our extensive knowledge of the New Jersey insurance market and regulatory environment;
As of December 31, 2006, our insurance subsidiary, Proformance Insurance Company (“Proformance”), was the eleventh largest and one of the fastest growing provider of private passenger auto insurance in New Jersey, based on direct written premiums of companies writing more than $5 million of premiums annually over the past three years, according to A.M. Best. From 2002 through 2006, we experienced a 10.5% compound annual growth rate, as our direct written premiums for all lines of business we write, including homeowners and commercial lines, increased from $114.6 million in 2002 to $171.1 million in 2006. As of December 31, 2006, our stockholders’ equity was $150.9 million, up from stockholders’ equity of $18.1 million as of December 31, 2002,reflecting a 69.9% compound annual growth rate. Included in stockholders’ equity is $62.2 million as a result of our initial public offering, which was completed on April 21, 2005.
Direct written premiums for the year ended December 31, 2006 decreased by $26.9 million, or 13.6%, to $171.1 million from $198.0 million in the comparable 2005 period.
For the year ended December 31, 2006 the decrease is due to the following: our closed agents business that was acquired as part of previous replacement carrier transactions with OCIC, Met P&C and Sentry decreased by $51.0 million due to the fact that as a result of the continued increase in the competitive nature of the New Jersey auto insurance market those agents were able to place that business with other carriers in the New Jersey market. New business generated by our partner agents for the year ended December 31, 2006 was $31.4 million, offset by attrition of existing business of $7.3 million. For the twelve months ended December 31, 2006, direct written premium generated from The Hanover and Hartford renewal business was approximately $11.1 and $4.1 million, respectively.
As of December 31, 2006, the rating tier modifiers and the distribution of risks within the tiers were as follows:
Our financial results may be affected by a variety of external factors that indirectly impact our premiums and/or claims expense. Such factors may include, but are not limited to:
On September 27, 2005, the Company announced that Proformance had entered into a replacement carrier transaction with The Hartford Financial Services Group, Inc., which we refer to as The Hartford, whereby certain subsidiaries of The Hartford (Hartford Fire Insurance Company, Hartford Casualty Insurance Company, and Twin City Fire Insurance) would transfer their renewal obligations for New Jersey homeowners, dwelling, fire, and personal excess liabilities policies sold through independent agents to Proformance. Under the terms of the transaction, Proformance is in the process of offering renewal policies to approximately 8,500 qualified policyholders of The Hartford. We received final approval of this transaction from the NJDOBI on November 22, 2005, the closing date.
As of December 31, 2006, the direct written premium generated from The Hartford renewal business was $4,134,877.
On February 21, 2006 the Company announced that Proformance had entered into a replacement carrier transaction with Hanover Insurance Group, which we refer to as Hanover, whereby Hanover would transfer their renewal obligations for New Jersey automobile, homeowners, dwelling fire, personal excess liability and inland marine policies sold through independent agents to Proformance. Under the terms of the transaction, Proformance is in the process of offering renewal policies to approximately 16,000 qualified policyholders of Hanover. NAHC and Proformance received approval of this transaction from the NJDOBI on February 16, 2006.
Hanover is not liable for any fees and or other amounts to be paid to Proformance and as such Proformance will not recognize any replacement carrier revenue from this transaction. The revenue that will be recognized as part of this transaction will be from the premium generated by the policies that renew with Proformance.
As of December 31, 2006, the direct written premium generated from Hanover renewal business was $11,080,943.
in the underlying calculation which supported the amounts due to Proformance for the 2004 year, the final year of our three year agreement with OCIC. The $696,000 was recorded as a bad debt expense in the Company’s consolidated statement of income for the year ended December 31, 2005.
officers and other key employees under the Company’s 2004 Stock and Incentive Plan. The SARS were granted with a base price of $9.94 per share, which was the closing price of the Company’s common stock on the Nasdaq National Market on the date of grant.
The Company reported, as a component of other liabilities on the consolidated balance sheet and other operating and general expenses in the consolidated statement of income, share-based compensation expense of $1,066,239 for the year ended December 31, 2006.
The revenue we earned from replacement carrier transactions relates to the funds that we received to assume the renewal obligations of those books of business. Revenues from replacement carrier transactions are recognized pro-rata over the period that we complete our obligations under the terms of the agreement, typically ranging from six months to a year, determined by the renewal option period of the policyholders. Certain replacement carrier contracts require additional consideration to be paid to us based on an evaluation of the ratio of premiums written to surplus. The calculation is performed and related revenue is recognized as earned annually, pursuant to the terms of the contract. Certain other transactions, such as the Hanover and Hartford transactions described above, require us to pay additional consideration in the future. We did not record any replacement carrier revenue for the year ended December 31, 2006 and 2005. Our strategy includes entering into additional replacement carrier transactions as opportunities arise. However, due to improvements in the New Jersey insurance market during 2005, it is not likely that we will enter into replacement carrier transactions which have as significant an impact on the Company’s operations, or are comparable in size to those entered into prior to 2005.
expenses, which consist of commissions we pay our agents. In addition, underwriting, acquisition and insurance related expenses include premium taxes and company expenses related to the production and underwriting of insurance policies, less ceding commissions that we receive under the terms of our reinsurance contracts, and other operating and general expenses which include general and administrative expenses.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. We have identified below two accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of these policies. In addition, please see “Overview” above for a discussion of the amount we estimated and recorded as replacement carrier revenue from related party in our consolidated statement of income for the year ended December 31, 2005 with respect to the OCIC replacement carrier transaction.
When reviewing reserves, we analyze historical data and estimate the impact of various loss development factors, such as our historical loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments, judicial decisions, legal developments in
For the year ended December 31, 2005, we increased reserves for prior years by $10.1 million. This increase was due to (i) increases in average severity for Personal Injury Protection (No-fault) losses of $9.4 million (ii) higher Commercial Auto Liability projected loss ratios for 2002-2004 due to the fact that actual loss development was higher than expected for those years, resulting in an increase of $1.8 million and (iii) Homeowners losses of $0.6 million and Other Liability losses of $1.6 million. This development was partially offset by continued favorable trends in loss development for Property Damage losses ($1.6 million), Auto Physical Damage losses ($1.2 million), and Bodily Injury losses of ($0.5 million), as reported claims frequency has dropped significantly and we have reduced our projected loss ratios in recognition of this trend.
For the year ended December 31, 2004, we reduced reserves for prior years by $0.7 million because our actual loss experience observed during the period, especially during the fourth quarter of 2004, was slightly lower than expected due to a reduction in the frequency of claims reported during the fourth quarter of 2004. In addition, as more fully described in Note 4 Reinsurance Activity to our consolidated financial statements, the commutation referred to for 2004 had no impact on our consolidated unpaid loss and loss adjustment expense reserves as of December 31, 2004. In addition, we increased reserves by $0.1 million for the year ended December 31, 2003. The incurred losses related to prior years of $0.1 million in 2003 included a commutation of a reinsurance agreement of $0.2 million which was offset by favorable loss development on prior accident year reserves.
The table below sets forth the types of reserves we maintain for our lines of business and indicates the amount of reserves as of December 31, 2006 for each line of business.
In establishing our net reserves as of December 31, 2006, our Chief Actuarial Officer has determined that the range of reserve estimates, at that date, was between $161.4 million and $184.8 million. The amount of net reserves at December 31, 2006, which represents the best estimate of management and our actuaries within that range, was $173.5 million. There are two major factors that could result in ultimate losses below management’s best estimate:
We believe that the claims department has improved its claims handling practices during the past two years with regard to claims reserving and settlement. These improvements could result in lower loss development factors than those which currently underlie our actuarial estimates.
about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 supersedes Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Applications of Certain Investments” (“EITF 03-1”) and EITF Topic D-44, Recognition of Other-Than-Temporary Impairment on the Planned Sale of a Security Whose Cost Exceeds Fair Value (“Topic D-44”) and nullifies the accounting guidance on the determination of whether an investment is other-than-temporarily impaired as set forth in EITF 03-1. FSP 115-1 is required to be applied to reporting periods beginning after December 15, 2005 and management has determined that the effect of adopting FSP 115-1 will not have a material impact on the Company’s consolidated financial statements. The Company has complied with the disclosure requirements of EITF-03-1, which were effective December 31, 2003 and remain in effect.
twelve months ended December 31, 2006, direct written premium generated from The Hanover and Hartford renewal business was approximately $11.1 and $4.1 million, respectively.
Net Income. Net income after tax for the year ended December 31, 2006 and 2005 was $14.4 million and $6.4 million, respectively. The increase in net income after tax for the year ended December 31, 2006 as compared to the same period in the prior year is a result of the factors discussed above.
For the years ended December 31, 2005 compared to the year ended December 31, 2004
Net Written Premiums. Net written premiums for the twelve months ended December 31, 2005 decreased by $3.6 million, or 1.9%, to $189.6 million from $193.2 million in the comparable 2004 period. The decrease in new written premiums for the twelve months ended December 31, 2005 was due to the decrease in direct written premiums for the same period.
Investment Income. Investment income for the twelve months ended December 31, 2005 increased by $5.3 million, or 74.7%, to $12.4 million from $7.1 million in the comparable 2004 period. The increase was due primarily to an increase in invested assets to $300.0 million at December 31, 2005 from $238.0 million at December 31, 2004. The increase in invested assets was primarily due to the capital raised in connection with our initial public offering completed on April 21, 2005. Our average book yield to maturity at December 31, 2005 and 2004 was 5.22% and 4.43%, respectively. The increase in yield was due to the purchase of securities with higher yields primarily as a result of purchasing shorter duration fixed income securities due to an inverted yield curve.
Net Realized Investment Gains . Net realized investment gains for the twelve months ended December 31, 2005 and 2004 were $0.4 million and $1.9 million, respectively.
Income Tax Expense. Income tax expense for the twelve months ended December 31, 2005 and 2004 was $1.9 million and $8.9 million, respectively. The decrease of $7.0 million in income tax expense for the year ended December 31, 2005 from the same period in the prior year was due to the decrease in income before tax for the same period.
On April 21, 2005, an initial public offering of 6,650,000 shares of the Company’s common stock (after the 43-for-1 stock split) was completed. The Company sold 5,985,000 shares resulting in net proceeds to the Company (after deducting issuance costs and the underwriters’ discount) of $62,198,255. The Company contributed $43,000,000 to Proformance, which increased its statutory surplus. The additional capital will permit the Company to reduce its reinsurance purchases and to retain more of the direct written premiums produced by its Partner Agents. On May 8, 2006, the Company contributed an additional $9,000,000 to Proformance, thereby further increasing its statutory surplus. The remainder of the capital raised will be used for general corporate purposes, including but not limited to possible additional increases to the capitalization of the existing subsidiaries.
The effective duration of our investment portfolio was 4.07 years as of December 31, 2006. By contrast, our liability duration was approximately 3.5 years as of December 31, 2006. We do not believe this difference in duration adversely affects our ability to meet our current obligations because we believe our cash flows from operations are sufficient to meet those obligations. Pursuant to our tax planning strategy, we invested the $40.6 million received from the OCIC replacement carrier transaction in long-term bonds in accordance with Treasury Ruling Regulation 1.362-2, which allows us to defer the payment of income taxes on the associated replacement carrier revenue until the underlying securities are either sold or mature. The effective duration of our investment portfolio, when excluding these securities, is reduced from 4.07 years to 3.69 years.
The Company has entered into a seven-year lease agreement for the use of office space and equipment. The most significant obligation under the lease terms other than the base rent are the reimbursements of the Company’s share of the operating expenses of the premises, which include real estate taxes, repairs and maintenance, utilities, and insurance. Net rent expense for 2006, 2005 and 2004 was $958,279, $945,391 and $919,058, respectively.
Proformance’s historic trends of net paid losses compared to net premiums collected for calendar years 2006, 2005 and 2004 reflect ratios of 75.8%, 60.8% and 43.3%, respectively. Each of the replacement carrier transactions with OCIC, Met P&C and Sentry Insurance created an unusual influx of premium, particularly in calendar years 2002 and 2003, causing a reduction in net paid loss ratios. In the 2000 and 2001 calendar years in which we did not have any replacement carrier transactions, our ratio of net paid losses to net written premiums averaged 65.3%. The ratio in 2001 was 73.4% due to the fact that the Company’s loss ratio deteriorated compared to the 2000 loss ratio, resulting in an increase in net paid losses for the same period. The reduction in this ratio was due to increase in the influx of net written premiums as a result of the replacement carrier transactions outlined above and time lag between when the net premium was written and the Actual Net Losses were paid in connection with that business. As expected this ratio has returned to levels consistent with ratios achieved in 2000 and 2001 as the business written in connection with the replacement carrier transactions entered into in 2002 and 2003 has been on our books for several underwriting cycles. We began to see this return in the latter portion of 2005 and it has continued throughout 2006. Proformance’s asset/liability match has been established based on the average duration of its claims payments, which we estimate to be approximately 3.5 years as of December 31, 2006. Not including the invested replacement carrier revenue associated with the OCIC replacement carrier transaction, the existing investment portfolio has an effective duration of 3.69 years. The long term investments associated with the OCIC replacement carrier transaction ($40.6 million) represents replacement carrier revenue received to support the premium to surplus leverage in connection with the offers of renewal to those policyholders. The liquidation of securities to retire outstanding claim payments could affect liquidity and future income negatively.
As of December 31, 2006 and December 31, 2005, the Company maintained a high quality investment portfolio.
As of December 31, 2006 and December 31, 2005, we did not hold any securities that were not publicly traded, because our investment policy prohibits us from purchasing those securities. In addition, at those dates, we did not have any non-investment grade fixed income securities.
As of December 31, 2006, fixed maturity securities having an unrealized loss of $427,755 a fair value of $72,699,688 and an amortized cost of $73,127,443 were in a continuous unrealized loss position for less than twelve months. As of December 31, 2005, fixed maturity securities having an unrealized loss of $1,773,955 a fair value of
$184,473,102 and an amortized cost of $186,247,057 were in a continuous unrealized loss position for less than twelve months.
As of December 31, 2006, gross unrealized losses totaled $111,057 for equity securities.
As of December 31, 2005, gross unrealized losses totaled $3,387,535. This amount was calculated using the following data: $1,756,164 of unrealized losses related to securities of the U.S. Government, government agencies and authorities, $456,673 related to state, local and government agencies, $834,448 related to industrial and miscellaneous, $14,430 related to mortgage backed securities and $325,820 related to equity securities.
There were no securities that were considered other-than-temporarily impaired as of December 31, 2006. There were no securities that were considered other-than-temporarily impaired as of December 31, 2005. The following summarizes our unrealized losses by designated category as of December 31, 2006.
The legal environment whereby court decisions and changes in backlogs in the court system could influence claim payout patterns.
Claims staffing levels - claims may be settled at a different rate based on the future staffing levels of the claim department.
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which replaces SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R requires all share-based payments to employees, including grants of employee stock options and stock appreciation rights, to be recognized in the financial statements based on their fair values and the recording of such expense in the consolidated statements of operations. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) 107, which expresses views of the SEC staff regarding the application of SFAS 123R. SAB 107 provides interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations, as well as provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. In April 2005, the SEC amended compliance dates for SFAS 123R to allow companies to implement SFAS 123R at the beginning of their next fiscal year, instead of the next fiscal reporting period that began after June 15, 2005. The Company adopted the provisions of SFAS 123R effective January 1, 2006 at which time the pro forma disclosures previously permitted under SFAS 123 were no longer an alternative to financial statement recognition. Under SFAS 123R, the Company was required to determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. For further details, please refer to Note 6 Share-based Compensation.
In November 2005, the FASB issued FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Applications of Certain Investments” (“FSP 115-1”), which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and how to measure such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 supersedes Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Applications of Certain Investments” (“EITF 03-1”) and EITF Topic D-44, Recognition of Other-Than-Temporary Impairment on the Planned Sale of a Security Whose Cost Exceeds Fair Value (“Topic D-44”) and nullifies the accounting guidance on the determination of whether an investment is other-than-temporarily impaired as set forth in EITF 03-1. FSP 115-1 is required to be applied to reporting
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements (EITF 05-6). EITF 05-6 provides guidance on determining the amortization period for leasehold improvements acquired in a business combination or acquired subsequent to lease inception. The Company has complied with the requirements of EITF-05-6, which were effective for periods which began after June 29, 2005.
In September 2005, the AICPA issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs in connection with modifications or exchanges of insurance contracts other than those specifically described in FASB 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The guidance in SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The Company has determined that the adoption will not have a material impact on the Company’s consolidated financial statements.
Our consolidated financial statements and independent auditor’s report thereon appear beginning on page. See index to such consolidated financial statements and reports on page.