payable annually. The underlying securities, with value in excess of the related debt, serve as collateral for these full-recourse loans, which must be repaid no later than 10 years from the date of issue. This loan program was terminated in 2002.
The Company evaluates performance and allocates resources based on past or expected results from insurance underwriting operations before income taxes. Underwriting gain or loss does not include net investment income or gains or losses on the Company’s investment portfolio. All investment-related revenues are managed at the corporate level. Underwriting gain or loss for the property and casualty insurance segment includes revenue and expense from the Company’s agency operations since the agency operations serve as a primary direct marketing facility for this segment. Management does not identify or allocate assets to reportable segments when evaluating segment performance and depreciation expense is not material for any of the reportable segments. The accounting policies of each reportable segment are the same as those described in the summary of significant accounting policies.
One customer of the property and casualty insurance segment represents approximately $13,773, $13,772 and $69,636 of the Company’s consolidated direct and assumed premium written in 2008, 2007 and 2006, respectively. An additional $99,589, $80,080 and $0 for 2008, 2007 and 2006, respectively, is placed with the Company by a non-affiliated broker on behalf of this same customer.
The amount of collateral required of an insured is determined by the financial condition of the insured, the type of obligations guaranteed by the Company, estimated reserves for incurred losses within the SIR or deductible hat have been reported to the insured or the Company, estimated incurred but not reported losses, and estimates for losses that are expected to occur, within the SIR or deductible, prior to the next collateral adjustment date. In general, the Company attempts to hold collateral equal to 100% of the ultimate losses that would be paid by or due the Company in the event of the insured’s default. Periodic audits are conducted by the Company to evaluate its exposure and the collateral required. If a deficiency in collateral is noted as the result of an audit, additional collateral is requested immediately. Because collateral amounts contain numerous estimates of the Company’s exposure, are adjusted only periodically and are sometimes adjusted based on the financial condition of the insured, the amount of collateral held by the Company at a given point in time may not be sufficient to fully reimburse the Company for all of its guarantees or amounts due in the event of an insured’s default. Further, the Company is not fully collateralized for the guarantees made for, or the deductible amounts that may be due from, the Company’s largest customer, and in the event of that customer’s default, such default may have a material adverse impact on the Company. The Company estimates its uncollateralized exposure related to this Fortune 500 company to be as much as 32% of shareholders’ equity at December 31, 2008.
In addition, the Company’s balance sheet includes paid and unpaid amounts recoverable from reinsurers under various agreements totaling $159,989 at December 31, 2008, as more fully discussed in Note D - Reinsurance. With minor exception, these recoverables are uncollateralized. The three largest estimated amounts due from individual reinsurers were $23,773, $18,631 and $18,083 at December 31, 2008. Included in the total recoverable amount are case basis and estimated IBNR losses of approximately $6,907 due from Converium Insurance (North America) Inc., which reported substantial reserve strengthening and/or impairment of assets in 2005 which have negatively affected their reported financial position. All amounts due from this reinsurer on paid claims as of December 31, 2008 are current and the Company has no information at this time to indicate that all obligations of this reinsurer will not be met.
The Company has $9,000 outstanding as of December 31, 2008 under the Company’s revolving line of credit at variable interest rates detailed below. No borrowings were outstanding against this line at December 31, 2007. The Company has $11,000 remaining unused under the revolving line of credit. The $9,000 of borrowings was used principally for treasury stock repurchases.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows for the year ended December 31:
In February 2007, the Financial Accounting Standards Board issued Statement No. 159, The Fair Value Option for Financial Assets and Liabilities - Including an Amendment of FASB Statement No. 115, to permit an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however the amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available-for-sale and trading securities. The fair value option permits all entities to choose to measure eligible items at fair value at specified election dates. The fair value option may be applied on an instrument-by-instrument basis, is irrevocable and is to be applied to entire instruments and not portions thereof. The Company did not elect the fair value option. SFAS No. 159 did not have a significant impact on the Company’s consolidated financial condition or results of operations.
Net income of the insurance subsidiaries, as determined in accordance with statutory accounting practices, was $19,064 $35,605 and $26,632 for 2008, 2007 and 2006, respectively. Consolidated statutory surplus for these subsidiaries was $315,529 and $360,965 at December 31, 2008 and 2007, respectively.