termination of the Plan, during 2001, the Insurance Company recognized a curtailment gain of approximately $1,109,000 resulting in a prepaid benefit cost of $1,454,694 as of December 31, 2001.
(3) The net loss and loss adjustment expense ratio is the net loss and loss adjustment expenses in relation to net premium earned.
(7) The ratio of net premiums written divided by ending statutory surplus.
(9) In 2005 the Company recorded a federal income tax benefit of $1,152,000 despite having pre-tax income of $7,930,000. The federal income tax benefit was due to the Company recognizing a $3,855,000 reduction in its deferred tax valuation allowance in 2005. See Note 5 to the consolidated financial statements, included elsewhere in this report, for further information regarding federal income taxes.
The increase in net premiums written is due to growth in direct premiums written of $3,545,000 discussed above offset by an increase in ceded premiums written of $537,000 during 2005.
The increase in loss and LAE of $3,659,000 is due primarily to the impact of reinsurance. Direct incurred losses and LAE, or the losses and LAE incurred by the Company before considering the impact of reinsurance,
The Company’s net loss and LAE ratio declined to 53.2% in 2005 compared to 62.4% in 2004 as a result of the quota share runoff, overall favorable loss experience during 2005 as compared to 2004 as well as redundant development on prior year reserves. As noted above, the Company’s net premium earned increased $8,589,000 due to the decline in earned premium ceded under the quota share agreement. While at the same time loss and LAE increased only $4,605,000 due to the decline in ceded loss and LAE under the quota share agreement.
For the personal segment the decline in the loss ratio is due to higher net premiums earned as a result of the quota share runoff, redundant development on prior year reserves and the fact that the Company’s 2004 net loss and LAE ratio was higher as a result of weather related losses related to a July 2004 severe thunderstorm that passed through the northeast section of Michigan. The redundant development was primarily in the homeowner and personal auto product lines. The homeowner’s line experienced redundant development of approximately $1,904,000 primarily in the accident years of 2004, 2003 and 2002 as a result of lower than expected losses on both incurred but not reported and existing case reserves as of December 31, 2004. The personal auto line experienced redundant development of approximately $426,000 primarily in the 2004 accident year.
Amortization of deferred policy acquisition costs increased $2,391,000 during 2005 due to the reduction in the quota share reinsurance ceding commission income component of deferred policy acquisition costs. The remaining increase of $705,000 is due to the increase in premium volume as compared to the prior year. Items
Gross investment income increased $286,000 from fixed maturities, $37,000 from equity securities and $50,000 from cash and cash equivalents. Gross investment income from the fixed maturity portfolio increased in 2005 to $1,659,000 compared to $1,373,000 in 2004. The rise in investment income from the fixed maturity portfolio is attributable to three forces. First, tax-equivalent book yield of the portfolio increased 10 basis points during 2005 to 4.51%. This was accomplished despite shortening the portfolio’s effective duration by over 1 year. Portfolio duration was reduced in an effort to remove some of the interest rate risk present and minimize unrealized losses to the portfolio brought on by an increase in market-wide interest rates. The Company took advantage of the attractive tax-equivalent yields available in the intermediate and long term portion of the tax exempt municipal sector which offset the otherwise adverse book yield impact of reducing duration. Second, reinvested cash flows from mortgage-backed security payments, maturities and corporate actions were redeployed into a higher yield environment, as short and intermediate yields rose substantially over the course of 2005. This rise in yields on the short end of the curve was directly attributable to monetary policy actions on the part of the Federal Reserve, as the Fed continued to increase its key overnight lending rate. These increases were in direct response to the continued strength of the U.S. economy and the inflationary pressures brought on by a ramp up in housing, energy and commodity prices. Third, the fixed maturity portfolio’s invested asset base increased approximately $4.46 million during 2005. This was the result of direct cash contributions to the portfolio as well as organic asset growth. This asset base growth increased the income generating capacity of the fixed maturity portfolio.
Gross investment income increased from the equity portfolio as a result of increased dividends received from mutual funds during 2005. Gross investment income on cash and cash equivalents increased during 2005 primarily from rising interest rates. The decline in investment expenses is attributable to lower internal costs related to managing the portfolio through increased utilization of the Company’s outside investment management consultants.
The Company reported net realized gains on investments of $609,000 and $277,000 for the years ended December 31, 2005 and 2004, respectively. The increase is due to more selling activity during 2005 compared to 2004. During 2005, the Company continued to shift its equity portfolio from common stocks to mutual funds
resulting in net realized gains from the sale of equity securities of $439,000 offset by realized losses of $100,000 related to two equity investments that the Company deemed to be other than temporarily impaired. During the year ended December 31, 2005 the Company focused on reducing the duration in the fixed maturity portfolio in order to temper the fluctuations in the market value of the portfolio. This resulted in net realized gains on the sale of fixed maturity securities of $269,000 during the year ended December 31, 2005.
Demutualization Expense. Demutualization expenses related to the Conversion in 2004 and amounted to $302,000 for the year ended December 31, 2004, and include the cost of engaging external accounting, actuarial, legal and other consultants to advise the Company in the demutualization process as well as the cost of printing and postage for communications with policyholders.
Net premiums earned for the year ended December 31, 2004 increased $9,097,000 or 50.3%. Approximately $6,024,000 of the increase is due to the decline in earned premium ceded to the reinsurer under the quota share reinsurance contract. Further contributing to the increase is approximately $3,406,000 from overall premium volume growth offset by a net increase of approximately $333,000 in earned premiums ceded under other reinsurance agreements.
The increase is driven primarily by a reduction in the ceding commission income component of deferred policy acquisition costs. Amortization of policy acquisition costs during the year ended December 31, 2004 and 2003 was $3,286,000 and $523,000, respectively, an increase of $2,763,000. The Insurance Company’s expense ratio, defined as policy acquisition and other underwriting expense as a percentage of net earned premiums, was 34.8% for the year ended December 31, 2004 compared to 38.1% for the same period in 2003. The decline in the expense ratio is due primarily to the increased net earned premiums as a result of the quota share contract runoff as well as continued efforts to limit the growth in other underwriting expenses.
Other Income, Net. Other income, net primarily includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income and expense items. Other income, net was approximately $386,000 in 2004 compared to $388,000 in 2003.
Cash flow provided by operations was $6,745,000 in 2005 compared to $6,953,000 in 2004 a decrease of $208,000. During the year ended December 31, 2005 as compared to 2004 net premiums collected increased $2,417,000 due to policy growth, net loss and LAE paid increased $3,413,000 while policy acquisition and other underwriting expenses paid increased $1,920,000. During the year ended December 31, 2005, net cash used under the quota share funds withheld account was $1,827,000 while during the same period in 2004 net cash used was $5,599,000, a change of $3,773,000. Cash paid for income taxes increased $2,008,000 due to an increase in taxable income during 2005 compared to 2004. Other cash provided by operational activities increased $943,000 during the year ended December 31, 2005 compared to 2004.
Cash flow used in investing activities was $15,266,000 and $10,432,000 during the years ended December 31, 2004 and 2003, respectively, an increase of $4,834,000. Net cash proceeds received from the issuance of common stock in the Conversion on October 15, 2004 amounted to $5,007,000. The majority of the net cash proceeds were placed into the Company’s fixed maturity investment portfolio.
The Holding Company has not paid and does not intend to pay dividends in the foreseeable future and cannot assure our stockholders that dividends will be paid in the future. The Holding Company’s principal source of cash available for payment of dividends is dividends from the Insurance Company. The annual future cash requirements of the Holding Company are not foreseen to be significant. They will include director fees and
In accordance with FASB Statement No. 109, Accounting for Income Taxes, we may recognize certain tax assets whose realization depends upon generating future taxable income. These tax assets can only be realized through the generation of future taxable income and thereby utilizing the net operating loss (NOL) and Alternative Minimum Tax (AMT) credit carry-forwards we have available. At December 31, 2005, the Company has a NOL carryforward of approximately $8,066,000 and an AMT credit carryforward of approximately $358,000. The AMT credit carryforward can be carried forward indefinitely. The NOL carryforward expires as follows:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Fremont Michigan InsuraCorp, Inc. and its subsidiary (the “Company”) at December 31, 2004, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
impairment, the Company, in addition to an investment’s market price history and its intent and ability to hold fixed maturity investments until maturity, considers the issuer’s operating results, financial condition and liquidity, its ability to access capital markets, credit rating trends, most current audit opinion, industry and securities markets conditions, and analyst expectations, in their totality to reach its conclusions. When a security in the Company’s investment portfolio has an unrealized loss in value that is deemed to be other than temporary, the Company reduces the book value of such security to its current market value, recognizing the decline as a realized loss in the statement of operations. Any future increases in the market value of investments written down are reflected as changes in unrealized gains as part of accumulated other comprehensive income within stockholders’ equity.
Additionally, the Company’s impairment evaluation and recognition for interests in mortgage-backed/asset-backed investments is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Under this guidance, impairment losses on investments must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. As a result of this re-evaluation process there were no impairment losses recorded during the years ended December 31, 2005, 2004 or 2003.
The Company presents other comprehensive income or loss as a component of stockholders’ equity on the consolidated statements of stockholders’ equity and comprehensive income. For the years ended December 31, 2005, 2004, and 2003 the unrealized gain or loss on investments included in other comprehensive income consisted of the following:
Property and equipment is recorded at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method. Estimated useful lives are: building-35 years, data processing equipment including software-3 to 5 years and furniture, fixtures and equipment-5 to 7 years. Maintenance, repairs and minor renewals are charged to expense as incurred. Depreciation expense was $141,664, $120,529 and $130,947 for the years ended December 31, 2005, 2004, and 2003, respectively. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Upon sale or retirement, the cost and related accumulated depreciation of assets disposed of are removed from the accounts; any resulting gain or loss is reflected in income.
Demutualization expenses include the cost of printing and postage for communications with policyholders and the cost of engaging external accounting, actuarial, legal and other consultants to advise the Company in the demutualization process.
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”). This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123. This standard becomes effective as of January 1, 2006 and applies to all awards granted, modified, cancelled or repurchased after that date as well as the unvested portion of prior awards. The adoption is not expected to have a material effect on the consolidated financial statements as the Company already values stock options issued based upon an option-pricing model and recognizes the fair value as an expense over the period in which the options vest.
The cost or amortized cost and estimated fair value of fixed maturities at December 31, 2005, by contractual maturity, are shown below. Expected maturities on certain corporate and mortgage-backed investments may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Net investment income for the years ended December 31, 2005, 2004 and 2003 is summarized as follows:
Sales of available-for-sale fixed maturities resulted in the following during the years ended December 31, 2005, 2004 and 2003:
During 2003, the Company engaged an investment management consultant for the fixed maturity portfolio. Under the guidelines provided to the investment management consultant the fixed maturity portfolio has experienced a rebalancing during 2005 and 2004. The focus of the Company’s rebalancing is to improve credit quality, liquidity and diversification within the portfolio, to create a more stable income stream and to enhance long-term total return. During 2005 and 2004, special attention was given to portfolio duration in order to reduce market value fluctuations in a rising interest rate environment. Despite the Company’s intent and ability to hold fixed maturity investments until maturity, proceeds from the sale of fixed maturity investments increased during 2005 as a result of rebalancing the portfolio.
The following tables show the estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual investments have been in a continuous unrealized loss position at December 31, 2005 and 2004.
At December 31, 2005, fixed maturities with a carrying value approximating $411,000 were on deposit with regulatory authorities, as required by law.
The fair values of available-for-sale fixed maturity and equity securities are based on quoted market prices, when available. If not available, fair values are based on values obtained from investment brokers.
The excess of loss program is the Company’s primary reinsurance coverage. For all lines of business the Company’s retention on any one risk in 2005 was $150,000 and in 2004 and 2003 the retention was $125,000.
There is an annual aggregate deductible feature in the amount of $400,000 that applied to the multi-line contract in 2004 and 2003.
The Company utilizes facultative reinsurance to provide additional underwriting capacity, to mitigate the effect of individual losses and to reduce net liability on individual risks. Coverage is determined on each individual risk. In 2005, the Company obtained coverage for commercial properties it insured in excess of $1,000,000. During 2005 the range of coverage was from $100,000 up to $3,925,000. In 2004, the Company obtained coverage for commercial properties it insured in excess of $2,500,000. During 2004 the range of coverage was from $500,000 up to $5,000,000. In 2003, the Company obtained coverage for properties it insured in excess of $500,000 on commercial risks and in excess of $1,000,000 on personal risks, recovery amounts were $4,500,000 on commercial risks and $1,000,000 on personal risks.
remains liable for the ceded amount of reserves for unpaid losses and loss adjustment expenses and ceded unearned premiums in the event the assuming insurance organizations are unable to meet their contractual obligations. As a result, the Company is subject to credit risk with respect to the obligations of its reinsurers. In order to minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors the economic characteristics of the reinsurers on an ongoing basis. All reinsurers except for one are rated A- or better by A. M. Best Company. The Company has one reinsurer with an A.M. Best rating of B++. The Company has not experienced a collectibility problem with any reinsurer.
The Company receives a ceding commission in conjunction with its reinsurance activities. These ceding commissions are offset against direct commission expense and were $124,274, $72,302 and $5,340,326 in 2005, 2004 and 2003, respectively. The decline in 2004 is due to the fact that the quota share agreement was placed into runoff on December 31, 2003.
The effect of reinsurance on premiums written and earned for the years ended December 31, 2005, 2004 and 2003, are as follows:
Actual federal income taxes vary from amounts computed by applying the current federal income tax rate of 34 percent to income before federal income taxes. For the years ended December 31, 2005, 2004 and 2003 the reasons for these differences and the tax effects thereof, are as follows:
are also subject to the Section 382 limitation however these credit carryforwards have no expiration and can be carried forward indefinitely. Based on the annual Section 382 limitation of the utilization of net operating loss carryforwards management has determined that approximately $3,098,000 of net operating loss carryforwards will not be realized and therefore a full valuation allowance will be maintained for the deferred tax asset associated with these amounts.
At December 31, 2005 and 2004, property and equipment consisted of the following:
prudent estimate than loss ratios based on the Company’s historical development patterns since 1997. The remaining redundant development of $278,000 came from the marine segment’s 2004 and 2003 accident years.
During 2003, the Company recognized an increase of approximately $1,100,000 in the liability for loss and loss adjustment expenses related to prior years as a result of strengthening its reserves. The adverse development in 2003, which approximated 25.1% of the net liability for loss and loss adjustment expenses as of the beginning of the year, is primarily attributable to variations from expected claim severity in the commercial line of business, specifically, commercial multiple peril for the 2000, 2001 and 2002 accident years. The variation from initial reserve estimates is attributable to several factors. First, the commercial multiple peril line includes several newer and growing product lines for which the Company has not had a robust history with respect to the nature of claims development, particularly with ‘longer-tail’ liability claims that take a long period of time to settle. Lack of a fully developed book of commercial multiple peril business has made our initial reserve estimates very difficult to predict. As such, the claim development has been more volatile and immature in the early stages of development. For many years, the Company’s core business consisted primarily of homeowners’ policies which are typically ‘shorter-tail’ claims that take a relatively short period of time to settle. Liability claims typically require more extended periods of investigation and at times protracted litigation before they are finally settled, and therefore tend to yield loss development and payment patterns that stretch over longer periods of time.
During 1998, 64 parties, including agents, directors, employees and other private investors purchased surplus notes aggregating $4,057,000 from the Company. During 2002, additional surplus notes aggregating $350,000 were purchased from the Company by its employees. These notes, referred to as Series A notes, paid an annual interest rate of 8.5 percent with principal and any accrued unpaid interest due on June 30, 2003.
The components of the accrued benefit cost and net periodic benefit cost are as follows:
The accrued benefit cost at December 31, 2005 and 2004, is included in accrued expenses and other liabilities in the accompanying balance sheets.
The Company uses a December 31 measurement date for its other postretirement plan. As this plan is not pre-funded, no contributions other than those necessary to cover benefit payments are anticipated. At December 31, 2005, the Company’s expected future benefit payments are as follows:
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to qualifying sponsors of retiree healthcare benefit plans. Based on the structure of the plan and the retiree population the Company has determined that the Act will not have a material impact on the postretirement benefit obligation. Therefore, the valuation of the unfunded postretirement benefit obligation and the determination of the net postretirement benefit cost included in these financial statements do not reflect the effects of the Act on the plan.
The Company has a defined contribution 401(k) plan covering substantially all employees meeting certain eligibility requirements. The Company matched 50% of employee contributions up to 4.5 percent of the employee’s salary in 2005 and up to 3.0 percent in 2004 and 2003. The Company may also make discretionary contributions to the Plan. Company contributions approximated $103,000 in 2005, $74,000 in 2004 and $69,000 in 2003.
The Company provides vacation and sick pay benefits for all full-time employees. After one year of employment, any earned and unused vacation (up to 30 days) is payable as a post employment benefit. Prior to December 31, 2003, any earned and unused sick time (up to 30 days) was payable as a post employment benefit. Effective December 31, 2003, the Company reduced the maximum amount of earned and unused sick time that an employee can accumulate from 30 days to 6 days. The Company has accrued a liability for these post employment benefits in the amounts of approximately $188,000 and $183,000 at December 31, 2005 and 2004, respectively.
As of December 31, 2005 and 2004, approximately $75,715,000 and $68,402,000, respectively, of consolidated assets represent assets of FIC that are subject to regulation and may not be transferred to FMIC in the form of dividends, loans or advances. Dividends paid by FIC are subject to limitations imposed by the Michigan Insurance Code (“Code”). Under the Code, FIC may pay dividends only from statutory earnings and capital and surplus. In addition, FIC may not declare an “extraordinary” dividend to its shareholders without the prior approval of the Michigan Office of Financial and Insurance Services (“OFIS”). An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of statutory capital and surplus as of December 31, of the preceding year or the statutory net income, excluding net realized investment gains, for the immediately preceding calendar year. Accordingly, FIC may pay dividends of approximately $2,599,000 in 2006 without prior approval. However, the OFIS has the authority to prohibit payment of any dividend.
note includes a 5 year balloon payment, which becomes due June 2010. During 2005 the agent earned $52,300 in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.
Non-employee directors of the Company also participated in the surplus note offerings and held surplus notes at December 31, 2005 and 2004, as disclosed in Note 9-Surplus Notes. For the years ending December 31, 2005, 2004 and 2003, non-employee directors holding surplus notes received directors’ fees of $54,900, $47,100 and $27,900, respectively.
The Company defines its operations as property and casualty insurance operations. The Company writes four major insurance lines exclusively in the State of Michigan: Personal Lines, Commercial Lines, Farm and Marine. The separate financial information of these four major insurance lines is consistent with the way results are regularly evaluated by management in deciding how to allocate resources and in assessing performance. All revenues are generated from external customers and the Company does not have a significant reliance on any single major customer.
Pursuant to the Plan, 5% of the outstanding shares of the Company have been reserved for future issuance in the form of newly-issued shares in satisfaction of awards under the Plan. If awards should expire, become unexercisable or be forfeited for any reason without having been exercised or without becoming vested in full, the shares of common stock subject to those awards would be available for the grant of additional awards. The total number of shares currently authorized in the Plan is 43,105 shares.
The compensation cost that has been charged against income for the year ended December 31, 2005 and the period from October 16, 2004 to December 31, 2004 was $37,391 and $7,916, respectively. The per share weighted-average fair value of options granted in 2005 and 2004 was $10.57 and $4.81, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2005 and 2004: dividend yield of 0%; expected volatility of 39.6%; risk-free interest rate of 4.34% in 2005 and 3.85% in 2004, and an expected life of 7 years.
An unaudited summary of the Company’s 2005 and 2004 quarterly performance is as follows: