Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operation and should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. The MD&A is divided into subsections entitled “Business Overview,” “Critical Accounting Policies,” “Results of Operations,” “Liquidity and Capital Resources,” “Share Dividend,” “Rights Offering,” and “Losses and Loss Adjustment Expenses.”
This Form 10-K, including this MD&A section, certain statements contained in this Form 10-K, including this MD&A section, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, and contain information relating to us that is based on the beliefs of our management as well as assumptions made by, and information currently available to, our management. The words “anticipate,” “expect,” “believe” and similar expressions as they relate to us or our management are intended to identify forward-looking statements.
We are a holding company based in Bermuda. We conduct our reinsurance business through AMIC Ltd., our subsidiary, which is a registered insurer in Bermuda. Our investment portfolio is held in and managed by Investco, which is a subsidiary of AMIC Ltd.
The amount that we record as our liability for loss and loss adjustment expenses is a major determinant of net income each year. As discussed in more detail below under the heading “Losses and Loss Adjustment
Expenses,” the amount that we reserve is based on actuarial estimates which are prepared as of June 30 and December 31 each year. Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a “low,” “central” and “high” estimate of the loss and loss adjustment expenses. As at December 31, 2007, the range of actuarially determined liability for loss and loss adjustment expense reserves was as follows: the low estimate was $16.3 million, the high estimate was $27.9 million, and the central estimate was $20.8 million. We selected reserves of $27.4 million as of December 31, 2007, which is near the high end of the range. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management’s policy has been to reserve conservatively at the higher end of the actuarial estimates.
Our net income decreased to $3,057,600 in 2007, compared to net income of $3,312,962 in 2006.
Net premiums earned decreased by 7.6% in 2007 to $7,973,646 from $8,628,534 in 2006. The decrease in net premiums earned during 2007 was due to an adjustment for premiums over ceded to AmerInst in prior years.
Net realized gains decreased by $199,234 in 2007 to $921,029 from $1,120,263 in 2006.
Invested assets, including investments, cash and cash equivalents and restricted cash and cash equivalents, increased by $779,005, or 1.4%, to $56,240,428 in 2007 compared to $55,461,423 in 2006. The increase was due to an increase in fair values of the investment portfolio. Investment yield of net investment income and net realized gains and losses in 2007 as of December 31 was 4.5% as compared to 4.7% in 2006. The investment yield of net investment income was 2.9% in 2007 and 2.6% in 2006.
Unrealized gain on investments was $7,628,904 at December 31, 2007 compared to $7,469,210 at December 31, 2006. We consider our entire investment portfolio to be available for sale and accordingly all
Policy acquisition costs of $2,269,322 were expensed in 2007 compared to $2,546,012 in 2006, a decrease of 10.9%. Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. Such costs as a percentage of premiums earned were 28.5% in 2007 and 29.5% in 2006.
Two semi-annual dividends of $0.45 per share were paid during 2007 and 2006, and a special dividend of $0.70 per share was paid in the first quarter of 2007. Since AmerInst began paying consecutive dividends in
AMIC Ltd.’s ability to pay dividends to AmerInst is subject to the provisions of the Bermuda insurance and companies laws. Under the Companies Act, that subsidiary would be prohibited from declaring or paying a dividend at December 31, 2007 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. As at December 31, 2007, approximately $20 million was available for the payment of dividends to shareholders. In addition, that subsidiary must be able to pay its liabilities as they come due after the payment of a dividend. Our ability to pay dividends to common shareholders and to pay our operating expenses is dependent on cash dividends from our subsidiaries. The payment of such dividends by AMIC Ltd., including its subsidiary, Investco, to us is also limited under Bermuda law by the Insurance Act and related regulations which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2007 and 2006 these requirements have been met as follows:
Because AMIC Ltd. is not admitted as an insurer in Illinois, CNA has the right to annually require AMIC Ltd. to procure a letter of credit issued by a U.S. bank in an amount equal to the total unearned premiums for the fiscal year plus CNA’s share of AMIC Ltd.’s loss reserves.
On March 2, 2006, the board of directors of AmerInst approved a share dividend of two shares of common stock for every share held by shareholders of record on April 2, 2006, subject to shareholder approval of an increase in the number of our authorized shares. Such approval was received at the AmerInst 2006 Annual General Meeting on June 1, 2006, which increased the authorized share capital of the Company from $500,000 to $2,000,000. The total issued shares were 331,751 prior to the share dividend and 995,253 afterwards. Unless otherwise noted, all share and per share numbers in our Consolidated Financial Statements and elsewhere in this annual report on Form 10-K reflect the share dividend.
The consolidated financial statements include our estimated liability for unpaid losses and loss adjustment expenses (“LAE”) for our insurance operations. LAE is determined utilizing both case-basis evaluations and actuarial projections, which together represent an estimate of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of trends in future claim severity and frequency. The estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as appropriate, and reflected in current financial reports.
An actuarial review and projection is performed for us by our independent actuary as of June 30 and December 31 of each year. We review the actuarial estimates throughout the year for the possible impact on our financial position. As noted in our discussion of our results of operations, based on the analysis by the Company’s actuaries, a reduction of $2.8 million from unpaid losses and loss adjustment reserves occurred in the fourth quarter of 2007. This reduction was the result of the completion of the December 31 actuarial review, which indicated positive loss development in policy years 1994 to 2002.
For premier plan and value plan business, many policies provide allocated loss adjustment expense coverage in addition to the standard $1 million per claim indemnity limit. The effect of a provision for allocated loss
adjustment expense in addition to limits was estimated by performing incurred and paid loss and allocated loss adjustment expense Bornhuetter-Ferguson (BF) calculations on the incurred and paid loss and allocated loss adjustment expense in addition to the limits. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our loss reserving philosophy.
The CAMICO Mutual Insurance Company was a new program for the Company in 2005. An estimated loss and allocated loss adjustment expense ratio of 70% was selected for this business.
The “cumulative redundancy (deficiency)” represents the aggregate change in the estimates over all prior years. For example, the 1997 liability has developed a $10,243,000 redundancy which has been reflected in income in subsequent years as the reserves were re-estimated.
The lower section of the table shows the cumulative amount paid in respect of the previously recorded liability as of the end of each succeeding year. For example, the 1997 year end liability was originally $19,763,000. As of December 31, 2007, we had paid $8,273,000 of the currently estimated $9,520,000 of losses and LAE that had been incurred for 1997 and prior years through the end of 2007; thus an estimated $1,247,000 in losses incurred through 1997 remain unpaid as of the current financial statement date.
The following table provides an analysis of our contractual obligations at December 31, 2007:
The amounts included for unpaid losses and loss adjustment expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, see “Losses and Loss Adjustment Expenses” beginning page 15. Due to the inherent uncertainty in the process of estimating the timing of these payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash, investments and future premium income.
We have audited the accompanying consolidated balance sheets of AmerInst Insurance Group, Ltd. and subsidiaries (the “Company”) as at December 31, 2007 and 2006, and the related consolidated statements of operations and other comprehensive income, changes in stockholders’ equity and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index and included in Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AmerInst Insurance Group, Ltd. and subsidiaries as at December 31, 2007 and 2006 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
AmerInst Insurance Group, Ltd., (“AmerInst” or the “Company”) was formed under the laws of Bermuda on July 16, 1998. The Company, through its wholly-owned subsidiary AmerInst Insurance Company, Ltd. (“AMIC Ltd.”) and its predecessor AmerInst Insurance Company, Inc. (“AIIC Inc.”), has been engaged in the reinsurance of claims-made insurance policies of participants in an AICPA-sponsored insurance program that provides accountants’ professional liability insurance coverage (“AICPA Plan”).
The reinsurance activity of AMIC Ltd. depends upon agreements entered into with outside parties. In August 1993, the AICPA Plan endorsed the CNA Financial Corporation (“CNA”) insurance group as its insurance carrier. AIIC Inc. then began a reinsurance relationship with CNA, taking a 10% participation of the first $1,000,000 of liability of each policy written under the plan. Effective in December 1999, the Company began taking a 10% share of the “value plan” business from CNA. The “value plan” provides for separate $1,000,000 limits for losses and separate $1,000,000 limits for expenses per occurrence and $2,000,000 in the aggregate. The Company’s maximum limits under the “value plan” are $2,000,000 per occurrence and $4,000,000 in the aggregate.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of AmerInst and its wholly-owned subsidiaries, AmerInst Mezco, Ltd. (“Mezco”), AMIC Ltd. and AmerInst Investment Company, Ltd. (“Investco”). Intercompany accounts and transactions have been eliminated on consolidation.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued FAS 157, Fair Value Measurement. This Statement provides guidance for using fair value to measure assets and liabilities. Under this standard, the definition of fair value focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). FAS 157 clarifies that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets and the lowest priority to unobservable data. Further, FAS 157 requires tabular disclosures of the fair value measurements by level within the fair value hierarchy. FAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted as of the beginning of a fiscal year. The Company believes that the adoption of FAS 157 will not have a material impact on its financial statements.
Pursuant to the reinsurance agreements, AMIC Ltd. is required to provide the ceding companies with collateral for AMIC Ltd.’s liabilities to them. At December 31, 2007 and 2006 $113,382 was held in deposits pursuant to the 2003 excess reinsurance agreement with PDIC. Also at December 31, 2007 and 2006, the carrying value of investments in a trust account held by Bank of New York pursuant to reinsurance agreements in effect from 1989 to mid-1993 was $2,038 and $115,273, respectively. Additionally, at December 31, 2007 and 2006, AMIC Ltd. had provided CNA with a Section 114 Trust, held by JPMorgan Chase Bank, with restricted cash and cash equivalents and investments with a carrying value of $23,160,559 and $19,922,503, respectively. At December 31, 2007 and 2006 AMIC Ltd. provided CAMICO with a Letter of Credit held by National City Bank with supporting investments with a carrying value of $4,370,598 and $4,110,082, respectively.
The cost or amortized cost, gross unrealized holding gains and losses, and estimated fair value of investments in fixed maturity investments, by major security type, and equity securities at December 31, 2007 and 2006 are as follows:
As of December 31, 2007, there were approximately 14 securities in an unrealized loss position with an estimated fair value of $6,373,174. Of these securities, there are 11 securities that have been in an unrealized loss position for 12 months or greater with an estimated fair value of $5,891,962. As of December 31, 2007, none of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
As of December 31, 2006, there were approximately 31 securities in an unrealized loss position with an estimated fair value of $16,654,190. Of these securities, there are 19 securities that have been in an unrealized loss position for 12 months or greater with an estimated fair value of $12,083,353. As of December 31, 2006, none of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The cost or amortized cost and estimated fair value of fixed maturity investments at December 31, 2007 by contractual maturity are shown below. Expected maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations without penalties.
Details of the liability for unpaid losses and loss adjustment expenses and related reinsurance recoveries receivable at December 31, 2007 and 2006 are as follows:
AmerInst, AMIC Ltd., Mezco and Investco have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. USA Risk Group (Bermuda) Ltd. provides AmerInst and AMIC Ltd. certain management, administrative and operations services under the direction of AmerInst’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party upon not more than 90 days nor less than 60 days prior written notice. Mr. Grayston, a director and President of the Company, and Mr. Nicol, Vice President and Treasurer of the Company, are the President and Senior Account Manager and Vice President, respectively, of USA Risk Group (Bermuda) Ltd. The company paid $235,000 in fees pursuant to this agreement during 2007 and 2006. Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $507,648 in 2007 and $424,258 in 2006.
Under current Bermuda law, the Company and its subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, the Company will be exempted from such taxes until the year 2016.
AmerInst’s ability to pay common shareholders’ dividends and its operating expenses is dependent on cash dividends from AMIC Ltd. including its subsidiary, Investco (collectively the “reinsurance subsidiaries”). The payment of such dividends by the reinsurance subsidiaries to AmerInst is limited under Bermuda law by the Bermuda Insurance Act 1978 and related regulations, as amended, which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2007 and 2006 these requirements have been met. The minimum required statutory capital and surplus was $4,111,443 and $4,224,205 and actual statutory capital and surplus was $25,135,361 and $23,118,869 at December 31, 2007 and 2006, respectively. The minimum required level of liquid assets was $32,946,033 and $33,233,869 and actual liquid assets were $69,063,405 and $67,505,696 at December 31, 2007 and 2006, respectively. Statutory income for the years ended December 31, 2007 and 2006 was $2,440,824 and $2,382,272.
The combined total net income for both segments is as follows: