The following table sets forth our selected historical consolidated financial information for the periods ended and as of the dates indicated. The selected consolidated statement of operations information for the years ended December 31, 2010, 2009 and 2008 and the selected consolidated balance sheet information as of December 31, 2010 and 2009 are derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected consolidated statement of operations information for the years ended December 31, 2007 and 2006 and the selected consolidated balance sheet information as of December 31, 2008, 2007 and 2006 are derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K.
We are a specialty provider of workers’ compensation insurance products and services. Through our subsidiaries, we seek to provide quality products and services that fit the needs of our insureds and clients and are dedicated to developing and maintaining a mutually beneficial long-term relationship with them. Historically, our workers’ compensation insurance coverage was offered to employers in California, New York, New Jersey, Arizona, Nevada and other states.
We did not achieve our overall business, financial and shareholder performance expectations for fiscal year 2010. Our net loss from continuing operations in 2010 was $43.9 million compared to $45.2 million in 2009. The major factors contributing to our net losses include:
unacceptable loss and loss adjustment and underwriting expenses given the lower in-force premium levels; and
the 2011 decision to withdraw from the New York/New Jersey market’
Our business is affected by the trends of the workers’ compensation insurance market. The workers’ compensation insurance market has historically fluctuated with periods of low premium rates and excess underwriting capacity resulting from increased competition, followed by periods of high premium rates and shortages of underwriting capacity resulting from decreased competition. Our revenues have historically been generated primarily in California and New York.
Net Premiums Earned. Direct premiums written include all direct premiums billed during a specified policy period. Assumed premiums written are premiums from third party companies or authorized state mandated pools. Net premiums written is the difference between direct and assumed premiums written and premiums ceded or paid to affiliate or third party reinsurers.
Net premiums earned are the elapsed portion of our net premiums written. At the end of each accounting period, (a) the portion of direct and assumed premiums that are not yet earned is included in unearned premiums and is realized in subsequent periods over the remaining terms of the policies; and (b) the portion of ceded premiums that are not earned is included in prepaid reinsurance premiums and is realized in subsequent periods over the remaining terms of the policies.
Severance and Other Charges. Severance and other charges represent infrequent expenses incurred that are not directly related to (1) our workers’ compensation business; or (2) the cost of being a public company. The expenses include the acceleration of future payments due under our operating leases, termination fees and other costs related to the restructuring of our facilities lease in Poughkeepsie, New York, the acceleration of the amortization of the debt issuance costs on our long-term debt obligations, and employee and former Co-Chief Executive Officer severance.
The results of CRM CA, CRM and Eimar are included in discontinued operations for all periods presented. CRM CA ceased providing administrative services to self-insured groups on December 31, 2010. As of September 8, 2008, we ceased to manage self-insured groups in New York or provide bill review and case management services for self-insured groups or third party clients.
We previously reported our results in four operating segments: primary insurance (Majestic Insurance), reinsurance (Twin Bridges), fee-based management services (CRM CA), and corporate and other (Majestic Capital, Majestic USA and Embarcadero). Effective January 1, 2010, we have reflected changes in segment reporting and no longer report multiple segments. The change from reporting four reportable segments to a single segment reflects our current business activities and organizational changes. The prior periods have been restated to conform to the current period presentation.
The changes in segment reporting include aggregating our primary insurance and reinsurance segments, Majestic Insurance and Twin Bridges, into a single “risk-bearing” segment in accordance with the framework established by segment reporting guidance. Twin Bridges only reinsures risk underwritten at Majestic Insurance, both use independent agents/brokers to produce business, and both Majestic Insurance and Twin Bridges, as insurance companies, are subject to insurance regulatory environments. Further, the operations of CRM CA have been reclassified as discontinued operations as described above in Discontinued Operations. Lastly, Majestic Capital, Majestic USA and Embarcadero have no revenues and are not viewed as a discrete operation for decision-making purposes and therefore are not a reportable segment.
We believe the most critical accounting policies relate to the reporting of reserves for losses and loss adjustment expenses, amounts recoverable from third party reinsurers, fixed-maturity securities, impairment of fixed-maturity securities, premiums receivable, deferred policy acquisition costs, goodwill, deferred income taxes, going concern, and contingencies relating to corporate litigation and regulatory matters. The following description of our critical accounting policies should be read in conjunction with the notes to our consolidated financial statements.
We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for losses and loss adjustment expenses represent the estimated cost of all reported and unreported losses and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Our reserves for loss and loss adjustment expenses are estimated using case-by-case valuations and various actuarial analyses. Additional information regarding our reserves for losses and loss adjustment expenses and our processes for establishing the reserves can be found in Item 1 under the headings “Business - Reserves for Losses and Loss Adjustment Expenses.”
Our loss reserves can also vary due to factors that include, but are not limited to, the following:
The predictive ability of loss development factors is dependent on consistent underwriting, claims handling, and inflation, among other factors, and predictable legislatively and judicially imposed legal requirements. If all things remain equal, losses incurred in 2010 should develop similarly to losses incurred in 2009 and prior years. Thus, if the net loss ratio, which is calculated by dividing the loss and loss adjustment expense by net premiums earned, for premiums written in year one is 94% we expect that the net loss ratio for premiums written in year 2 also would be 94%. However, due to the inherent uncertainty in the loss development factors, our actual liabilities may differ significantly from our original estimates.
We have limited historical experience in our excess insurance policy business and therefore we perform a ground-up analysis of loss emergence patterns of the insured. The expected ultimate impact of these excess policies is based upon actual experience of the insureds’ and industry excess of loss factors which vary by state and hazard group. Gross losses were developed to ultimate and the portion of the losses expected to exceed our retention with respect to each insured was calculated. We reevaluated the loss ratios at December 31, 2010 and recognized favorable development for that year ended. The favorable development relates primarily to California accident years 2004 and 2006 for which actual results have been better than industry excess of loss factors.
Reserve Sensitivities. Although many factors influence the actual cost of claims and the corresponding unpaid loss and loss adjustment expense estimates, we do not measure and estimate values for all of these variables individually because many of the factors that are known to impact the cost of claims cannot be measured directly. This is the case for the impact of economic inflation on claim costs and coverage interpretations. In most instances, we rely on historical experience or industry information to estimate values for the variables that are explicitly used in the unpaid loss and loss adjustment expense analysis. We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of future effects of these factors. It is important to note that actual claims costs will vary from our estimate of ultimate claim costs, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant time lags associated with the settlement of claims and the fact that not all events affecting future claim costs can be estimated.
Claim cost inflation can result from medical cost inflation, wage inflation and severity of injury. As discussed above, the actuarial methods employed include an amount for claim cost inflation based on historical experience with some adjustment in cases of legislative reforms. We assume that the historical effect of this factor, which is embedded in our experience and industry experience, is representative of future effects for claim inflation. To the extent that the historical factors and the actuarial methods utilized, are inadequate to recognize future inflationary trends, our unpaid loss and loss adjustment expense liabilities may be inadequate. The more recent accident years are subject to greater variability. If our estimate of future loss cost trends is three percentage points inadequate (e.g., if we estimate a 6% annual trend and the actual trend is 9%), our unpaid loss and loss adjustment expense liability would be inadequate by approximately $10.2 million on a pre-tax basis, or 3%, as of December 31, 2010. Under these assumptions, the inadequacy of approximately $10.2 million represents approximately 70% of total shareholders’ equity at December 31, 2010. The impact of any reserve deficiencies, or redundancies, on our reported results and future earnings is discussed below.
We review our reserves on a quarterly basis to determine whether they are consistent with our actual results. In the event of a discrepancy, we would seek to determine the causes (underwriting, claims, inflation, regulatory) and would adjust our reserves accordingly. In the event that our estimates of ultimate unpaid loss and loss adjustment expense liabilities prove to be greater or less than the ultimate liability, our earnings and financial position could be positively or negatively impacted. Earnings would be reduced by the amount of any deficiencies in the year(s) in which the claims are paid or the unpaid loss and loss adjustment expense liabilities are increased. For example, if we determined our unpaid loss and loss adjustment expense liability of $314.5 million as of December 31, 2010 to be 5% inadequate, we would experience a pre-tax reduction in earnings of approximately $15.7 million. The reduction could be realized in the year when the deficiency is identified. The deficiency would also impact our financial position because our statutory surplus would be reduced by an amount equivalent to the reduction in net income. Any deficiency is typically recognized in the unpaid loss and loss adjustment expense liability and, accordingly, it typically does not have a material effect on our liquidity because the claims have not been paid. Since the claims will typically be paid out over a multi-year period, we have generally been able to adjust our investments to match the anticipated future claim payments. Conversely, if our estimates of ultimate unpaid loss and loss adjustment expense liabilities prove to be redundant, our future earnings and financial position would be improved.
Approximately 60% of the discrepancy between the estimated statutory loss reserves of the CA DOI and our carried statutory loss reserves at December 31, 2010 is attributable to statutory loss reserves for business underwritten in California, where certain assumptions made by CA DOI resulted in higher estimated statutory loss reserves. These assumptions include: (1) a greater projected amount of development expected after eight years (the tail); and (2) a difference in the loss ratio used to approximate our statutory loss reserves - the CA DOI maintains that given the significant growth of premiums for the years 2007-2009, the loss ratio experienced will not be better than the industry loss ratio (as determined by the Workers; Compensation Insurance Rating Bureau of California - or WCIRB) for those accident years.
The inclusion of reported loss development of our California business in the establishment of statutory loss reserves for business underwritten in New York and New Jersey. The same case reserving philosophy is maintained nationwide under the direction of a claims executive with over twenty-five years of industry experience.
Amounts recoverable from reinsurers are estimated on an individual contract basis, in a manner consistent with the associated reserve for losses and loss adjustment expenses. Included in reinsurance recoverables are paid losses recoverable from reinsurers and prepaid reinsurance premiums to reinsurers. Such recoverables are reported net of any allowance for estimated uncollectible reinsurance recoverables. We evaluate and monitor the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, which themselves are subject to significant judgments and uncertainties described above under the heading “Reserve for Losses and Loss Adjustment Expenses.” Changes in the estimates and assumptions underlying the calculation of our loss reserves may have an impact on the balance of our reinsurance recoverables. In general, an increase in our underlying loss reserves on claims subject to reinsurance should increase our reinsurance recoverables. The amount of the increase would depend on a number of considerations including, but not limited to, the terms and attachment points of our reinsurance contracts and the incurred amount on various claims subject to reinsurance. Changes in reinsurance recoverables are recorded in the period in which the estimate is revised. We assessed the collectability of our year-end receivables and believe all amounts are collectible based on currently available information. Therefore, at December 31, 2010 and 2009, we had no reserve for uncollectible reinsurance recoverables.
Our fixed-maturity securities are classified as available-for-sale and are reported at their estimated fair value based on quoted market prices or dealer quotes. Unrealized investment gains and losses on securities are recorded as a separate component of other comprehensive income or loss, net of deferred income taxes to the extent that the underlying investment is held by a taxable entity. Realized gains and losses are determined on the basis of specific identification.
our intent and ability not to sell the security for a sufficient time period for it to recover its value;
the credit quality and any downgrades of the security by a rating agency; and
Premiums receivable include premium amounts due from policyholders. Premiums receivable are recorded net of any allowance for estimated uncollectible premiums. The allowance for doubtful accounts represents management’s best estimate of uncollectible premiums included in premiums receivable.
Goodwill represents the excess of the cost of acquiring a business enterprise over the fair value of the net assets acquired. Goodwill is not amortized but is tested for impairment at least annually, or more frequently if events or circumstances, such as adverse changes in the business climate, indicate that there may be justification for conducting an interim test. We perform our annual goodwill impairment testing in the fourth quarter of each year.
As a result of our 2009 annual impairment testing, we determined that the goodwill recorded in the primary insurance segment was fully impaired. Consequently, we recorded goodwill impairment charges of $2.7 million in the year ended December 31, 2009. Factors that occurred in the fourth quarter of 2009 that resulted in the full impairment of our goodwill include: (1) the downgrade of Majestic’s AM Best rating from “A-“ to “B++” with negative implications, (2) a reduction in Majestic’s projected premiums written due to the AM Best downgrade, (3) an increase in Majestic’s losses and loss adjustment expenses, and (4) the unexpected net operating loss in the fourth quarter of 2009 - which resulted from adverse development of Majestic Insurance’s current and prior year losses and loss adjustment expenses.
The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At and for the year ended December 31, 2010, we had a consolidated retained deficit of $59.8 million and a loss from continuing operations before taxes of $44.9 million. We have generated net losses for the last three years and expect to continue to generate net losses for the foreseeable future. In addition, based on the following, management has determined that there is substantial doubt surrounding our ability to meet our obligations as they become due in the foreseeable future and continue as a going concern:
The inability to fund the ongoing expenses of Majestic Capital, Majestic USA and Embarcadero (the Holding Companies) and discontinued operations for the foreseeable future. The Holding Companies and discontinued operations generate no revenue but are obligated to pay the following expenses: debt service, public company costs, other general corporate overhead and costs to defend and settle pending litigation and regulatory actions, including the proposed settlement involving the New York self-insured groups discussed in “Item 3 - Legal Proceedings - Pending Litigation - Litigation Involving the New York Self-Insured Groups>” Historically, these expenses were funded by (1) the operations of our fee-based subsidiaries when they were continuing operations; (2) BMA approved dividends/return of capital from Twin Bridges.; (3) the CA DOI approved Form D filing by which certain of Majestic USA’s other general corporate overhead was allocated to/funded by Majestic Insurance; and (4) dividends from Majestic Insurance. Given the termination of our fee-based business and the regulatory aforementioned restrictions placed on Majestic Insurance and Twin Bridges, there may be limited/ no funds available to cover the ongoing expenses of the Holding Companies and discontinued operations.
Based on the above factors, we may be forced to seek relief through a filing under the U.S. Bankruptcy Code or Bermuda Companies Act (bankruptcy filing). A bankruptcy filing would result in the violation of one or more legal and financial covenants of our debt and other contractual obligations as described in “Item 7 - Liquidity and Capital Resources - Capital Resource - Event of Default Under Bankruptcy, Insolvency or Liquidation.” Our auditors have issued a disclaimer of opinion with respect to our financial statements of and for the year ended December 31, 2010.
The underwriting expense ratio is calculated by dividing underwriting and acquisition expenses by net premiums earned.
The GAAP combined ratio is the sum of the loss and loss adjustment expense ratio and the underwriting expense ratio. The GAAP combined ratio is a key measurement of profitability traditionally used in the property-casualty insurance business.
In December 2009, A.M. Best downgraded Majestic Insurance’s financial strength rating to “B++” from “A-“, which impeded its ability to renew existing insured that require an A- rating and to attract new business in an already highly competitive market. Our total in-force premiums were 45% lower and our in-force policy count was 53% lower in 2010 as compared to 2009.
A reduction in B++ premiums underwritten in New York and New Jersey resulting from the continuing effects of underwriting actions taken on our business underwritten in these states, and difficulties we continue to face in this marketplace, as a result of regulatory restrictions with regard to pricing. This contributed to the 48% decrease in in-force premiums and a 47% decrease of in-force policy count year over year for the New York/New Jersey markets.
Assumed Premiums Written. Assumed premiums written increased $4.4 million, or 202%, to $6.6 million in 2010, from $2.2 million in 2009. This increase resulted primarily from premiums assumed under the April 1, 2010 assumed share agreement more fully discussed in “Item 1. Business - Assumed Quota Share Reinsurance.”
The decrease in direct premiums written in 2010 as compared to 2009 as discussed above; and
Effective July 1, 2010, we did not renew our ceded quota share agreements as more fully discussed in “Item 1 - Business - Ceded Quota Share Reinsurance.” This resulted in lower ceded premiums written during the third and fourth quarters of 2010 as compared to the same period last year.
Net premiums earned decreased $41.4 million, or 34% to $80.5 million in 2009 from $121.9 million in 2008. Of this decrease, $33.7 million was attributable to primary insurance policy business and $7.7 million was attributable to excess insurance policy business. Our net earned premiums were lower in 2009 compared to 2008 primarily due to (1) higher ceded earned premiums due to the full year effect of ceded quota share agreements year over year; (2) lower direct premiums written in 2009 compared to 2008; and (3) estimated reinstatement premiums of $3.1 million on Majestic’s excess of loss treaty that expired June 30, 2009.
The remaining decrease in our investment income in 2010 compared to 2009 is attributable to lower net realized gains on our available-for-sale investment portfolio and lower net investment income in 2010 compared to 2009. In 2009, in order to maximize the after-tax yield of our investment portfolio, we restructured our investment portfolio. We realized net gains on the liquidation of our tax-exempt municipal bonds and reinvested the proceeds in taxable fixed-maturity securities. Lower investment yields on our new taxable securities and a decrease in the average amount of invested assets held resulted in lower investment income in 2010 compared to 2009. The investment yield on our available-for-sale portfolio was 3.5% in 2010 compared to 3.6% in 2009.
Investment income increased $2.4 million, or 17%, to $16.3 million in 2009 from $13.9 million in 2008. Of this increase, $3.3 million was attributable to an increase in net realized gains on the restructuring of our available-for-sale investment portfolio in 2009. While the average amount of invested assets increased year over year, a significant decrease in the investments yield on new investments resulted in lower investment income in 2009 compared to 2008. The investment yield on our available-for-sale portfolio was 3.6% in 2009 compared to 4.5% in 2008
The components of our investment income in 2010, 2009 and 2008 are as follows:
The components of our 2010, 2009 and 2008 loss and loss adjustment expense ratio (LAE) are as follows:
(1) The current year ULAE ratio is impacted by ceded quota share agreements and the related ceding commission income as follows: (a) the ceded quota share agreement in place between July 1, 2008 and June 30, 2009 included 6% ceding commission income to cover ULAE, resulting in a lower current year ULAE ratio; and (b) the ceded quota share agreements in place between July 1, 2009 and June 30, 2010 had no ceding commission income to cover ULAE, resulting in a higher current year ULAE ratio.
As a result of changes in estimates of insured events in prior years, we experienced unfavorable development of $2.8 million in 2010, where $3.4 million of unfavorable development in our primary insurance business was offset by $0.6 million of favorable development in our excess insurance business. Our primary insurance business experienced unfavorable development in California accident years 2007 and 2008 where incurred and paid losses developed above actuarial projections. Our excess insurance business had favorable development on policies underwritten in California, where losses have not emerged above the self-insured retention, which was offset by unfavorable development of policies underwritten in New York.
As a result of changes in estimates of insured events of prior years, we experienced unfavorable development of $5.8 million for the year ended December 31, 2009 where $7.9 million of unfavorable development it our primary insurance business was offset by $2.1 million of favorable development in our excess insurance business. Our primary insurance business experienced unfavorable development as a result of loss cost trends in California and New Jersey, predominantly in accident year 2008. Our excess insurance business had favorable development where accident years 2008 and 2006 continue to develop better than industry excess of loss factors initially projected.
Lower broker commissions, premium taxes and other policy issuance costs related to the year-over-year reduction in our direct premiums written;
A $1.6 million decrease in uncollectible premiums primarily resulting from underwriting actions taken in New York and New Jersey beginning in 2009; and
A decrease in other operational expenses that resulted from various cost cutting measures instituted in 2010.
Underwriting and acquisition expenses decreased by $3.7 million, or 9%, to $36.4 million in 2009 from $40.1 million in 2008. The factors contributing to this decrease were:
A $3.6 million increase in our ceding commission income due to the full year effect of our ceded quota share agreements;
A decrease in allocated general corporate overhead expenses in 2009 compared to 2008. In 2009, allocated general corporate overhead expenses were reduced as a result of a $3.0 million dividend paid from Majestic Insurance to its parent company Majestic USA. In 2008, no parent company dividends were paid; therefore, there was no reduction to allocated general corporate overhead expenses for that year ended.
Our underwriting expense ratio in 2009 was 45% compared to 33% in 2008. The increase in our expense ratio is primarily attributable to the year-over-year reduction in our net earned premiums.
The reallocation of personnel and other resources from Majestic USA to our insurance company operations in 2010;
A $0.4 million benefit recognized in 2010 related to the early termination of an escrow agreement to cover indemnification claims with respect to Majestic Insurance’s pre-acquisition reserves for losses and loss adjustment expenses.
General and administrative expenses increased $4.4 million, or 66%, to $11.1 million in 2009 from $6.7 million in 2008. The factors contributing to this increase were:
An increase in the general corporate overhead expenses retained by Majestic USA in 2009 compared to 2008 as described above in Underwriting and Acquisition Expenses.
Severance and Other Charges. Severance and other charges increased $7.6 million, or 139% to $13.1 million in 2010 from $5.5 million in 2009. The increase was attributable the following charges incurred in 2010 compared the recognition of severance expense related to our former Co-Chief Executive Officer during 2009:
An $9.1 million charge which represents the remaining future obligations due under operating leases for (1) our integrated policy administration system, and (2) furniture and fixtures in our Poughkeepsie, New York office space. Our 2010 operating results triggered a violation of the lease covenant whereby a material adverse change in our financial condition would cause the remaining payments due under both leases to become immediately due;
A $1.1 million acceleration of the amortization of our prepaid debt issuance costs associated with our Junior Debt. As a result of the uncertainty surrounding our ability to continue as a going concern and possible default on the Junior Debt due to possible future bankruptcy proceedings, we determined there is no future value to this asset at December 31, 2010;
Loss from Continuing Operations before Income Taxes. Loss from continuing operations was $44.9 million in 2010 compared to $41.7 million in 2009. The $3.2 million, or 8% increase in our loss from continuing operations is primarily attributable severance and other charges and lower investment income, offset by the reduction in general and administrative expenses and the net effect of lower premium volume in our insurance operations.
Tax (Benefit) Provision from Continuing Operations. We recorded an income tax benefit of $1.0 million in 2010, a $3.5 million tax provision in 2009, and an income tax benefit of $2.4 million in 2008. We carried a full valuation allowance on our net deferred tax assets at both December 31, 2010 and 2009.
The 2010 income tax benefit included a deferred tax benefit of $14.5 million and a $13.5 million non-cash valuation allowance with respect to our net deferred tax asset. In 2010, we reduced our valuation allowance to offset the tax effect of increases in net unrealized gains of our investment portfolio, which resulted in our recognition of an income tax benefit for that year ended.
Discontinued Operations. The results of CRM CA, CRM and Eimar are included in discontinued operations for all periods presented. We recorded losses from discontinued operations of $4.7 million in 2010, $1.7 million in 2009 and $2.8 million in 2008.
Included in our 2010 loss from discontinued operations related to CRM and Eimar is $4.6 million related to the proposed settlement of litigation involving the New York self-insured groups. All years presented include legal defense costs related to our proposed settlement and other regulatory proceedings and pending litigation. The proposed settlement involving the New York self-insured groups and our other regulatory proceedings and pending litigation are described in “Part I. Item 3 - Legal Proceedings” and “Part II. Item 8 - Financial Statements - Note 21. Contingencies.”
Net Loss. Consolidated net loss was $48.6 million in 2010 compared to $46.8 million in 2009. The $1.8 million, or 4% increase in our consolidated net loss is attributable to an increase in severance and other charges and the proposed settlement costs of the New York self-insured group litigation recorded in discontinued operations offset by an increase in our operating results and a decrease in our non-cash full valuation allowance on our deferred tax asset due to appreciation of our available-for-sale investment portfolio.
Consolidated net loss was $46.8 million in 2009 compared to $1.5 million in 2008. The $45.3 million increase in our consolidated net loss is attributable to decreases in the results of our insurance operations in 2009 compared to 2008, the establishment of a non-cash full valuation allowance on our net deferred tax asset in 2009, and severance expense for our former co-chief executive officers and the impairment of goodwill in 2009 compared to 2008.
We invest the funds made available by our insurance subsidiaries’ capital and the net cash flows from operations, with the objective to earn income and realize gains on investments. As of December 31, 2010, our investment portfolio, which includes available-for-sale investments, short-term investments, investment in unconsolidated subsidiary, cash and cash equivalents, receivables for investments sold and payables for investments purchased totaled $287.8 million, compared to $332.7 million at December 31, 2009.
Our investment portfolio is invested in publicly traded, investment grade fixed-income securities with an average credit rating of AA, as rated by the independent investment rating service Standard and Poor’s (S&P). The following table shows the ratings distribution of our available-for-sale portfolio by S&P rating as a percentage of total market value as of the date indicated:
We regularly evaluate our investment portfolio to identify other-than-temporary impairments in the fair values of the securities held in our investment portfolio. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be other-than-temporary, such investment is written-down to its fair value. If we do not intend or are unable to hold the other-than-temporarily impaired investment, the amount written-down is recorded in earnings as a realized loss on investments. If we do not have the intent to sell the security, and it is more likely than not that it will not be required to be sold before recovery of its cost basis, we separate the other-than-temporary impairment into two components - credit losses and losses attributed to other factors. The amount of the other-than-temporary impairment related to credit losses is recorded in earnings as a realized loss on investments. The amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive loss.
We consider various factors in determining whether a decline in the fair value of a security is other-than-temporary, including:
Majestic Insurance maintains a portfolio of invested assets with varying maturities and a substantial amount of short-term investments to provide adequate cash for the payment of claims. At December 31, 2010, short-term investments and fixed maturity investments held by Majestic Insurance and maturing within two years amounted to $59.2 million. The invested assets are expected to provide adequate short-term sources of liquidity until the conservation and rehabilitation plan is effective.
$15.0 million to the CA DOI with respect to unpaid loss and loss adjustment expenses;
The letters of credit for the benefit of the CA DOI with respect to unpaid losses and loss adjustment expenses, United States Department of Labor, the San Francisco office space, the integrated policy administration system and excess workers’ compensation insurance policy are secured by a combination of cash and the investments that are on deposit with Comerica. The letter of credit for the benefit of the CA DOI with respect to its unaffiliated reinsurer is secured by a third party letter of credit of $21.0 million with its unaffiliated reinsurer.
Sources of Liquidity - Non-Insurance Subsidiaries. Historically, the expenses of Majestic Capital, Majestic USA and Embarcadero (the Holding Companies) were funded by the operations of our fee-based subsidiaries, dividends and return of capital from Twin Bridges as approved by the BMA (BMA) and amounts due to Majestic USA from Majestic Insurance under an intercompany administrative services agreement and dividends from Majestic Insurance.
In the near term, there will be limited or no funds available to cover the ongoing expenses of the Holding Companies or to pay amounts related to the costs to defend and settle pending litigation and regulatory actions, including the proposed settlement involving the New York self-insured groups. Our pending litigation and regulatory actions are further described in “Item 3 - Legal Proceedings.” The inability to fund the expenses of the Holding Companies is attributable to:
our exit from the fee-based management services business in New York and California;
Twin Bridges’ inability to pay any dividends/distribute capital without prior approval of the BMA as discussed in “Item 1 - Regulation - Bermuda Insurance Regulation - Dividend Limitations.”
Based on the above factors, we may be forced to seek relief through a filing under the U.S. Bankruptcy Code or Bermuda Companies Act.
Net cash from operating activities decreased by $34.6 million in 2010 compared to 2009 and by $52.5 million in 2009 compared to 2008. Our operating cash flows continued to be negatively impacted in all years presented due to our net operating losses and decreased both due to a reduction in net premiums collected and an increase in net claims’ paid.
Net cash provided by investing activities decreased by $10.9 million in 2010 compared to 2009. The decrease in cash from 2010 to 2009 was primarily due to the net purchases of available-for-sale investments following the restructuring of our investment portfolio. Net cash from investment activities increased by $76.8 million in 2009 compared to 2008. The increase in cash was in part due to certain of the proceeds from maturities and sales of our available-for-sale investments that were not reinvested until 2010.
Our insurance subsidiaries require cash and liquid investments to pay claims and expenses. Historically, the amount of capital in our insurance subsidiaries influences how much premium we can write.
The amount of capital in our insurance and reinsurance subsidiaries is maintained relative to standardized capital adequacy measures. In the United States and Bermuda, insurers and reinsurers are required to maintain certain minimum levels of capital and risk-based capital, the calculation of which includes numerous factors specified by the respective insurance regulatory authorities and the related insurance regulations. Factors that affect capital requirements generally include premium volume, the extent and nature of loss and loss expense reserves, the type and form of insurance and reinsurance business underwritten and the availability of reinsurance protection on terms that are acceptable to us.
Previously Announced and Subsequent Termination of Bayside Amalgamation Agreement. On September 21, 2010, Majestic Capital entered into an amalgamation agreement with Bayside. For additional information on the amalgamation, see “Item 8 - Note 1 - Previously Announced Bayside Amalgation.” The amalgamation was expected to close during the first quarter of 2011, however, the agreement was terminated by Bayside due to a material deterioration of our surplus and the failure to satisfy certain closing conditions, including the inability to secure regulatory approval and a failure to satisfy other closing conditions.
Upon a court declared bankruptcy of Embarcadero, principal and unpaid interest and related administrative costs become immediately due and payable. Principal and accrued interest payable on the Senior Debt is approximately $8.1 million at December 31, 2010.
Facilities Lease - Poughkeepsie, New York - We lease office space in Poughkeepsie, New York for our east coast. Upon an adjudication of bankruptcy of Majestic USA, the landlord may (1) terminate the lease upon five days written notice to Majestic USA; or (2) continue to enforce the terms of the lease whereby all unpaid rental amounts under the lease, including current and outstanding additional rent shall become immediately due and payable. Future remaining payments due under the Poughkeepsie, New York facilities lease, which expires December 2022, are approximately $14.8 million at December 31, 2010.
This amount excludes the remaining amounts due under the furniture and fixtures leases of $1.1 million as these amounts are included in other liabilities on the consolidated balance sheet.
We have audited the accompanying consolidated balance sheets of Majestic Capital, Ltd. as of December 31, 2010 and 2009, and the related statements of operations and comprehensive loss, shareholders' equity, and cash flows for the years then ended. Our audit also included the supplemental schedules listed in the Index at Item 15. These financial statements and supplemental schedules are the responsibility of the Company's management. Our responsibility is to report on these financial statements and supplemental schedules based on our audits.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As shown in the financial statements, the Company has incurred losses of $44.8 million and $41.6 million for the years ended December 31, 2010 and 2009, respectively. These losses have significantly weakened the Company's financial position and its ability to fund its operations and, at December 31, 2010, the Company's accumulated deficit is $59.8 million. As further discussed in Notes 1 and 24, the following events have limited the sources of cash available to the Company: (1) termination of the Company’s previously announced merger with a third party; (2) the conservation and rehabilitation of Majestic Insurance Company, the Company’s principal operating subsidiary, by the California Department of Insurance; and (3) the restrictions of the Bermuda Monetary Authority on Twin Bridges, the Company’s Bermuda reinsurance subsidiary. Furthermore, as discussed in Note 4, the Company is in violation of covenants governing certain of its contractual obligations. As discussed in Note 1, based on the above factors, the Company may be forced to seek relief through a filing under the U.S. Bankruptcy Code or Bermuda Companies Act (bankruptcy filing). A bankruptcy filing would result in the violation of one or more legal and financial covenants of the Company’s debt and other contractual obligations. All of these matters raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.
Because of the possible material effects on the financial statements and supplemental schedules referred to above of the matters described in the preceding paragraph, we are unable to, and do not, express an opinion on these financial statements and supplemental schedules as of and for the year ended December 31, 2010.
March 17, 2009, except for Notes 3 and 5, as to which the date is April 21, 2011
On May 5, 2010, CRM Holdings, Ltd. held its 2010 Annual General Meeting of Shareholders, at which the shareholders voted on and approved changing the name of CRM Holdings, Ltd. to Majestic Capital, Ltd. (Majestic Capital or the Company). In addition, the name of CRM USA Holdings Inc. was changed to Majestic USA Capital, Inc.
At the Company’s 2010 Annual General Meeting of Shareholders, the Company’s shareholders authorized the Board of Directors, in its discretion, to effect a reverse share split of the Company’s common and Class B shares within a range of 1-for-5 shares to 1-for-10 shares, at any time prior to November 5, 2010. On November 2, 2010, the Company’s Board of Directors implemented a 1-for-10 reverse share split, effective at the close of business on November 4, 2010 as more fully described in Note 5. Unless otherwise stated, the information in the accompanying financial statements gives effect to the reverse share split. As a result, references to outstanding shares, per share information and amalgamation consideration have been adjusted for the split.
Majestic USA has one principal subsidiary, Embarcadero Insurance Holdings, Inc. (Embarcadero). Embarcadero has one principal operating subsidiary, Majestic Insurance Company (Majestic Insurance), and has one dormant subsidiary, Great Western Insurance Services, Inc. (Great Western).
In this report, the term “the Company,” refers to Majestic Capital and its subsidiaries on a consolidated basis, unless otherwise indicated or unless the context otherwise requires.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At and for the year ended December 31, 2010, the Company had a consolidated retained deficit of $59.8 million and a loss from continuing operations before taxes of $44.9 million. The Company has generated net losses for the last three years and expects to continue to generate net losses for the foreseeable future. In addition to the Company’s ongoing operating losses, management considered the following factors in arriving at its conclusion that there is substantial doubt surrounding the Company’s ability to meet its obligations as they become due in the foreseeable future and continue as a going concern:
The termination of the Company’s previously announced merger with Bayside as discussed under the heading Termination of the Bayside Amalgamation Agreement in Note 24. The Company will not be able to benefit from the financial condition, reputation and regulatory and rating agency standing of Lancer, an affiliated insurance company of Bayside;
Junior Subordinated Debt Obligation (Junior Debt) - upon commencement of a voluntary bankruptcy, insolvency or liquidation of Majestic USA or its guarantor, Majestic Capital; or upon court appointment of a receiver to wind up or liquidate Majestic USA’s or Majestic Capital’s affairs due to the court’s decree under bankruptcy or insolvency law, principal and unpaid interest, including any deferred interest on the Junior Debt and related administrative costs become immediately due and payable. Principal of $36.1 million and accrued interest of $4.2 million, including deferred interest payable is included in long-term debt and other liabilities, respectively, in our consolidated balance sheet at December 31, 2010.
Senior Debt Obligation (Senior Debt) - upon a court declared bankruptcy of Embarcadero, principal and unpaid interest and related administrative costs become immediately due and payable. Principal of $8.0 million and accrued interest payable of $0.1 million is included in long-term debt and other liabilities, respectively, in our consolidated balance sheet at December 31, 2010.
The completion of the amalgamation is subject to various conditions, including among others (i) obtaining the approval of the Company’s shareholders, (ii) receipt of insurance regulatory approvals, (iii) adoption of certain amendments to the governing documents of the Company’s Trust Preferred Securities, and (iv) modification of the Company’s lease of office space in Poughkeepsie, New York on terms that are acceptable to Bayside. The Company has made customary representations, warranties and covenants in the amalgamation agreement, including agreements restricting the Company’s operations in certain respects pending the completion of the amalgamation.
Certain prior year amounts have been reclassified to conform to the basis of presentation used in 2010.
The Company’s fixed-maturity securities are classified as available-for-sale and are reported at their estimated fair value based on quoted market prices or dealer quotes. Unrealized investment gains and losses on these securities are recorded as a separate component of accumulated other comprehensive income, net of deferred income taxes to the extent the underlying investment is held in a taxable entity.
Investment income is recognized when earned. For the purposes of determining realized gains and losses, the cost of securities sold is based on specific identification as of the trade date.
Certain investments have been pledged as security under certain credit facilities, as more fully described in Note 13.
Certain short-term investments have been pledged as security under certain credit facilities, as more fully described in Note 13.
Accounts receivable consist primarily of guarantee fund assessments from policyholders and other services receivable from the self-insured groups formerly managed by CRM CA, CRM and Eimar. Accounts receivable are carried at face value less any allowance for doubtful accounts. The allowance for doubtful accounts represents the Company’s best estimate of uncollectible amounts included in accounts receivable and amounted to $0.4 million and $0.1 million at December 31, 2010 and 2009, respectively.
The estimate of a reporting unit’s fair value may be based on one or a combination of approaches including (1) the ratio of market value to book value for the unit’s peer companies, and (2) the sales prices of acquired peer companies relative to their trading stock market values. Other key inputs, judgments and assumptions in order to determine the estimated fair value of the reporting unit include projected earnings, current book value, regulatory rating of the reporting unit, the level of economic capital required to support the mix of business, long-term growth rates, and projections of new and renewal business.
Fixed assets are tested for potential impairment (1) whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable; and (2) when there is a change in the estimated useful life of fixed assets. Changes in the useful lives of our fixed assets for the year ended December 31, 2010 are described in Note 10.
These estimates are also subject to the effects of trends in loss severity and frequency and other trends such as fluctuations in inflation, prevailing economic, social and judicial trends, legislative changes and internal and third party claims handling procedures. There also may be a significant delay between the occurrence of the insured event and the time the claim is actually closed. Accordingly, the ultimate settlement of losses and related loss adjustment expenses may vary significantly from the estimates included in the Company’s consolidated financial statements. These estimates are reviewed regularly and are adjusted as experience develops or new information becomes known. Any such adjustments are included in income in the period in which they become known.
A portion of the Company’s premiums are written on an adjustable basis, and premiums from those policies can be adjusted retrospectively in accordance with the actual loss experience of the policyholders’ claims arising during the policy term. These retrospective premium adjustments are periodically made to the net premiums earned to reflect the changes in the estimation of the policyholders’ ultimate losses as more information becomes available over time.
Reinsurance accounting is followed for ceded and assumed transactions when the risk transfer provisions of applicable accounting standards have been met. To meet risk transfer requirements, a reinsurance contract must transfer insurance risk, consisting of both underwriting and timing risk, and bear a reasonable possibility of a significant loss to the reinsurer. Management has evaluated its reinsurance agreements and has determined that significant insurance risk is transferred to the reinsurers and that the Company’s reinsurance contracts are short-duration prospective contracts.
Earned but unbilled premiums include estimated future audit premiums and are subject to changes in payrolls due to growth, economic conditions and seasonality. The estimates are continually reviewed and adjusted as experience develops or new information becomes known. Any such adjustments are included in current operations. At the end of the policy terms, payroll-based premium audits are performed to determine earned premiums for that policy year and the premiums are adjusted accordingly.
Advertising costs, including selling and marketing expenses, are expensed as incurred. Advertising costs totaling $0.3 million, $0.5 million and $0.4 million were included in general and administrative expenses for the years ended December 31, 2010, 2009 and 2008, respectively.
Majestic USA is a sponsor of and has a variable interest in CRM USA Holdings Trust I (the Trust). The Trust was established for the sole purpose of issuing capital and common securities. On November 14, 2006, the Trust issued $35.0 million of Trust capital securities and $1.1 million of Trust common securities and invested the proceeds in junior subordinated debt obligations (Junior Debt) issued by Majestic USA in the aggregate principal amount of $36.1 million. The Junior Debt is the sole asset of the Trust. The capital and common securities of the Trust, representing the undivided beneficial ownership interests in the assets of the Trust, have no stated maturity and must be redeemed upon maturity of the Junior Debt securities. The Trust is required to make quarterly distributions on the capital and common securities at a fixed annual rate of 8.65% until December 15, 2011 and after such date at a fixed spread of 3.65% above 3-month London Interbank Offer Rate per annum. The common securities are held by Majestic USA and represent 100% of the issued and outstanding common securities of the Trust. They are reflected as investment in unconsolidated subsidiary in the Company’s consolidated balance sheets. The Company deemed its investment in unconsolidated subsidiary to be fully impaired at December 31, 2010 and recorded a $1.1 million charge in investment income in the consolidated statement of operations under the heading Investment in Unconsolidated Subsidiary in Note 6.
The Company accounts for share-based compensation plans using the fair value accounting method. The fair value method requires compensation cost to be measured based on the fair value of the equity instrument at the grant or award date. Share-based compensation is recognized over the vesting period of the grant or award.
The Company previously reported its results in four operating segments: primary insurance (Majestic Insurance), reinsurance (Twin Bridges), fee-based management services (CRM CA), and corporate and other (Majestic Capital, Majestic USA and Embarcadero). Effective January 1, 2010, the Company has reflected changes in segment reporting and no longer reports multiple segments. The change from reporting four reportable segments to a single segment reflects the Company’s current business activities and organizational changes.
The changes in segment reporting aggregate our primary insurance and reinsurance segments, Majestic Insurance and Twin Bridges, into a single “risk-bearing” segment in accordance with the framework established by segment reporting guidance. Twin Bridges only reinsures risk underwritten at Majestic Insurance, both use independent agents/brokers to produce business, and both Majestic Insurance and Twin Bridges, as insurance companies, are subject to insurance regulatory environments. Further, the operations of CRM CA have been reclassified as discontinued operations as more fully described in Note 3. Lastly, Majestic Capital, Majestic USA and Embarcadero have no revenues and are not viewed as a discrete operation for decision-making purposes and therefore are not a reportable segment. The prior years presented have been restated to conform to the current year presentation.
In June 2009, the FASB issued revised guidance on the accounting for variable interest entities. The revised guidance, which is now part of ASC 810, Consolidations, amends the consolidation rules applicable to a variable interest entity (VIE). Under the revised guidance, a company would consolidate a VIE as the primary beneficiary when a company has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Ongoing reassessment of whether a company is the primary beneficiary of a VIE is required. The new guidance replaces the quantitative-based approach previously required for determining which company, if any, has a controlling financial interest in a VIE. The Company adopted the revised guidance on January 1, 2010 and the adoption had no effect on the Company’s financial condition or results of operations.
In October 2010, the FASB issued updated guidance to address the diversity in practice for the accounting for costs associated with acquiring or renewing insurance contracts. This guidance, which is now part of ASC 944, Financial Services - Insurance, modifies the definition of acquisition costs to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. If application of this guidance would result in the capitalization of acquisition costs that had not previously been capitalized by a reporting entity, the entity may elect not to capitalize those costs. The updated guidance is effective for periods ending after December 15, 2011. The Company is currently evaluating the potential impact, if any, of the adoption of this guidance on its financial condition and results of operations.
In January 2010, the FASB issued new guidance for fair value measurements and disclosures. The new guidance, which is now part of ASC 820, Fair Value Measurements and Disclosures, clarifies existing disclosure requirements regarding the level of disaggregation and inputs and valuation techniques and provides new disclosure requirements regarding disclosures about, among other things, transfers in and out of levels 1 and 2 of the fair value hierarchy and details of the activity in level 3 of the fair value hierarchy. The new guidance is effective for fiscal years beginning after December 15, 2009 for the levels 1 and 2 disclosures and for fiscal years beginning after December 15, 2010 for level 3 disclosures. The levels 1 and 2 disclosure requirements were applied prospectively to the Company’s fair value disclosure effective with the first quarter of 2010 and the level 3 disclosure will be applied prospectively to the Company’s fair value disclosure subsequent to the effective date.
The results of CRM CA, CRM and Eimar are included in discontinued operations for all periods presented.
CRM CA has ceased providing administrative services to its last self-insured group under management on December 31, 2010. Consequently, the Company closed down its California fee-based operations and CRM CA is reported as a discontinued operation in the consolidated statements of operations for all periods presented. Income from discontinued operations before income taxes related to CRM CA was $0.0 million, $0.9 million and $1.0 million in 2010, 2009 and 2008, respectively.
The administration of the claims for the New York self-insured groups, formerly managed by CRM NY, was transferred to third party administrators appointed by the New York Workers’ Compensation Board, and in accordance with the terms of a settlement agreement entered into between CRM and the New York Workers’ Compensation Board, CRM surrendered its third-party administrator’s license in New York on September 8, 2008. The surrender of CRM’s administrator’s license prohibits CRM from actively engaging in this business in New York. Consequently, the Company will not derive any revenues from fee-based management services in New York currently or in the future and does not expect to incur any significant ongoing operating expenses, except for legal defense costs.
The following table presents the components of severance and other charges:
At December 31, 2010, the Company believes that it is in violation of one of its PAS lease covenants whereby a material adverse change to the Company’s financial condition would trigger the remaining payments under the PAS lease agreement to become immediately due. Accordingly, the Company recorded a charge of $8.9 million for the year ended December 31, 2010. This charge is comprised of (1) an $8.0 million charge which represents an approximation of the original encumbrance capital costs paid by the lessor, including penalties due as stipulated by the PAS lease; (2) a $0.2 million write off of other assets related to a security deposit which would be required to be returned to lessor; and (3) a $0.7 million write off of prepaid expenses for information technology charges related to the policy administration system which more than likely will have no future value to the Company. The $8.0 million of future obligations due under the PAS lease agreement is included in other liabilities in the consolidated balance sheet at December 31, 2010.
During 2010, the Company restructured the lease for its Poughkeepsie office space and entered into a lease amendment and license agreement, effective September 1, 2010. Pursuant to the amendment and agreement, the Company eliminated certain office space subject to a license to occupy the eliminated office space through at least December 31, 2011. In exchange, the Company paid $1.75 million to the landlord that consisted of a $1.4 million termination fee and the assumption of $0.35 million of leasehold improvements for the eliminated office space. The Company also agreed to forgive a $0.7 million receivable related to certain tax credits due to the Company from the landlord under the terms of the pre-amended lease.
In 2008, the Company entered into agreements to lease furniture and fixtures (F&F) for its office space in Poughkeepsie, New York and San Francisco, California. The F&F lease agreements contains various administrative, reporting, legal and financial covenants. At December 31, 2010, the Company believes it is in violation of one of its F&F lease covenants whereby a material adverse change to the Company’s financial condition would cause the remaining payments under the F&F lease agreements to become immediately due. Accordingly, the Company recorded a charge of $1.1 million for the year ended December 31, 2010 which represents the remaining future obligations due under the F&F lease agreements. The $1.1 million of future obligations due under the F&F lease agreements are included in other liabilities in the consolidated balance sheet at December 31, 2010.
During 2010, the Company reduced its workforce by approximately 21% or 42 employees, the majority of which were located in Poughkeepsie, New York. This reduction reflects the decrease in premium levels experienced by the Company’s insurance subsidiaries and is designed to better align the Company’s workforce to current business levels, properly manage the Company’s expenses, and support the Company’s business strategy going forward. A pre-tax charge of $0.5 million relating to the cost of severance and related costs was recorded for the year ended December 31, 2010. Unpaid employee severance of $0.1 million is included in other liabilities at December 31, 2010. There was no unpaid employee severance at December 31, 2009.
On March 13, 2009, Daniel G. Hickey Jr., resigned as the Company’s Chief Executive Officer, Chairman of the Board, and as a director and officer of the Company’s subsidiaries. The Company entered into a separation agreement with Mr. Hickey under which the Company (1) agreed to make cash payments of $3.3 million over the next three years; (2) immediately vested and distributed 46 thousand pre-reverse split shares of restricted stock; and (3) agreed to pay medical and life insurance benefits for up to three years. The separation agreement prohibits Mr. Hickey from competing with the Company in the California self-insured group market until March 13, 2012 and from soliciting employees and customers through March 13, 2011. In conjunction with Mr. Hickey’s separation agreement, the Company recorded $3.8 million of severance expense in the first quarter of 2009.
Due to the Company’s decreased presence in the self-insured group market and the current economic and regulatory environment, the Company determined that there is not a significant ongoing economic benefit related to Mr. Hickey’s and Martin D. Rakoff’s non-compete/non-solicitation covenants. Mr. Rakoff was the Company’s former Co-Chief Executive Officer and Deputy Chairman of the Board who resigned December 19, 2006. Previously, the Company recognized severance expense for Mr. Rakoff over the term of his non-compete/non-solicitation covenant, which expired December 2010. The Company accelerated the recognition of Mr. Rakoff’s severance expense and recorded the $1.5 million of remaining severance payments in the first quarter of 2009.
Unpaid severance related to our Co-Chief Executive Officers of $0.3 million and $4.3 million is included in other liabilities at December 31, 2010 and 2009, respectively.
The amortized cost and estimated fair value of the Company’s available-for-sale investments at December 31, 2010 by contractual maturity are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The Company regularly evaluates its available-for-sale fixed-income securities to determine whether impairment represents other-than-temporary declines in the fair value of the investments. Criteria considered during this process includes but is not limited to:
the Company’s intent not to sell and the likelihood it would not be required to sell the security before it recovers its value;
Part of the evaluation of whether particular securities are other-than-temporarily impaired involves assessing whether the Company has both the intent and ability to continue not to sell securities in an unrealized loss position until recovery. Significant changes in these factors could result in a charge to net earnings for impairment losses.
The sources of investment income from continuing operations were as follows:
Level 2 - Valuation based on quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, etc.) or can be corroborated by observable market data. Financial assets utilizing Level 2 inputs include: U.S. government and agency securities; non-U.S. government obligations; corporate and municipal bonds; asset-backed securities and mortgage-backed securities.
Fair value guidance requires disclosure of fair value information about other financial instruments for which it is practicable to estimate such fair value and excludes certain insurance related financial assets and liabilities. Estimates of the fair value of these financial instruments at December 31, 2010 are as follows:
The 2006 acquisition of Embarcadero resulted in the establishment of goodwill of $2.7 million. The Company performed its annual impairment testing of goodwill in the fourth quarter of 2009 and determined that its goodwill was impaired. Consequently, the Company recorded impairment charges of $2.7 million in the year ended December 31, 2009. Factors that occurred in the fourth quarter of 2009 that resulted in the full impairment of goodwill include: (1) the downgrade of Majestic Insurance’s AM Best rating from A- to B++ with negative implications, (2) a reduction in Majestic Insurance’s projected premiums written due to the AM Best downgrade, (3) an increase in Majestic Insurance’s losses and loss adjustment expenses, and (4) the unexpected net operating loss in the fourth quarter of 2009, which resulted from adverse development of Majestic Insurance’s current and prior year losses and loss adjustment expenses.
The Company’s information technology other intangible asset represents the prepaid costs for the outsourcing of its entity wide information technology function. The cost of the information technology other intangible asset is amortized over its contractual life. Should the Company renew or extend the term of the contract, costs incurred would be amortized over the term of the renewal or extension contract.
The cost of the information technology other intangible asset was being amortized over its useful contractual life which terminates in October 2012. As a result of the uncertainty surrounding the Company’s ability to continue as a going concern described under the heading Going Concern in Note 1, management has adjusted the useful life of its information technology other intangible asset to terminate December 31, 2011. The amount of additional amortization of the Company’s information technology other intangible assets recognized in the fourth quarter of 2010 was immaterial to the Company’s results of operations. Amortization expense for the years ended December 31, 2010, 2009 and 2008 was $0.2 million, $0.2 million and $0.1 million, respectively. Amortization expense for other intangible assets is estimated to be $0.3 million in 2011.
Fixed assets are stated at cost less accumulated depreciation and amortization. Fixed assets are summarized as follows:
As a result of (1) the lease amendment and license agreement related to our Poughkeepsie, New York office facilities described under the heading Facilities Lease Amendment in Note 4; and (2) the uncertainty surrounding the Company’s ability to continue as a going concern described under the heading Going Concern in Note 1, management has adjusted the useful life of its fixed assets in the year ended December 31, 2010. Accordingly, the Company recorded additional depreciation and amortization of fixed assets of $0.1 million in the fourth quarter of 2010.
As a result of changes in estimates of insured events in prior years, the Company experienced unfavorable development of $2.8 million for the year ended December 31, 2010, where $3.4 million of unfavorable development in its primary insurance business was offset by $0.6 million of favorable development in its excess insurance business.
The Company’s primary insurance business experienced unfavorable development in California accident years 2007 and 2008 where incurred and paid losses developed above actuarial projections. The Company’s excess insurance business had favorable development on policies underwritten in California, where losses have not emerged above the self-insured retention, which was offset by unfavorable development of policies underwritten in New York.
For primary insurance policies underwritten in California, for which the Company has a significant amount of historical claims data, management estimates future liabilities by using actuarially acceptable methods based upon historical development patterns. These methods look at historical paid and reported claim counts and average costs of incurred losses, average case reserves, claim closing rates, counts and average values of unpaid losses, as well as variations of such techniques. For other jurisdictions for which the Company does not have extensive historical claims data, management relies heavily on industry loss development factors in combination with price, rating bureau loss cost estimates by class code, and exposure information. Estimates of ultimate claims liability for each accident year are derived using such techniques.
For the most current accident year, the Company also uses a loss ratio method that starts with a projected loss ratio for each line of business, estimated from the prior accident year, adjusted for projected wage inflation, loss cost inflation, and pricing adjustments. This adjusted loss ratio is applied to the earned premium for the current accident year to derive the ultimate estimated claims liability. These estimates are reviewed quarterly and are adjusted throughout the current year whenever there is enough overall evidence that one or more of the assumptions used have changed such as to materially impact the total estimated ultimate liability for claims reported on the Company’s consolidated balance sheet. Additional factors that influence incurred losses and loss adjustment expenses for a given period include the number of exposures covered in the current year, trends in the frequency and severity of claims, and changes in the cost of adjusting claims.
The Company established loss reserves at December 31, 2010 based upon its current best estimate of loss and loss adjustment expenses. Loss reserves do not represent an exact calculation of liability, but instead represent management’s best estimates, generally utilizing actuarial expertise and projection techniques, at a given accounting date. Reserves for losses and loss adjustment expenses are estimates and are inherently uncertain; they do not and cannot represent an exact measure of liability. Loss reserve estimates are reviewed regularly and are adjusted as experience develops or new information becomes known. Such adjustments are included in the period in which they become known.
Primary insurance policies are issued through independent brokers to selected businesses. Coverage under these policies attaches typically at the first dollar of loss or in excess of policy deductibles. Excess insurance policies are issued through independent and related party brokers to self-insured groups or individual self-insured entities. Coverage under these policies attaches in excess of the group’s or individual’s self-insured retention, which range from $500 thousand to $1 million.
The Company purchases excess of loss, quota share and facultative reinsurance from third party reinsurers to reduce its maximum potential loss on individual risks and to protect against possible catastrophes. Reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is fully obligated to indemnify the ceding company to the extent of the coverage ceded.
Majestic Insurance has a secured letter of credit facility with Comerica Bank (“Comerica Credit Facility”), whereby Majestic Insurance is able to draw secured letters of credit in an amount equal to the funds posted by Majestic Insurance. The Comerica Credit Facility has a limit of $75.0 million and may be secured by cash, investments or a combination thereof. Majestic Insurance pays a fee of 0.30% to 0.50% of the principal amount of each letter of credit issued.
At December 31, 2010, Majestic Insurance had the following letters of credit outstanding under the Comerica Credit Facility:
$15.5 million to the United States Department of Labor with respect to USL&H policies;
$8.0 million for lease obligations related to its integrated policy administration software; and
The letters of credit for the benefit of the CA DOI with respect to unpaid losses and loss adjustment expenses, the United States Department of Labor, the San Francisco office space, the integrated policy administration system and special excess workers’ compensation policy were secured by a combination of cash and the investments that are on deposit. The letter of credit for the benefit of the CA DOI with respect to unauthorized reinsurers was secured by a third party letter of credit of $21.0 million with an unaffiliated reinsurer. There were no amounts drawn against the letters of credit at December 31, 2010 and 2009.
In connection with the financing of the acquisition of Embarcadero on November 14, 2006, Majestic USA issued $36.1 million of Junior Debt in exchange for $35.0 million in aggregate proceeds from the sale of Trust capital securities and $1.1 million of Trust common securities. The Junior Debt matures December 15, 2036 at which time the entire principal is due and bears interest at an annual fixed rate of 8.65% until December 15, 2011. After such date, the interest rate will adjust quarterly at a fixed spread of 3.65% above 3-month LIBOR per annum. The payments of all amounts due on the Junior Debt are guaranteed by the Company. This guarantee will remain in place until the full redemption of the Junior Debt.
As of December 31, 2010, the Company’s long-term debt is as follows:
The components of loss from continuing operations before income taxes were as follows:
The significant components of the consolidated (benefit) provision for income taxes were as follows:
The income tax (benefit) provision from continuing operations differs from the amount computed by applying the U.S. Federal income tax rate of 35% to loss before income taxes as a result of the following:
Based on the accounting guidance, the Company’s assumptions are limited to business strategies which it can control. Given these limitations, the Company concluded that estimated future taxable income and certain tax planning strategies do not constitute sufficient positive evidence to conclude that it is more likely than not that the net deferred tax assets would be realizable in the foreseeable future. Consequently, the Company continues to carry a net deferred tax valuation allowance of $32.4 million at December 31, 2010, an increase of $15.3 million from its net deferred tax valuation allowance of $17.1 million at December 31, 2009.
Majestic USA and its subsidiaries file federal income tax returns and income tax returns in various state jurisdictions in the United States. At December 31, 2010, Majestic USA had $32.1 million and $15.7 million of federal net operating loss carryforwards which expire in 2030 and 2029, respectively. Tax years 2006 through 2009 and 2005 through 2009 are subject to examination by federal and state tax authorities, respectively. Tax years 2006 and 2007 are currently being examined by the Internal Revenue Service (“IRS”). It is possible that the IRS audit may result in additional payment.
In accordance with its accounting policy, the Company recognizes interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes. The Company did not incur any income tax related interest income, interest expense or penalties for the years December 31, 2010, 2009 and 2008.
Holders of common shares are entitled to one vote per share, subject to a mechanism in the Company’s bye-laws whereby the maximum voting rights of any one shareholder or group of shareholders is limited to 9.9%.
Holders of Class B shares have the same rights and privileges as holders of common shares, except they have no general right to vote. The Class B shares are exchangeable into common shares at any time, provided that certain voting percentage limits are not breached or adverse tax consequences to the Company do not result.
The Company leases office space, office equipment and its integrated policy administration system under various operating lease agreements. Some of the office space leases contain rent adjustment provisions to compensate the lessor for increases in operating costs. Leasehold improvements related to these operating leases are amortized over the shorter of their estimated useful lives or the noncancellable lease term. Rent expense from continuing operations under these operating leases was approximately $4.8 million, $3.5 million and $3.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.
At December 31, 2010, the Company is in violation of certain lease covenants on its policy administration system and furniture and fixtures lease and has recorded a charge for future obligations due under these lease agreements as described under the headings Policy Administration System Operating Lease and Acceleration of Related Expenses and Other Facilities Charges in Note 4. While the Company continues to make payments under these agreements, the remaining amounts due under these agreements are included in other liabilities in the consolidated balance sheet at December 31, 2010 and therefore are not included in the minimum future payments under operating leases table below.
Total minimum future payments under the operating leases are as follows (in thousands):
The Company believes it was in compliance with its remaining operating lease covenants at December 31, 2010, however, there is uncertainty surrounding the Company’s ability to continue as a going concern and possible default on its operating lease obligations in the future due to possible bankruptcy proceedings as described under the heading Going Concern in Note 1.
Following is a summary of non-vested shares as of December 31, 2010 and changes during the year:
Currently, the Company pays Hickey-Finn broker fees for primary insurance business placed with Majestic Insurance. In addition, the Company purchases certain bonds and liability coverage from Hickey-Finn. Amounts related to these transactions are not material to the consolidated financial statements.
the Company will turn over to the State of New York $4.1 million the Company has not yet paid under severance agreements with its former co-chief executive officers;
the Company will commute, on an undiscounted basis, our loss reserves currently held on excess insurance policies it issued to four of the self-insured groups previously managed by CRM;
the Company will forego its rights to disclaim coverage and/or impose penalties for late notice for certain claims arising under certain excess insurance policies it issued to the self-insured groups previously managed by CRM; and
the Company will adjust the attachment points and increase policy limits on certain aggregate insurance polices it issued to certain self-insured groups previously managed by CRM.
If completed, the proposed settlement would resolve the claims by the State of New York and certain lawsuits that are described below.
New York State Office of the Attorney General Investigation. In March 2008, CRM was advised that the New York State Office of the Attorney General (NY Attorney General) had commenced an investigation of CRM and had issued a subpoena for documents related to CRM’s administration of the Healthcare Industry Trust of New York (HITNY). Subsequent NY Attorney General inquiries and requests for documents indicated a focus on the Company’s initial public offering in December 2005, and in August 2009, the Company was advised that the NY Attorney General would seek testimony of six current or former directors and officers of the Company and CRM. Thereafter, in December 2009, the Company received a “Notice of Imminent Enforcement Action” from the NY Attorney General, in which the NY Attorney General informed the Company that the NY Attorney General was intending to file civil claims against the Company, certain of its subsidiaries and certain directors and officers to seek redress of allegedly unlawful practices unless an acceptable settlement could be reached. The NY Attorney General alleged that the Company and the other named parties engaged in fraudulent practices in connection with CRM’s administration and marketing of workers’ compensation group self-insurance trusts in New York and in connection with the Company’s initial public offering completed in December 2005. These practices are alleged to have violated New York’s Executive Law and Martin Act, and the NY Attorney General informed the Company that it would seek injunctive relief, restitution, damages, penalties and costs with respect thereto. During recent settlement negotiations, the NY Attorney General advised the Company that any such action commenced may allege criminal actions or inaction. For information regarding the proposed settlement of this matter, please see above under the heading “- Proposed Settlement of Litigation Involving New York Self-Insured Groups.”
FS Kids LLC, et al. v. Compensation Risk Managers, LLC. On November 24, 2008, FS Kids, LLC, Mask Foods, Inc., Valu Home Centers, Inc., KBLM Foods, Inc., KDJB Foods, Inc., Gaige & Son Grocery, Inc., TJ’s Market, Inc., BB&T Supermarkets Inc., BNR-Larson, LLC, and Gift Express of New York, Inc., all of which were former members of the Wholesale Retail Workers’ Compensation Trust of New York (WRWCTNY), on their own behalf and on behalf of all others similarly situated, sued CRM in New York Supreme Court, Erie County. On August 26, 2009, the plaintiffs filed an amended complaint seeking class action certification and alleging that CRM: (1) breached its contract with WRWCTNY; (2) breached its duty of good faith and fair dealing owed to WRWCTNY; (3) breached its fiduciary duties owed to WRWCTNY; (4) was negligent in administering WRWCTNY; (5) engaged in deceptive business practices; (6) was unjustly enriched; and (7) should indemnify the plaintiffs for any assessments that they may incur. The plaintiffs are seeking damages arising from (a) the plaintiffs’ joint and several liability for the deficit of WRWCTNY and (b) any unpaid claims of the plaintiffs’ injured employees.
70 Sheldon Inc., et al. v. Compensation Risk Managers, LLC. On August 20, 2009, 70 Sheldon, Inc., Advance Relocation Storage, Inc., All County Bus, LLC, Alpha Services of Westchester, Inc., A. T. & A. Trucking Corp., B. Pariso Transport, Inc., Carmen M. Pariso, Inc., Covered Wagon Train, Inc., Exclusive Ambulette Service, Inc. Ficel Transport, Inc., North Shore Ambulance and Oxygen Service, Inc., Rivlab Transportation Corp., Woodland Leasing Co., Inc., all of which were former members of the Transportation Industry Workers’ Compensation Trust (the Transportation Trust), on their own behalf and on behalf of all others similarly situated, sued CRM in New York State Supreme Court, Erie County. The lawsuit seeks class action certification and alleges that CRM: (1) breached its contract with the Transportation Trust; (2) breached its duty of good faith and fair dealing owed to the Transportation Trust; (3) breached its fiduciary duties owed to the Transportation Trust; (4) was negligent in administering the Transportation Trust; (5) engaged in deceptive business practices; (6) was unjustly enriched; and (7) should indemnify the plaintiffs for any assessments that they may incur. The plaintiffs are seeking damages (a) arising from the plaintiffs’ joint and several liability for the deficit of the Transportation Trust, (b) from any unpaid claims of the plaintiffs’ injured employees, (c) from potentially being liable for the costs of liquidation charged or to be charged by the WCB, and (d) from fees paid by the plaintiffs and the Transportation Trust to CRM pursuant the service agreement between CRM and the Transportation Trust. On October 20, 2009, CRM filed a motion to dismiss the plaintiffs’ complaint. In April 2010, CRM submitted an application to the Panel seeking to coordinate pretrial proceedings and on February 23, 2011, the Panel issued an order that this action would be one of the Coordinated Lawsuits. An initial conference was held on April 18, 2011. Pursuant to that conference, an order will be circulated whereby within thirty days of the order, HITNY plaintiff will circulate its proposed third amended complaint and the parties will then either consent to the service of same or require motion practice which will be scheduled at a later date. In the interim, all discovery proceedings and pending motions are presently stayed. For information regarding the proposed settlement of this lawsuit, please see above under the heading “- Proposed Settlement of Litigation Involving New York Self-Insured Groups.”
Healthcare Industry Trust of New York, et al. v. Compensation Risk Managers, LLC, et al. On November 2, 2009, HITNY and 89 of its former members filed a lawsuit in New York State Supreme Court, Albany County against CRM, CRM USA Holdings, CRM Holdings, Majestic Insurance Company, Embarcadero, Twin Bridges, Eimar, and certain current and former directors and officers of CRM Holdings. The plaintiffs also named HITNY’s former actuaries, auditors, trustees and brokers as defendants in the lawsuit.
Plaintiffs are seeking damages from the defendants’ alleged failure to carry out their respective contractual, common law and statutory obligations to the plaintiffs to provide third-party administration and insurance services to HITNY. As against CRM, its affiliated entities and directors and officers, the lawsuit alleges that: (1) CRM breached its contract with HITNY; (2) CRM breached its duty of good faith and fair dealing owed to HITNY; (3) CRM breached its fiduciary duties owed to HITNY; (4) CRM engaged in common law fraud during its administration of HITNY; (5) CRM, its affiliated entities and directors and officers converted the assets of HITNY’s members for personal use; (6) CRM, its affiliated entities and directors and officers were unjustly enriched; (7) CRM negligently misrepresented information relative to HITNY; (8) CRM committed fraud in the inducement with respect to plaintiffs’ decision to join HITNY; (9) CRM and its directors and officers engaged in deceptive business practices; (10) CRM, its affiliated entities and directors and officers are alter egos of each other and should be liable for the debts, judgments and liabilities of each other; and (11) CRM, certain of its affiliated entities, a current director and a former officer committed a civil conspiracy in violation of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §1962(c) (RICO).
The plaintiffs are seeking damages (a) arising from the plaintiffs’ joint and several liability for the deficit of HITNY, (b) from any unpaid claims of the plaintiffs’ injured employees, (c) from potentially being liable for other costs to be charged by the WCB, and (d) from fees paid by HITNY to CRM and its affiliated entities. In addition, the plaintiffs are seeking treble damages for the allegedly deceptive business practices and RICO claims.
Three Brothers Electric, Inc., et. al. v. Compensation Risk Managers, LLC. On February 23, 2011, Three Brothers Electric, Inc., Action Residential Insulation, Inc., Brothers & Company, Inc., Calvin Maintenance, Inc., Carrea & Sons, Inc., Conroy & Conroy Contractors, Inc., Delia Heating Ventilating & Air Conditioning, Inc., JPR Plumbing & Heating Co., Inc., Linaire Sheet Metal Corp., Mandon Building Systems, Inc., MLP Plumbing & Mechanical, Inc., Northern Mechanicals, Inc., OMC, Inc., Precision Carpentry of Westchester, Inc., Rochester Custom Exteriors Inc., Sid Beebe & Sons Builders, In., Tim Gray Masonery Construction, Inc., Torino Industrial, Inc., Village Dock, Inc. and Wilkstone, LLC, all of which were former members of Elite Contractors Trust of New York, on their own behalf and on behalf of all others similarly situated, sued Compensation Risk Managers, LLC in New York Supreme Court, Erie County.
This subsequently filed related action will also be coordinated with the other pending actions against CRM. Accordingly, CRM has not yet responded to the complaint pursuant to the Litigation Coordination Panel's February 23, 2011 Order, as discussed above. For information regarding the proposed settlement of this lawsuit, please see above under the heading “ Proposed Settlement of Litigation Involving New York Self-Insured Groups.”
Binghamton Giant Market v. Compensation Risk Managers, LLC, et al. On or about February 13, 2007, CRM and The Wholesale & Retail Workers' Compensation Trust of New York (collectively, the “Binghamton Giant Defendants”) were named as defendants in a lawsuit brought by Binghamton Giant Market, Inc. (Binghamton Giant). Binghamton Giant’s complaint alleges, in essence, that from October 1, 2001 until September 30, 2005, when Binghamton Giant was a member of Wholesale-Retail, it was charged contribution dollars for remuneration that included full overtime pay for Binghamton Giant’s employees and that this resulted in Binghamton Giant being overcharged in contributions. Binghamton Giant contends that the contributions for overtime are to be calculated using straight time for the overtime, not the overtime rate. Binghamton Giant's Complaint does not distinguish between Wholesale-Retail and CRM and alleges three causes of action: (1) the Binghamton Giant Defendants have breached their contractual obligations to Binghamton Giant; (2) the Binghamton Giant Defendants have been unjustly enriched at Binghamton Giant’s expense; and (3) the Binghamton Giant Defendants have breached a fiduciary duty owed to Binghamton Giant. Binghamton Giant is seeking damages against the Binghamton Giant Defendants, jointly and severally, in the amount of $100,000 on each of the causes of action.
In re: CRM Holdings, Ltd. Securities Litigation. On February 5, 2010, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York on behalf of a class consisting of all persons or entities who purchased the securities of CRM Holdings between December 21, 2005 and November 5, 2008. The complaint was filed by Beverly L. Munter, individually and on behalf of all others similarly situated, and charges CRM Holdings and certain of its executive officers and directors with violations of federal securities laws.
On May 21, 2010, the court granted plaintiffs’ motion appointing Brett Brandes and Beverly L. Munter as lead plaintiffs in the action, Glancy Binkow & Goldberg LLP as lead counsel for the class, and consolidation of any subsequently filed lawsuits with the action under the caption In re: CRM Holdings, Ltd. Securities Litigation.
New York State Workers' Compensation Board v. Classic Insurance Agency et al. v. Compensation Risk Managers, LLC. On January 3, 2003, a lawsuit was filed naming The Kids Waterfront Corp., a former member of the Transportation Industry Worker's Compensation Trust (Transportation Trust) as a defendant. In the action, the plaintiff had suffered a double leg amputation and had alleged various claims of negligence and statutory liability in connection with unsafe machinery. The matter was ultimately settled, with respect to The Kids Waterfront, Corp., CRM, and the Transportation Trust, on July 21, 2006, in consideration of $500,000.
Because of the amount involved, Clarendon National Insurance Company (Clarendon), the excess carrier for the Transportation Trust, was notified of the claim. In response, Clarendon issued a reservation of rights letter to disclaim liability based upon various theories relating to the plaintiff's employment status. In light of these coverage issues, the Transportation Trust instituted a declaratory judgment action in May 2006, seeking a judicial declaration that Clarendon should provide excess coverage in the amount of $200,000.00 to the Transportation Trust for damages arising out of the Underlying Action. On December 19, 2006, the Declaratory Judgment Action was settled, wherein the Transportation Trust agreed to release Clarendon in consideration of $200,000.00. On June 4, 2008, a lawsuit was brought by the Transportation Trust and Clarendon against Classic Insurance Agency, the insurance brokers for The Kids Waterfront, Corp. The complaint asserts claims for negligent misrepresentation and fraud in connection with the defendants' submission of the application for membership in the Transportation Trust on behalf of The Kids Waterfront, Corp. The complaint sought recovery of defense fees and/or settlement proceeds paid in the Underlying Action including the $500,000 settlement. Following the assumption of the Transportation Trust, a motion was filed and granted substituting the WCB, as successor in interest to the Transportation Trust, as the plaintiff in place of CRM.
Contractors Access Program of California v. Majestic Capital, Ltd., et al. On December 20, 2010 Contractors Access Program of California (CAP), by Bickmore Risk Services, as Conservator, sued CRM, CRM CA, Majestic USA, Majestic Capital, Ltd., Twin Bridges (Bermuda) Ltd., Majestic Insurance Company, Daniel G. Hickey, Jr., and Chester Walczyk in California Superior Court, County of San Francisco. The plaintiffs also named two former trustees along with their respective employers. Plaintiffs are seeking damages from the defendants’ alleged mismanagement and wrongful conduct with respect to CAP. As against CRM CA and its affiliated entities, the lawsuit alleges that CRM CA and its affiliated entities: (1) breached fiduciary duties and aided and abetted in breaches of fiduciary duties owed to CAP; (2) breach of the Service Agreement and Field Consulting Agreement; (3) unjust enrichment; (4) rescission and restitution against Majestic Insurance Company; and (5) fraudulent conduct within the meaning of Business & Professions Code§17200. The plaintiffs are seeking damages (a) for the amount of CAP’s underfunding, which the plaintiffs have currently estimated to be in excess of $34 million, or as established at trial, (b) exemplary and punitive damages, (c) rescission of plaintiffs’ purchase of membership interests in CAP and the return of their contributions paid into the program, or damages according to proof at trial, and (d) costs and attorney fees. On or about February 28, 2011, Plaintiff filed an amended complaint making similar allegations to the original complaint and deleting the rescission cause of action. CRM CA and its affiliated entities’ responsive pleadings are due on April 12, 2011. The Company intends to vigorously defend this litigation, which is in a preliminary stage, and the Company cannot estimate what impact, if any, the litigation may have on its business reputation, results of operations, financial condition or cash flows. If, however, this matter is decided adversely to the Company, it may result in a material adverse effect on its business, results of operations, financial conditions and cash flows.
RBG Management Corp. et al. v. Compensation Risk Managers, LLC, et al. In November 2008, RBG Management Corp., Red & White Markets, Inc., Doria Enterprises Inc. and Grace’s Marketplace Inc., all of which were former members of the Wholesale Retail Workers’ Compensation Trust of New York (“WRWCTNY”), sued CRM, WRWCTNY, certain current and former officers and directors of CRM, the Board of Trustees of WRWCTNY, and S.A.F.E., LLC, which is the successor third-party administrator for WRWCTNY, in the Supreme Court of the State of New York, New York County. The lawsuit sought a declaratory judgment relieving the plaintiffs from any liabilities owed in relation to their previous membership in WRWCTNY and damages arising from allegations that the defendants breached their fiduciary duties to the plaintiffs by failing to maintain adequate reserves and failing to properly determine an adequate level of reserves necessary to maintain the solvency of WRWCTNY.
In November 2009, the plaintiffs served an amended complaint which seeks damages, in an undetermined amount, from CRM arising from allegations that CRM breached its fiduciary duties to the plaintiffs. The plaintiffs are seeking to bring the claim derivatively on behalf of WRWCTNY. The amended complaint does not name any current or former officer or director of CRM. On December 11, 2009, CRM filed a motion to dismiss the plaintiffs’ amended complaint. CRM’s motion to dismiss was granted on March 25, 2010 and the plaintiffs dismissed the action against the other defendants.
Each U.S. domestic insurance company’s state of domicile imposes minimum risk-based capital requirements that were developed by the National Association of Insurance Commissioners (“NAIC”). The formula for determining the amount of risk-based capital specifies various weighting factors that are applied to financial balances or levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of total adjusted capital and surplus to authorized risk-based capital, as defined by the NAIC. Specific corrective action can result for companies below specific trigger points or with ratios that are classified within certain levels. The NAIC provides authoritative guidance on current statutory accounting practices by promulgating a codified set of statutory accounting practices which the CA DOI requires Majestic Insurance to follow. While Majestic Insurance did not meet the minimum risk-based capital requirements as of December 31, 2010, it did exceed them as of December 31, 2009. The possibility that Majestic Insurance may not continue to meet its minimum risk-based capital requirements in 2011 and conservation and rehabilitation of Majestic Insurance is described in under the heading Conversation of Majestic Insurance in Note 24.
The following is a summary of Majestic Insurance’s statutory net income for the years ended December 31, 2010, 2009 and 2008 and the statutory capital and surplus as of December 31:
The following is a summary of Twin Bridges’ statutory net income for the years ended December 31, 2010, 2009 and 2008 and the statutory capital and surplus as of December 31:
Summarized below are the unaudited quarterly financial data for 2010 and 2009. Results from discontinued operations are segregated from continuing operations for all periods presented.
In connection with the workforce reduction, the Company recorded a charge in the first quarter of 2011 of approximately $0.6 million associated with one-time termination benefits, primarily related to severance, health insurance costs and other employment benefits.
On March 21, 2011, Bayside terminated the previously announced merger agreement between Bayside and the Company. Bayside cited a material deterioration in the Company’s surplus, an inability to secure regulatory approval for the merger, and a failure to satisfy the closing condition with respect to the termination of the Company’s lease for office space in Poughkeepsie, New York on terms acceptable to Bayside. Certain circumstances surrounding the termination of the Bayside agreement were not met, therefore the Company is neither required to pay a termination fee to Bayside nor reimburse Bayside for expenses incurred in connection with the previously announced amalgamation.
The CA DOI cites the following reasons for the statutory conservation of Majestic Insurance: (1) the Termination of the Bayside Amalgamation Agreement described above, as the Company will not benefit from the financial condition, reputation and regulatory and rating agency standing of Lancer, the affiliated insurance company of Bayside; (2) the findings of the CA DOI examination of Majestic Insurance indicate that Majestic Insurance’s carried statutory loss reserves at December 31, 2010 are understated by $41 million, which if recorded, would result in the failure of Majestic Insurance to meet minimum regulatory requirements; (3) the continuing material deterioration of the financial condition of Majestic Insurance due to ongoing operating losses; (4) the potential impact on Majestic Insurance of the ongoing regulatory and litigation issues faced by its affiliates, Majestic Capital, CRM; and CRM CA and (5) the possibility that Majestic Capital and its non-insurance subsidiaries could seek protection under applicable United States and Bermuda bankruptcy and other similar laws.
AmTrust would assume 100% of Majestic Insurance’s loss reserves through a loss portfolio transfer (LPT) as discussed below;
The rights to renew Majestic Insurance’s expiring book of business would be transferred to AmTrust; and
On March 30, 2011, Majestic entered into a term sheet with AmTrust and the CA DOI which contained additional terms of the contemplated transactions. The term sheet was non-binding except for binding provisions relating to access by AmTrust to personnel, properties, books and records of Majestic Insurance for due diligence purposes, confidentiality and exclusivity. Under the exclusivity provision, Majestic Insurance granted AmTrust an exclusivity period until the earlier of June 20, 2011, the commencement of a conservation proceeding or termination of the term sheet.
These ratings actions reflect A.M. Best’s concern over the termination of the aforementioned amalgamation of the Company with Bayside, the Company’s continued deterioration in its overall earnings and the material deterioration in the Company’s surplus. In addition, A.M. Best’s concerns were further compounded by the possible conservation of Majestic Insurance by the CA DOI and the related rehabilitation plan, taken in conjunction with the proposed transactions described above in AmTrust Non-Binding Letter of Intent and Term Sheet.
The financial strength rating of Majestic Insurance and the debt ratings of Majestic USA and Embarcadero will remain under review with negative implications concerning the conservation of Majestic Insurance and execution of the rehabilitation plan by the CA DOI and the determination of bankruptcy proceedings of Majestic Capital and its non-insurance subsidiaries.
On March 31, 2011, Majestic Insurance notified Comerica of its default under the terms of the Comerica Credit Facility - specifically non-compliance with financial covenants due to the A.M. Best downgrade. Comerica has indicated that it would not terminate the Comerica Credit Facility due to the pending transactions described in the AmTrust Non-Binding Letter of Intent and Term Sheet and the fact that the credit facility is fully collateralized by the invested assets of Majestic Insurance.
Termination of Policy Administration Operating Lease and Call on Letter of Credit