Physical Properties of the Company and Its Subsidiaries. The Company leases buildings that are used in the normal course of business. The principal executive office is owned by Mutual and is located at 2108 East South Boulevard, Montgomery, Alabama, in a 342,000 square foot building. The Company leases other offices and facilities in Georgia, Mississippi, and Tennessee. The executive office is a component of all segments. Other offices are components of the insurance segments and noninsurance segment.
Alfa Corporation is affiliated with Alfa Mutual Insurance Company, Alfa Mutual Fire Insurance Company, and Alfa Mutual General Insurance Company (collectively, the Mutual Group). The Mutual Group owns 54.9% of Alfa Corporation’s common stock, their largest single investment. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Alfa Virginia Mutual Insurance Company (Virginia Mutual) currently cedes 80% of its direct business to Alfa Mutual Fire Insurance Company (Fire) under an affiliate agreement signed in August 2001.
Property casualty insurance operations accounted for 80.1% of revenues and 81.1% of net income in 2005. Life insurance operations generated 17.6% of revenues and 25.8% of net income during the same period. Noninsurance net income, combined with corporate expenses for 2005, resulted in a net loss of $6.9 million or 6.9% of net income.
Future results of operations will depend in part on the Company’s ability to predict and control benefit and settlement expenses through underwriting criteria, product design and negotiation of favorable vendor contracts. The Company must also seek timely and accurate rate changes from insurance regulators in order to meet strategic business objectives. Selection of insurable risks, proper collateralization of loans and leases and continued staff development also impact the operating results of the Company. The Company’s inability to mitigate any or all risks mentioned above or other factors may adversely affect its profitability.
73% of the Company’s assets and 59% of the Company’s liabilities are reported at December 31, 2005 and therefore have a direct effect on net earnings and stockholders’ equity. The Company’s “Summary of Significant Accounting Policies” is presented in Note 1 of the Notes to Consolidated Financial Statements.
The estimated liabilities for losses and loss adjustment expenses include the accumulation of estimates of losses for claims reported prior to the balance sheet dates, estimates of losses for claims incurred but not reported and the development of case reserves to ultimate values, and estimates of expenses for investigating, adjusting and settling all incurred claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation. The estimates are necessarily subject to the outcome of future events, such as changes in medical and repair costs as well as economic, political and social conditions that impact the settlement of claims. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Due to the Company’s current mix of exposures, the majority of claims are settled within twelve months of the date of loss.
The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions related to the type of loss. The amounts of loss reserves for unreported claims and loss adjustment expenses are determined using historical information by line of business as adjusted to current conditions. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. Organized by accident year and evaluation dates, historical data on paid losses, loss adjustment expenses, case reserves, earned premium, catastrophe losses and carried reserves is provided to the Company’s actuaries who apply standard actuarial techniques to estimate a range of reasonable reserves. The carried reserve is then compared to these estimates to determine whether it is reasonable and whether any adjustments need to be recorded. The Company’s appointed actuary conducts his own analysis and renders an opinion as to the adequacy of the reserves. Reserve estimates are closely monitored and are rolled forward quarterly using the most recent information on reported claims. Each quarter, after the rolled forward analysis has been completed, a meeting is held to discuss the actuarial data. Management evaluates reserve level estimates across various segments and adjustments are made as deemed necessary. It is expected that such estimates will be more or less than the amounts ultimately paid when the claims are settled. Changes in these estimates are reflected in current operating results. An increase in the ending reserve for incurred but not reported losses of 1% would have negatively impacted income before income taxes by $453,358 at December 31, 2005. Similarly, increases of 1% in the reserves for unpaid losses and loss adjustment expenses would have reduced pretax earnings by $882,892 and $239,113, respectively.
Due to the Company’s geographically concentrated operations, it is possible that changes in assumptions based on regional data could cause fluctuations in reported results. However, the Company’s exposure to large adjustments in these reserves created by these assumption changes is partially limited by its participation in Alfa’s catastrophe protection program. Historically, the Company’s reserves, in the aggregate, have been adequate when compared to actual results. Given the inherent variability in the estimates, management believes the aggregate reserves are within a reasonable and acceptable range of adequacy.
Benefit reserves for traditional life products are determined according to the provisions of Statement of Financial Accounting Standard (SFAS) No. 60, Accounting and Reporting by Insurance Enterprises. The methodology used requires that the present value of future benefits to be paid to or on behalf of policyholders less the present value of future net premiums (that portion of the gross premium required to provide for all future benefits and expenses) be determined. Such determination uses assumptions, including provision for adverse deviation, for expected investment yields, mortality, terminations and maintenance expenses applicable at the time the insurance contracts are issued. These assumptions determine the level and the sufficiency of reserves. The Company annually tests the validity of these assumptions.
Benefit reserves for universal life products are determined according to the provisions of SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. This standard directs that, for policies with an explicit account balance, the benefit reserve is the account balance without reduction for any applicable surrender charge. Benefit reserves for the Company’s annuity products, like those for universal life products, are determined using the requirements of SFAS No. 97.
In accordance with the provisions of SFAS No. 60 and the AICPA Audit and Accounting Guide, credit insurance reserves are held as unearned premium reserves calculated using the “rule of 78” method. Reserves for supplementary contracts with life contingencies are determined using the 1971 Individual Annuity Mortality Table and an interest rate of 7.5%. Likewise, reserves for accidental death benefits are determined predominately by using the 1959 Accidental Death Benefit Mortality Table and an interest rate of 3%. Reserves for disability benefits, both active and disabled lives, are calculated primarily from the 1952 Disability Study and a rate of 2.5%. A small portion of the Company’s disabled life reserves are calculated based on the 1970 Intercompany Group Disability Study and a rate of 3%.
Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in stockholders’ equity as a component of accumulated other comprehensive income (loss) and, accordingly, have no effect on net income. Fair values for fixed maturities are based on quoted market prices. The cost of investment securities sold is determined by using the first-in, first-out methodology. In some instances, the Company may use the specific identification method. The Company monitors its investment portfolio and conducts quarterly reviews of investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Such evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. Declines resulting from broad market conditions
Policy acquisition costs, such as commissions, premium taxes and certain other underwriting and marketing expenses that vary with and are directly related to the production of business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium payment period of the related policies using assumptions consistent with those used in computing policy benefit reserves. Acquisition costs for universal life type policies are being amortized over a thirty-year period in relation to the present value of estimated gross profits that are determined based upon surrender charges and investment, mortality and expense margins. Investment income is considered, if necessary, in the determination of the recoverability of deferred policy acquisition costs. Acquisition costs for property casualty insurance are amortized over the period in which the related premiums are earned. Future changes in estimates, such as the relative time certain employees spend in initial policy bookings, may require adjustment to the amounts deferred. Changes in underwriting and policy issuance processes may also give rise to changes in these deferred costs.
On January 3, 2005, the Company completed the purchase of Vision, a full-service managing general agency that writes nonstandard automobile insurance policies in nine states, and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC.
During the fourth quarter, a new property casualty policy administration system was implemented for the automobile line of business.
Other income increased $14.7 million in 2005 after decreasing $1.7 million in 2004. In 2005, AVIC contributed $3.5 million of the increase and Vision contributed $22.9 million, which was offset by intercompany eliminations of $12.0 million.
Operating income for the property casualty subsidiaries increased by approximately $11.5 million, or 17%, in 2005 and $15.6 million, or 29%, in 2004. In 2005, AVIC and Virginia Mutual contributed $2.9 million in operating income. AIC and AGI operating income increased $8.6 million as the non-storm loss ratio, declined from 59.4% in 2004 to 58.2% in 2005. During the first quarter of 2005, $11.6 million in pretax storm losses were incurred which was the limit under the Company’s catastrophe program. Storm losses of $9.2 million were incurred during 2004. The expense ratio was impacted with the introduction of the new policy administration system by $2.4 million, or 0.5% of the expense ratio. The return on average equity for 2005 was 18.6%, compared to 16.7% for 2004. Return on average equity, a non-GAAP financial measure, is defined as net income divided by the simple average of beginning and ending stockholders’ equity.
Life insurance operating income increased $3.0 million or 16% in 2005 as a result of a lower mortality ratio of 96% compared to 104% during 2004, premiums and policy charges growth of 8%, and net investment income growth of 4% due to increased investments in fixed maturities at a slightly lower yield. Mortality, a non-GAAP financial measure, represents the ratio of actual to expected death claims. Therefore, in 2005, the Company experienced more favorable financial results when compared to 2004 due to the lower mortality ratio.
Corporate expenses increased by $2.1 million in 2005 and $2.9 million in 2004. Current year results were impacted by increased costs on the Company’s short-term borrowings and the elimination of profits generated by transactions between the property casualty segment and Vision, which was acquired in January 2005. In 2004, corporate expenses were negatively influenced by increased professional fees related to the compliance requirements of the Sarbanes-Oxley Act of 2002 and rising interest rates.
The following table sets forth summarized financial information for the Company’s property casualty insurance subsidiaries, AIC, AGI and AVIC, for the years ended December 31, 2005, 2004 and 2003:
The loss adjustment expense (LAE) ratio has been impacted by the addition of AVIC, which has a different expense structure than AIC and AGI. AVIC pays Vision a fee based on earned premiums to provide loss adjustment activities. This fee structure contributed 0.4% to the LAE ratio.
Index to Financial Statements At December 31, 2005, the Company’s property casualty subsidiaries’ Adjusted Capital calculated in accordance with National Association of Insurance Commissioners (NAIC) Risk-Based Capital (RBC) guidelines was $407.5 million compared to the Authorized Control Level (Required) RBC of $30.3 million. These statutory measures serve as a benchmark for the regulation of an organization’s solvency by state insurance regulators.
Operating income increased by approximately $15.6 million despite $9.2 million in pretax catastrophic storm losses in 2004. Approximately $7.9 million in similar losses were incurred in 2003. The underwriting margin of 10.3% in 2004 was the result of a 61.3% loss ratio (59.4% excluding storm losses), a 4.2% LAE ratio and a 24.1% expense ratio compared to a loss ratio of 62.4%, a LAE ratio of 3.9% and an expense ratio of 25.9% in 2003.
The non-storm loss ratio decrease was due primarily to a lower loss ratio in the automobile line of business. As the largest line of business within the Company, automobile comprised 60.7% of property casualty written premiums in 2004 and generated another strong loss ratio of 62.2%.
The Alfa Group had approximately $347.5 million in gross catastrophe losses during 2004 due to the impact of hurricanes and other severe weather occurring in the second and third quarters. The effect of claims from these events impacted underwriting results by $0.07 per share, based upon the pooling agreement and catastrophe protection program. Another factor in the improved underwriting margin was a decrease in the expense ratio from 2003 levels primarily attributable to the favorable comparison created by adjustments recorded during 2003 to reserves established to cover the cost of purchasing books of business from independent exclusive agents upon their separation from the Company.
Invested assets grew 16.4% in 2004 while investment income increased by $6.2 million primarily due to an increase in partnership earnings. At December 31, 2004, the Company’s property casualty subsidiaries’ Adjusted Capital calculated in accordance with NAIC RBC guidelines was $369.8 million compared to the Authorized Control Level (Required) RBC of $21.5 million.
The mortality ratio declined to 96% of expected in 2005 from 104% of expected in 2004. The result was an increase of only $1.3 million in benefits and claims expense for the year, which is offset by a decline of $918 thousand in legal costs and relatively low growth in operating expenses. Amortization of deferred policy acquisition costs have increased as a result of growth in deferred costs related to new business production increases.
Invested assets increased 7.2%, with an increase of amortized value in fixed income securities of 12.5%, while net investment income increased 3.7%, with income from fixed maturities up $1.1 million, reflecting a slightly lower yield. Writedowns accounted for $1.1 million of the reduction in realized investment gains, net of tax.
Index to Financial Statements At December 31, 2005, the life subsidiary’s Adjusted Capital calculation in accordance with NAIC RBC guidelines was $189.9 million compared to the Authorized Control Level (Required) RBC amount of $12.9 million.
Life insurance operating income, net of tax, decreased $295,000 or 1.5% in 2004. Death claims increased $2.6 million, or 10.5% in 2004, while mortality declined from 105% in 2003 to 104% in 2004. Investment income increased 9.8% while invested assets grew by 7.0% due to positive cash flows. General expenses increased by approximately $1.5 million or 16.2% primarily due to an increase in legal costs. Amortization of deferred policy acquisition costs declined by 8.7% as amortization factors were adjusted to properly reflect expected gross profits of universal life products.
The following discussion relates to the Company’s noninsurance subsidiaries, Financial, Vision, AAM, AAG and ABC.
On January 3, 2005, the Company completed the purchase of Vision, a full-service managing general agency that currently writes nonstandard automobile insurance policies in nine states. In addition, during 2005, Vision wrote a limited amount of homeowner business through other carriers as a general agency. Vision is headquartered in Brentwood, Tennessee and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC.
OFC Capital, the commercial leasing division of Financial, was sold on December 31, 2005. As a result of management’s decision in the fourth quarter of 2004 to sell OFC Capital, a significant portion
Loan operations in Financial continue to grow with a 12.3% increase in the loan portfolio, an increase in the loan portfolio yield to 7.41% from 6.89%, and a delinquency ratio of only 1.44%. Interest rate increases during the year reduced margins slightly. Equity in net earnings (after internal capital charge) of MidCountry increased 113.7% for the year while the carrying value increased 3.6%. These components of Financial produced net income of $3.1 million for the year.
Corporate expense increased approximately $2.9 million, or 162.7% in 2004 primarily due to higher auditing and legal expenses compounded by negative comparisons created by a favorable adjustment made to reserves for employee benefit costs of $1.7 million in 2003. In addition, interest expense on short-term borrowings increased by $265,000 as interest rates climbed during 2004. The weighted average rate increased from 1.2% to 2.3% with corporate debt increasing from $52.6 million at the end of 2003 to $58.1 million on December 31, 2004.
The Company has historically produced positive cash flow from operations which has resulted in increasing amounts of funds available for investment and, consequently, higher investment income. Investment income is also affected by investment yields. Information about cash flows, invested assets and yields are presented below for the years ended December 31, 2005, 2004 and 2003:
Index to Financial Statements The composition of the Company’s investment portfolio is as follows at December 31, 2005 and 2004:
The majority of the Company’s investment portfolio consists of fixed maturities that are diverse as to both industry and geographic concentration. In 2005, the overall mix of investments shifted with rising interest rates reducing unrealized gains within the fixed maturity portfolio and the Company increasing other long-term investments in affiliates by $55.5 million as a result of the sale of OFC Capital.
At December 31, 2005, approximately 44.1% of fixed maturities were mortgage-backed securities. Such securities are comprised of Collateral Mortgage Obligations (CMO’s) and pass through securities. Based on reviews of the Company’s portfolio of mortgage-backed securities, the impact of prepayment risk on the Company’s financial position and results from operation is not believed to be significant. These risks are discussed in more detail in
We have audited the accompanying consolidated balance sheets of Alfa Corporation and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 7, 2006, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alfa Corporation and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 7, 2006, expressed an unqualified opinion on those consolidated financial statements.
In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments (consisting primarily of normal recurring accruals, except as explained in Note 2-Pooling Agreement) necessary to present fairly its financial position, results of operations and cash flows. The accompanying financial statements are prepared on the basis of accounting principles generally accepted in the United States of America. Generally accepted accounting principles differ in certain respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed. Such practices differ from state-to-state, may differ from company-to-company within a state, and may change in the future. Currently, the Company’s statutory net income and surplus are the same under the State of Alabama and NAIC accounting practices.
The accompanying consolidated financial statements include, after intercompany eliminations, Alfa Corporation and its wholly-owned subsidiaries
Alfa Corporation operates predominantly in the insurance industry. At December 31, 2005, its insurance subsidiaries write life insurance in Alabama, Georgia and Mississippi and property casualty
insurance in Georgia, Mississippi, Missouri, Indiana, Ohio, Virginia, Tennessee, Arkansas, Kentucky, and Florida. In addition, AVIC assumes business in Texas.
Alfa Corporation is affiliated with Mutual, Alfa Mutual Fire Insurance Company (Fire), and Alfa Mutual General Insurance Company (General). These companies are known collectively as the Mutual Group. The Mutual Group owns 54.9% of Alfa Corporation’s common stock, their largest single investment. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Alfa Virginia Mutual Insurance Company (Virginia Mutual) currently cedes 80% of its direct business to Fire under an affiliate agreement signed in August 2001.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates and assumptions are particularly important in determining the reserves for future policy benefits, losses and loss adjustment expenses and deferred policy acquisition costs. Actual results could differ from those estimates.
Property Casualty Products: Premiums written are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Premiums reported are net of ceded premiums. The liability for estimated unpaid property casualty losses and loss adjustment expenses is based upon an evaluation of reported losses and on estimates of incurred but not reported losses. Adjustments to the liability based upon subsequent developments are included in current operations.
At December 31, 2005, the Company has a stock-based employee compensation plan, which is described more fully in Note 15-Stock-Based Compensation. The Company accounts for this plan under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, using the recognition and measurement principles of the intrinsic value method. Compensation cost on fixed awards with prorata vesting is recognized using the straight-line method. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Declines in fair values of fixed maturities and equity securities deemed to be other than temporary are recognized in the determination of net income. Generally, realized gains and losses on sales of investments are recognized in net income using the first-in, first-out methodology. In some instances, the Company may use the specific identification method if so directed by the investment portfolio
manager. Realized investment gains and losses are reported on a pretax basis as a component of revenues. Income taxes applicable to net realized investment gains and losses are included in the provision for income tax.
Other Long-term Investments: Partnerships, joint ventures and unconsolidated investee companies accounted for using the equity method are a component of other long-term investments and other long-term investments in affiliates. Investments in partnerships, joint ventures and unconsolidated investee companies are stated at the underlying audited equity value based on accounting principles generally accepted in the United States of America. Investments are reviewed annually for impairments and adjusted accordingly. It is the Company’s policy to review investments for applicability of Financial Accounting Standards Board Interpretation (FIN) 46(R), Consolidation of Variable Interest Entities. At December 31, 2005, the Company determined that no investment required consolidation based on FIN 46(R) criteria.
Amounts recoverable from property casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts.
The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
Intangible assets include agent relationships, information technology, and restrictive covenants, and are amortized on a straight-line basis over periods ranging from 5 to 20 years. The Company performs an annual review of its intangible assets in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. This review is to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable.
Included in other assets, furniture, equipment, capital leases, software and leasehold improvements are stated at cost less accumulated depreciation or amortization. Depreciation is computed principally using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line basis over the lesser of the lease terms or the estimated useful lives of the improvements.
The Company accounts for derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities-An Amendment of FASB Statement No. 133, and SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statements require that the Company recognize all derivatives as either assets or liabilities in the consolidated balance sheet at fair value. Changes in the fair value of derivatives are recorded currently in earnings unless special hedge accounting criteria are met. For derivatives designated as fair value hedges, the changes in the fair value of both the derivative instrument and the hedged item are recorded in earnings. For derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivative are reported in other comprehensive income. Any ineffective portions of hedges would be recognized in earnings.
As part of its funding efforts, the Company issued a $70 million long-term obligation maturing on June 1, 2017 in the second quarter of 2002 that is included in total borrowings. Management believes it is prudent to limit the variability of a portion of its interest payments. It is the Company’s objective to hedge 100 percent of its variable-rate long-term interest payments over the first five years of the life of the debt obligation.
To meet this objective, management entered into an interest rate swap to manage fluctuations in cash flows resulting from interest rate risk. The interest rate swap changes the variable-rate cash flow exposure of the variable-rate long term debt obligation to fixed-rate cash flows by entering into a receive-variable, pay-fixed interest rate swap. Under the interest rate swap, the Company receives variable interest payments and makes fixed interest rate payments, thereby creating long-term debt with a fixed rate of 4.945%. During 2005, interest received ranged from 2.358% to 4.361%.
If it is determined that the swap has ceased to be a highly effective hedge, is sold, or is terminated, the Company will discontinue hedge accounting prospectively. The change in fair value of the hedged item attributable to hedged risk, as has been reported in accumulated other comprehensive income, would be amortized to interest expense over the remaining life of the hedged item.
applicable reserves as determined by management and are included in current operating results. Reserves may be adjusted based upon outside counsels’ advice regarding the law and facts of the case, any revisions in the law applicable to the case, the results of depositions and/or other forms of discovery, general developments as the case progresses such as a favorable or an adverse trial court ruling, whether a verdict is rendered for or against the Company, whether management believes an appeal will be successful, or other factors that may affect the anticipated outcome of the case. Management believes adequate reserves have been established in known cases. However, due to the uncertainty of future events, there can be no assurance that actual outcomes will not differ from the assessments made by management.
Certain amounts in prior periods have been reclassified to conform to the presentation adopted in the current fiscal year. Such reclassification did not impact earnings.
The Mutual Group, Virginia Mutual and the Company write preferred risk automobile and homeowner insurance, manufactured home insurance, fire and allied lines, standard risk automobile and homeowner insurance, and a limited amount of commercial insurance, including auto, church and businessowner insurance. Mutual is also a direct writer of farmowner insurance. Specialty and AVIC are direct writers of nonstandard risk automobile insurance.
Under the Pooling Agreement, each participant cedes premiums, losses, and underwriting expenses on all of their direct property casualty business to Mutual, and Mutual in turn retrocedes to each participant a specified portion of premiums, losses, and underwriting expenses based on each participant’s pooling percentage. The Mutual Group’s direct property casualty business (together with the property casualty business ceded by the Company) is included in the pool.
As a result of the Pooling Agreement, the Company had a receivable of $9,321,639 from and a payable of $714,555 to the Mutual Group at December 31, 2005 and 2004, respectively, for transactions originating in December and settled the following month.
The Company incurred catastrophe losses of $11.6 million, $9.2 million, and $7.9 million in 2005, 2004, and 2003, respectively. These losses resulted in reductions to the Company’s net income of approximately $0.09, $0.07, and $0.06 per diluted share, after reinsurance and taxes in the respective years.
The Boards of Directors of the Mutual Group and of the Company’s property casualty insurance subsidiaries have established the pool participation percentages and must approve any changes in such participation. The Alabama Insurance Department reviewed the Pooling Agreement and the Department determined that the implementation of the Pooling Agreement did not require the Department’s approval.
Should any member of the affiliated group be unable to meet its obligation on a claim for a policy written by the Company’s property casualty subsidiaries, the obligation to pay the claim would remain with the Company’s subsidiaries. The participation of the Company in the Pooling Agreement may be changed or terminated without the consent or approval of the stockholders, and the Pooling Agreement may be terminated only by mutual agreement of the parties in writing. Any such termination, or a change in the Company’s allocated share of the pooled business, inclusion of riskier business or certain types of reinsurance assumed in the pool, or other changes to the Pooling Agreement, could have a material adverse impact on the Company’s earnings. Participants’ respective abilities to share in the pooled business are subject to regulatory capital requirements.
Mutual owns 42.7%, Fire owns 11.4% and General owns 0.8% of the Company’s common stock. The Board of Directors of the Company consists of eleven members, six of whom serve as Directors of Mutual, Fire and General and two of whom at December 31, 2005 were executive officers of the Company. One of the Company’s directors and most of the Company’s executive officers, including the Company’s President, also hold the same positions with Mutual, Fire, General and Specialty. The Company paid stockholder dividends to the Mutual Group totaling $17,159,686 in 2005, $15,109,690 in 2004 and $13,741,391 in 2003.
The Mutual Group and the Company’s insurance subsidiaries are considered an insurance company holding system with Mutual being the controlling party under the Alabama Insurance Holding Company Systems Regulatory Act and their activities and transactions are subject to reporting, examination and regulation thereunder.
In 1997, Mutual established a revolving line of credit with Financial of $20 million at a rate of interest equal to the one-month London Interbank Offered Rate (LIBOR) plus .75%. No balance was outstanding at either December 31, 2005 or 2004. No interest was paid to Financial related to this line of credit in 2005, 2004 or 2003.
In 1999, Realty secured a line of credit with Financial of $250,000 with interest payable monthly at the Company’s commercial paper rate then applicable plus .35%. No balance was outstanding at either December 31, 2005 or 2004. No interest was paid to Financial related to this line of credit in 2005, 2004 or 2003.
Also, during 1999, Builders established a line of credit with Financial of $5 million with interest payable monthly at the Company’s commercial paper rate then applicable plus 1.00%. The unpaid balance on this line of credit was $4,020,917 and $2,506,774 at December 31, 2005 and 2004, respectively. Interest paid to Financial in 2005 and in 2004 subsequent to the sale of Builders to Southern was $162,461 and $41,334, respectively.
The Company’s commercial paper is guaranteed by Mutual and Fire. The Company paid fees of $50,000 and $25,000 to Mutual and Fire, respectively, for their guarantees in 2005 and 2004.
Periodically, certain of the Company’s subsidiaries have purchased property insurance and general liability insurance protection from Mutual and Fire. The annual premium paid for such policies totaled approximately $19,300 in 2004 and $19,600 in 2003. No premiums were paid to Mutual or Fire for policies of these types in 2005.
Builders contracts with the Mutual Group for the construction of certain commercial facilities. The Mutual Group paid $6,240 in the first two months of 2004 and $299,471 in 2003 to Builders under such contracts. Builders also received $1,429 in rental income from the Mutual Group during 2004.
The Company periodically has investment transactions with the Mutual Group. In 2004, the Company bought one security at fair value of $3,094. In addition, during 2003, the Company sold seven securities to the Mutual Group at fair value for a loss of $1,128,328. No such transactions occurred during 2005. The Company is also a partner in Alfa Investors Partnership with the Mutual Group. The amount contributed to the partnership was $36.3 million and $33.1 million at December 31, 2005 and 2004, respectively. The Company had committed to fund up to $3.2 million additional investment in the partnership at December 31, 2005. The Company received distributions from the partnership of $1.2 million and $3.5 million in 2005 and 2004, respectively. In 2000, the Company became a member in Alfa Ventures II, LLC with the Mutual Group. The amount contributed to the limited liability company was approximately $1.9 million at both December 31, 2005 and 2004, respectively. The Company received distributions from this partnership of $3,002,218 in 2005 and $479,974 in 2004.
The Company’s life subsidiary is a general partner in two investment partnerships with a trust created by Mutual and Fire. The carrying value of the partnerships was $986,658 and $931,384 at December 31, 2005 and 2004, respectively.
On December 31, 2005, the Company completed the sale of Financial’s leasing division, OFC Capital, to OFC Servicing Corporation, a subsidiary of MidCountry. Included in other long-term investments in affiliates is a note receivable of $55.5 million related to this transaction.
Unrealized investment gains and losses are based on fair values that were determined using nationally recognized pricing services, broker/dealers securities firms and market makers.
Management analyzes net unrealized losses on investments for impairment. The following table shows the Company’s net unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005:
There were 53 equity positions with unrealized losses at December 31, 2005. No single position comprised over 12% of the gross unrealized losses at that date.
The Company’s fixed maturity portfolio is predominantly comprised of investment grade securities. At December 31, 2005, approximately $26.3 million in fixed maturities (1.9% of the total fixed maturity portfolio) are considered below investment grade. The Company considers bonds with a quality rating of BB+ and below, based on Standard & Poor’s rating scale, to be below investment grade.
Proceeds from sales of equity securities were $137,282,425 in 2005, $167,267,526 in 2004 and $126,036,887 in 2003. Gross gains of $14,545,779 in 2005, $20,503,986 in 2004 and
$10,785,331 in 2003 and gross losses of $2,847,685 in 2005, $3,063,865 in 2004 and $4,488,106 in 2003 were realized on those sales. The Company also recorded a loss of approximately $1,004,197 in 2005 and $953,349 in 2003 for equity securities whose valuation was deemed to be an other than temporary decline. The Company recorded no such writedowns during 2004.
The Company’s commercial lease portfolio totaled approximately $2.5 million and $4.8 million at December 31, 2005 and 2004, respectively. The majority of the commercial lease portfolio was reclassified to Assets Classified as Held for Sale at December 31, 2004 and subsequently sold in the fourth quarter of 2005 (refer to Note 17-Business Combinations and Divestitures). During 2005, 2004 and 2003, the Company charged off leases totaling $1,415,578, $8,303,396 and $2,265,023, respectively. At December 31, 2005, the Company had an allowance for losses of $8,083,758 on the lease portfolio. At December 31, 2004, the allowance for losses on the lease portfolio was $9,727,546 including $3,553,763 on assets classified as held for sale. The Company has estimated the fair value of the commercial lease portfolio to be approximately $2.5 million and $5.0 million at December 31, 2005 and 2004, respectively. The estimated fair value of the lease portfolio at December 31, 2005 approximates carrying value after allowing for estimated lease losses. At December 31, 2004, the estimated fair value of the lease portfolio was determined by discounting the estimated future cash flows from the lease portfolio at 8.5%, the current interest rate offered for similar leases, and after allowing for estimated lease losses. Assets leased to affiliated companies are expected to be held until the lease terminates and, therefore, fair value is assumed to equal net cost. The Company had impaired leases of $1,101,050 and $1,173,593 subject to individual valuation at December 31, 2005 and
2004, respectively. Leases that are more than 90 days late are placed in a nonaccrual status and totaled $9,881,175 and $8,571,638 at December 31, 2005 and 2004, respectively. Repossessed assets, net of allowances for losses on disposal, included in other assets were $350,156 and $897,118 at December 31, 2005 and 2004, respectively.
investments in low-income housing partnerships of $4.1 million in 2005 and $10.9 million in 2004. In addition, the Company’s investment in MidCountry was approximately $53.3 million, $51.5 million and $14.4 million at December 31, 2005, 2004 and 2003, respectively. Net investment income from MidCountry was $1,153,811, $540,189 and $965,229, respectively in 2005, 2004 and 2003.
Other Investments: Included in the Company’s other long-term investments is its leased asset portfolio (refer to Note 11-Operating Leases) and a position in Waveland NCO Alabama Ventures, LLC, a certified capital company that is an investment premium tax credit program sanctioned by the State of Alabama. This investment is carried at its unpaid principal balance of $2.9 million at December 31, 2005. Principal and interest are received in accordance with a contractual agreement and repayment of principal is protected by strict guidelines imposed by the governing agency. Also included within other long-term investments to affiliates is a note receivable from OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry, for $55,543,362 resulting from the sale of OFC Capital (refer to Note 18-Business Combinations and Divestitures). The leased asset portfolio and the note receivable are carried at the net book value.
Short-term investments are reflected at fair value and are comprised almost exclusively of money market funds and are not discounted due to their liquidity and short-term nature. Therefore, the Company considers the fair value of its short-term investments to be equal to cost.
The composition of the liability for future policy benefits and life and health claim reserves and the more significant assumptions used in its calculation are as follows:
For the year ended December 31, 2005, premiums under individual ordinary life insurance participating policies were $5,176,439, or 4% of total premiums collected. The Company accounts for its policyholder dividends based upon dividends apportioned for payment for the next year plus any adjustments for dividends paid differently from those apportioned in the prior year. Total policyholder dividends incurred for 2005 were $4,009,119. The Company paid dividends in the amount of $3,963,044 during 2005 to policyholders and did not allocate any additional income to such policyholders. The Company did not issue any participating policies during 2005. The amount of insurance inforce on participating policies represents 1% of ordinary life insurance inforce or approximately $236 million.
There are inherent uncertainties in reserving for unpaid losses. Management’s philosophy has been to establish reserves at a high level of confidence. The liability for estimated unpaid losses and loss adjustment expenses is based on a detailed evaluation of reported losses and of estimates of incurred but not reported losses. Adjustments to the liability based on subsequent developments are included in current operations. The estimated cost of loss and loss adjustment expenses attributable to insured events of prior years increased by approximately $4.1 million during 2005 as a result of re-estimation of unpaid losses and loss adjustment expenses. Increases or decreases of this nature occur as the result of claim settlements during the current year, and as additional information is received regarding individual claims, causing changes from the original estimates of the cost of these claims. Recent loss development trends are also taken into account in evaluating the overall adequacy of unpaid losses and loss adjustment expenses. The Company is primarily an insurer of private passenger motor vehicles and of single-family homes and has limited exposure for difficult-to-estimate claims such as environmental, product and general liability claims. The Company does not believe that any such claims will have a material impact on the Company’s liquidity, results of operations, cash flows or financial condition. Deducted from the liability for estimated unpaid losses and loss adjustment expenses are the Company’s estimates of salvage and subrogation recoverable of approximately $9.8 million and $10.1 million at December 31, 2005 and 2004, respectively. The table below summarizes the 2005 changes in estimated loss reserves by component and period in thousands of dollars.
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision for income taxes is as follows:
In addition, the Company had $20.9 million and $15.9 million in short-term debt outstanding to affiliates at December 31, 2005 and 2004, respectively, with interest payable monthly at rates established using the existing commercial paper rate and renewable for multiples of 30-day periods at the commercial paper rate then applicable. Due to the short-term nature of the Company’s outstanding debt to affiliates, the fair value approximates the carrying value.
Certain legal proceedings are in process at December 31, 2005. Costs for these and similar legal proceedings, including accruals for outstanding cases, totaled approximately $2.2 million in 2005, $2.2 million in 2004, and $1.1 million in 2003. These proceedings involve alleged breaches of contract, torts, including bad faith and fraud claims, and miscellaneous other causes of action. These lawsuits involve claims for unspecified amounts of compensatory damages, mental anguish damages, and punitive damages.
Approximately 17 legal proceedings against the Company’s life subsidiary were in process at December 31, 2005. Of the 17 proceedings, seven were filed in 2004, five were filed in 2003, four were filed in 1999, and one was filed in 1996.
Contractual Obligations: The Company has a limited number of contractual obligations in the form of long-term debt and leases. These leases have primarily been originated by its insurance subsidiaries and Vision. Operating leases supporting the corporate operations are the responsibility of Mutual, an affiliate. In turn, the Company reimburses Mutual monthly for a portion of these and other expenses based on a management and operating agreement. There are currently no plans to change the structure of this agreement. The Company’s contractual obligations at December 31, 2005 are summarized below:
At December 31, 2005, the Company had repurchased a total of 8,266,623 shares at a cost of $65,383,384 and due to the exercise of stock options had reissued 2,850,815 shares at a cost of $14,726,132 under this program. In addition, the Company began funding its dividend reinvestment plan through the sale of treasury stock during 2002 and therefore had reissued an additional 1,607,767 shares at a cost of $9,679,875 at December 31, 2005.
These transactions increased the total number of shares outstanding to 80,284,018 shares.
Financial leases certain property and equipment to the Company’s subsidiaries, Mutual and its affiliates (refer to Note 3-Related Party Transactions) and to third parties under operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. Total rental income for the years ended December 31, 2005, 2004 and 2003 was $3,905,441, $4,093,525 and $4,702,117, respectively. No contingent rentals have been included in income. Similarly, the Company recorded depreciation expense on leased assets within the Noninsurance segment of $2,853,390, $2,903,678 and $3,118,034 in 2005, 2004 and 2003, respectively. The cost, accumulated depreciation and net book value of major classes of leased property at December 31, 2005 were:
The Company leases certain office facilities and equipment from Financial and third parties under various operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. These leases expire at various dates through 2010. Vision’s office facility lease agreement contains scheduled rent increases over the term of the lease. At December 31, 2005, the aggregate minimum rental payments to be made under leases having initial or remaining lease terms in excess of one year are $1,172,572 in 2006, $964,669 in 2007, $830,802 in 2008, $698,729 in 2009, $332,606 in 2010 and $0 thereafter. Certain leases are subject to allocation under a Management and Operating Agreement (refer to Note 3-Related Party Transactions) and the Pooling Agreement (refer to Note 2-Pooling Agreement). Lease expense incurred for these leases, prior to allocation, was $1,535,480 in 2005, $549,922 in 2004 and $620,800 in 2003.
Future minimum lease payments to be received on capital leases including interest at December 31, 2005 are $1,498,783 in 2006, $1,135,883 in 2007, $796,275 in 2008, $211,555 in 2009, and $0 in 2010. Future minimum lease receivables do not include contingent rentals.
The Company leases certain equipment under agreements that are classified as capital leases. The cost of equipment under capital leases included in other assets was $185,443 and $0 at December 31, 2005 and 2004, respectively. Accumulated amortization of the leased equipment at December 31, 2005 and 2004 was $60,715 and $0, respectively. Amortization of assets under capital leases is included in depreciation expense. At December 31, 2005, future minimum lease payments required under the capital leases are $124,858 in 2006, $21,358 in 2007 and $0 thereafter.
Life reinsures portions of its risks with other insurers. While the amount retained on an individual life will vary depending upon age and mortality prospects of the risk. Life generally will not retain more than $500,000 of individual life insurance on a single risk with the exception of COLI and group policies where the retention is limited to $100,000 per individual. Life has reinsured approximately $2,545,947,598 of its life insurance inforce with other insurance companies and has taken reserve credits for approximately $7,996,836 on account of such reinsurance at December 31, 2005. Amounts paid or deemed to have been paid for Life’s reinsured contracts are recorded as reinsurance receivables. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
Under the 1993 and 2005 Plans, options ratably become exercisable annually over three years and expire ten years from the date of the award. Summarized information for stock option grants is as follows:
The weighted-average grant-date fair value of options granted for the year was $6.09 in 2005, $5.69 in 2004 and $4.96 in 2003.
The following table summarizes information about stock options outstanding and exercisable at December 31, 2005:
The Company uses the intrinsic value based method to determine the value of options granted under the 1993 Plan. Under the intrinsic value based method, if options are granted at the market value of the common stock on the grant date, no compensation cost is recognized. The Company uses the fair value method to determine the value of options granted under the 2005 plan. The fair value method measures options at fair value on the grant date using an option-pricing model and compensation cost is recognized. Compensation cost for options with graded vesting is recognized using the straight-line method over the three year vesting period. The Company recognized compensation cost related to options of $234,542 in 2005, $146,888 in 2004 and $167,510 in 2003. Current and prior year expense includes costs related to dividend equivalents on options granted in prior years.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model based on the following weighted-average (or range) assumptions:
Risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury note yield rate in effect on the date of the grant.
Expected volatility is based on historical volatility of the Company’s shares.
As discussed in Note 19-Financial Accounting Developments, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R in December 2004, which changed the accounting for stock-based compensation, requiring companies to expense stock options and other equity awards based on their grant-date fair values.
The Company recorded goodwill related to the purchase of Vision in the amount of $13.9 million and other intangible assets in the amount of $9.1 million. Vision is reported in the noninsurance segment. Refer to Note 17-Business Combinations and Divestitures for further discussions regarding the business combination.
As of December 31, 2005, other intangible assets by asset class are as follows:
The cost of other intangible assets is being amortized over a range of 5 to 20 years, with a weighted average original life of 17.5 years. Amortization expenses for 2005 were $683,400. Amortization expense for intangible assets is estimated to be $683,400 in 2006, $683,400 in 2007, $683,400 in 2008, $683,400 in 2009 and $379,400 in 2010.
On January 3, 2005, the Company completed the acquisition of Vision, a managing general agency, by acquiring all of the member’s equity of Vision for a total purchase price of $24.6 million. Vision’s results of operations have been included in the consolidated financial statements since the date of acquisition. The Company has deemed this acquisition to be immaterial to its overall financial position.
The aggregate purchase price of $24.6 million consisted of $15.3 million in cash, 325,035 non-registered shares of common stock of the Company valued at $5 million, and contingent consideration of $4.3 million.
The Company has agreed to pay additional consideration in future periods, based upon the attainment of defined operating objectives by the acquired entity. At December 31, 2005, maximum potential future consideration pursuant to such arrangements, to be resolved over the four years ending December 31, 2009, is $11.2 million. The probable or expected contingency payout is recorded at $4.3 million and is included in other liabilities in the consolidated balance sheet.
On December 30, 2005, the Company amended the LLC Interest Purchase Agreement dated August 2004. The amendment changed the earnout target provisions for the four years beginning January 1, 2006 and ending December 31, 2009.
On December 31, 2005, the Company completed the sale of a substantial portion of its commercial lease portfolio and other assets, net of related liabilities, to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry. The Company’s commercial leasing division operated under the name OFC Capital. OFC Capital’s results of operations have been included in the consolidated financial statements in the Noninsurance segment through divestiture. This transaction was subject to certain regulatory approvals, including from the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, which were received during the fourth quarter of 2005.
Beginning in 2006, OFC Servicing Corporation will service the Company’s retained commercial lease portfolio. The commercial leasing activities will continue to be reported in the Noninsurance segment.
APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees and non-employees, including grants of stock options, to be recognized in the income statement based on fair value at grant date. Pro forma disclosure will no longer be an alternative.
SFAS 123(R) permits public companies to adopt its requirement using one of two methods:
A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date.
A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures, either (a) all prior periods presented or (b) prior interim periods of the year of adoption.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement for APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary changes in accounting principles be recognized retrospectively to financial statements for prior periods,
In June 2005, the FASB issued a final FASB Staff Position (FSP) EITF 03-1-a (retitled FSP FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments) which will replace the guidance set forth in paragraphs 10-18 of EITF Issue No. 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. This staff position has not had a significant impact on the Company’s financial position or results of operations.
In June 2005, the FASB ratified the consensus on EITF Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights. This Issue affects accounting by general partners evaluating whether to consolidate limited partnerships. The EITF agreed on a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate. The presumption of general-partner control would be overcome only when the limited partners have either “kick-out rights” or “participating rights”. This guidance was effective after June 29, 2005 for all new limited partnerships formed and for existing limited partnership agreements for which the partnership agreements are modified. For general partners in all other limited partnerships, the guidance in this Issue is effective no later than the beginning of the first reporting period in fiscal years beginning after December 31, 2005, and application of either one of two transition methods described in the Issue would be acceptable. During the fourth quarter of 2005, two limited partnerships in which the Company’s life subsidiary has been a general partner with one percent ownership interests were modified to become general partnerships. Consequently, the Company expects EITF Issue No. 04-5 to continue to have no significant impact on the Company’s financial position and results of operations.
In November 2005, the FASB issued FSP Nos. FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment. The FSP 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. The guidance in the FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The Company has reviewed the guidance of FSP Nos. FAS 115-1 and 124-1 and has determined that the adoption of the FSP on January 1, 2006 will not have a significant impact on the Company’s financial position or results of operations.
Effective January 1, 2006, the Pooling Agreement was amended to remove Specialty from the coinsurance allocation and update the limits and participation levels. The Company’s lower catastrophe pool limit increased $3.3 million to $21.2 million and the upper catastrophe pool limit increased $81.8 million to $525.5 million (refer to Note 2-Pooling Agreement).