(b) Common shares outstanding exclude non-vested restricted shares of 45, 90 and 134 for 2005, 2004 and 2003, respectively.
(c) The results of the Assumed Agency Business’s operations and its balance sheet data are included in the Infinity figures as of and for the twelve-month periods ended 2005, 2004 and 2003.
Underwriting margins remained strong in 2005 with a reported GAAP combined ratio of 88.6%, down slightly from the 89.1% reported for 2004. Underwriting results in 2005 and 2004 benefited from $32.8 million and $14.5 million, respectively, of favorable development on prior year accident year reserves. Excluding the favorable development, Infinity’s combined ratio increased slightly from 90.8% to 92.0%. The increase is primarily a result of significant growth in new business writings, which typically have higher loss and LAE ratios than renewal business, in Florida and in several of Infinity’s twelve Remaining Focus States. Infinity had limited exposure to losses from the hurricanes in both 2005 and 2004. Total catastrophe related losses were $2.3 million and $1.6 million in 2005 and 2004, respectively.
Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. Infinity estimates liabilities for the costs of losses and LAE for both reported and unreported (IBNR) claims based on historical trends in the following key assumptions adjusted for deviations in such trends:
Where deviations from historical trends in these key items exist, when possible, quantitative and qualitative modifications to, or selections of, such factors are made to reflect such deviations. Management analyzes the adequacy of reserves using actuarial
Factors that can significantly affect actual frequency include, among others, changes in weather and class of driver. Estimates of average frequency can be affected by changes in claims settlement and reserving practices. Loss severity can be affected by auto repair and medical cost inflation, jury awards and changes in policy limit profiles. Estimation of LAE reserves is subject to variation from factors such as the use of outside adjusters, frequency of lawsuits, claims staffing and experience levels.
Management believes that Infinity’s relatively low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity. For example, approximately 84% of policies included within the nonstandard book of business include only the state-mandated minimum policy limits for bodily injury and property damage, which somewhat mitigates the challenge of estimating average severity. These low limits tend to reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout.
Ultimate loss estimates usually experience the greatest adjustment within the first twelve months after the accident year. Accordingly, the highest degree of uncertainty is associated with reserves for the current accident year because the current accident year contains the greatest proportion of losses that have not been reported or settled, and these elements must be estimated as of the current reporting date. The proportion of losses with these characteristics diminishes in subsequent years.
Applying the four-year historical variances calculated above to the current 2005 accident year’s estimate of ultimate losses would yield an indication of sensitivity to held reserves from $(22.8) million to $21.1 million, or about (3.7)% to 3.4% of held reserves, generating an impact to after-tax income of $14.8 million to $(13.7) million, respectively. The final outcome may fall below or above these amounts.
The following tables present the development of Infinity’s loss reserves, net of reinsurance, on a GAAP basis for the calendar years 1995 through 2005. The Infinity table includes the loss reserves of the NSA Group through December 31, 2002, the addition of the Assumed Agency Business on January 1, 2003, and those of Infinity combined for 2003 and all subsequent years. The top line of each table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for the indicated years. The next line, captioned Liability for Unpaid Losses and LAE - as re-estimated at December 31, 2005, shows the re-estimated liability as of December 31, 2005. The remainder of the table presents intervening development as percentages of the initially estimated liability. The development results from additional information and experience in subsequent years. The middle line shows a cumulative deficiency (redundancy) which represents the aggregate percentage increase (decrease) in the liability initially estimated. The lower portion of the table indicates the cumulative amounts paid as of successive periods as a percentage of the original loss reserve liability.
These tables do not present accident or policy year development data. Furthermore, in evaluating the re-estimated liability and cumulative deficiency (redundancy), it should be noted that each percentage includes the effects of changes in amounts for prior periods. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on these tables.
Management regularly evaluates for potential impairment each security position that (i) has a fair value of less than 80% of its book value or (ii) the unrealized loss exceeds $100,000, as well as (iii) each position held for which one or more impairment charges have been recorded in the past or (iv) other positions held related to an issuer of a previously impaired security. The process of evaluation includes assessments of each item listed above. Since it is not possible to accurately predict if or when a specific security will become other than temporarily impaired, total impairment charges could be material to the results of operations in a future period. However, management believes that it is not likely that such impairment charges will have a significant effect on Infinity’s liquidity.
In February 2006, Infinity increased its quarterly dividend to $.075 per share from $.06 per share. On an annual basis, Infinity’s dividend payments will be approximately $6.2 million.
In January 2005, the Board of Directors authorized a share repurchase program expiring on December 31, 2007 whereby the Company may repurchase up to an aggregate amount of $50 million of its outstanding common shares. During 2005, Infinity repurchased 29,720 shares at an average cost of $33.59.
Infinity and its insurance subsidiaries’ contractual obligations as of December 31, 2005 are (in thousands):
Infinity’s Audit Committee has approved investment guidelines for the Company and its wholly-owned subsidiaries. The policy specifically addresses overall investment objectives, permissible assets, prohibited assets, permitted exceptions to the policy and credit quality.
Additionally, Infinity employs an independent company, American Money Management (“AMM”), to conduct, in accordance with the Company’s investment guidelines, all of the investment purchases and sales for the Company and its insurance subsidiaries. The Company’s Chief Financial Officer and the Audit Committee, at least quarterly, review the performance of the portfolio management and AMM’s compliance with the Company’s investment guidelines.
Infinity’s consolidated investment portfolio at December 31, 2005 contained $1.3 billion in fixed maturity securities and $59.7 million in equity securities, all carried at fair value with unrealized gains and losses reported as a separate component of shareholder’s equity on an after-tax basis. At December 31, 2005, Infinity had pretax net unrealized losses of $4.9 million on fixed maturities and pretax unrealized losses of $0.7 million on equity securities.
Investments in mortgage-backed securities (“MBS”) represented approximately one-fourth of Infinity’s fixed maturity portfolio at December 31, 2005. MBS are, in periods of rising interest rates, subject to significant extension risk due to the fact that mortgages may be repaid more slowly than expected as borrowers postpone refinancing in anticipation of lower fixed rates in the
The table below sets forth the scheduled maturities of fixed maturity securities at December 31, 2005 based on their fair values. Securities that do not have a single maturity date are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
The fair values of Infinity’s fixed maturity investments fluctuate in response to changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.
The following table summarizes the estimated effects of hypothetical increases and decreases in interest rates on Infinity’s fixed maturity portfolio and long-term debt. It is assumed that the effects are realized immediately upon the change in interest rates. The hypothetical changes in market interest rates do not reflect what could be deemed best or worst case scenarios. Variations in market interest rates could produce significant changes in the timing of repayments due to prepayment options available. For these reasons, actual results might differ from those reflected in the table.
The following table shows Infinity’s bonds and redeemable preferred stocks, by NAIC designation and comparable Standard & Poor’s Corporation rating as of December 31, 2005. (in thousands)
Equity price risk is the potential economic loss from adverse changes in equity security prices. Infinity’s exposure to equity price risk is limited as its equity investments comprise only 4.3% of its total investment portfolio. Two-thirds of the equity holdings are common stocks concentrated in the media and healthcare industries, while the largest holding is $5.1 million or 8.5% of the $59.7 million portfolio. The five largest investments, out of a total of 33 investments, comprise 35% of the total equity portfolio. Holdings include 29 common stocks, with an average beta of 1.04, and four preferred stocks.
Goodwill carried on Infinity’s balance sheet represents the excess of AFG’s carrying value over tangible assets in the NSA Group and the Assumed Agency Business at the date of transfer to Infinity in contemplation of Infinity’s initial public offering in early 2003. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Infinity performs impairment test procedures on an annual basis. These procedures require Infinity to calculate the fair value of goodwill, compare the result to its carrying value and record the amount of any shortfall as an impairment charge. Infinity performed this test as of October 1, 2005 using a variety of methods, including estimates of future discounted cash flows and comparisons of the market value of Infinity to its major competitors as well as the overall market. The October 1, 2005 test results indicated that there was no impairment at that date. Infinity intends to perform this test annually each October 1.
(1) 2005, 2004 and 2003 excludes $9.8 million, $16.4 million and $13.5 million, respectively, of premiums written on behalf of other companies. 2005, 2004 and 2003 also exclude $4.3 million, $7.2 million and $48.0 million, respectively of unearned premium transfers. Year 2003 includes $22.2 million of premium ceded prior to the assumption from GAI.
Infinity’s personal auto writings in its Top Five Focus States for the year ended December 31, 2005 grew 5.3% compared to 2004. Policies-in-force for these states grew 4.1% compared to December 31, 2004. Although premium growth slowed to 3.6% in the second half of the year in California, Infinity’s largest state, personal auto premiums for the year were 5.6% higher than in 2004. Policies-in-force for California grew 3.1% compared to December 31, 2004. Rate increases on targeted programs in Florida slowed new business production in the second half of the year, but the strong growth in the first half of the year resulted in annual premium growth of 22.4% while policies-in-force grew 20.4%. Georgia also had positive growth in both premium and policy counts of 9.7% and 9.5% respectively.
Personal auto premiums and policy counts declined at December 31, 2005, in both Pennsylvania and Connecticut compared to December 31, 2004. The premium decline in Pennsylvania of 14.8% was a result of certain competitors taking rate decreases and implementing aggressive commission incentives. In Connecticut, Infinity worked throughout the year to get a replacement product for the business written through GAI and assumed by Infinity approved by the Department of Insurance. This product was approved early in the third quarter. However, premiums declined during the year as Infinity was not accepting new business in the old program. In the fourth quarter of 2005, Infinity sold the renewal rights on the old Connecticut program to an unaffiliated insurance carrier. However, Infinity will continue to focus on growth in Connecticut through its recently filed new programs.
In the twelve Remaining Focus States, personal auto premiums and policies-in-force grew 26.4% and 17.8% compared to December 31, 2004, respectively. Eight of the twelve states had positive premium growth for the year, with Alabama, Arizona, Missouri, Ohio, South Carolina, Texas and Virginia all posting double-digit growth.
Earned premiums increased 10.2% during the twelve months ended December 31, 2005, partially due to the elimination of the physical damage quota share agreement at December 31, 2004. Excluding the effect of this agreement, earned premiums grew at a more modest 3.9%.
Gross written premiums for the year ended December 31, 2004 declined 2.7% compared to 2003. Although Infinity worked during the year to introduce new programs in its Focus States, the growth achieved in selected states was more than offset by a deliberate effort by Infinity to reduce the writings in its Non-Focus States. The introduction of the new programs was evident during the second half of the year as premiums in the Focus States grew 9.0% after declining 4.0% during the first half of the year. During 2004, Infinity implemented 45 rate revisions in various states with an overall rate impact of 2.6% increase.
In the twelve Remaining Focus States, personal auto premiums declined 4.3% during 2004 compared to the year ended December 31, 2003. During the fourth quarter of 2004, the growth rate in these states turned positive as premium from the introduction of 14 new programs in various states accelerated offsetting the decline in older programs. Substantial growth in Alabama, Arizona, South Carolina and Texas contributed to the growth in policies-in-force, which was 10.2% higher at December 31, 2004 compared to the same period in 2003.
Gross written premiums and policies-in-force for Infinity’s commercial vehicle business were relatively flat for the year ended December 31, 2004. In Infinity’s Focus States, commercial vehicle premiums increased 28.7%. However, this growth was offset by a 39.8% decline in premiums in the Non-Focus States, primarily New York. Gross premiums and policies-in-force for the Classic Collector business increased 17.4% and 12.8%, respectively, offset by a decline in the homeowners business. Premiums increased in each of the fourteen Focus States that had an active Classic Collector program.
Earned premiums increased 24.8% during the twelve months ended December 31, 2005, primarily as a result of the reduction in the premiums ceded under the physical damage quota share agreement during December 31, 2004. Excluding the effect of this agreement, earned premiums declined 4.1% as a result of the decline in gross written premiums.
The statutory combined ratio represents the sum of the following ratios: (i) losses and LAE incurred as a percentage of net earned premiums and (ii) underwriting expenses incurred as a percentage of net written premiums. Certain expenses are treated differently under statutory and GAAP accounting principles. Under GAAP, commissions, premium taxes and other variable costs incurred in connection with writing new and renewal business are capitalized as deferred policy acquisition costs and amortized on a pro rata basis over the period in which the related premiums are earned; on a statutory basis these items are expensed as incurred. In addition, costs for computer software developed or obtained for internal use are capitalized under GAAP and amortized over their useful life, rather than expensed as incurred, as required for statutory purposes. Finally, beginning January 1, 2005, statutory accounting principles require corporate litigation expenses, except for class action lawsuits, to be included for purposes of calculating the loss ratio, but are not required to be included on a GAAP basis. As a result, reported development on prior accident year periods will be different on a statutory basis than on a GAAP basis. Beginning January 1, 2006, Infinity will include corporate litigation expenses, except for class action lawsuits, in the GAAP combined ratio, amounts already included in the 2005 statutory combined ratios. Additionally, bad debt charge-offs on agent balances and premium receivables will be included only in the GAAP combined ratios.
The combined ratio in the Non-Focus States remained well above 100%. Earned premiums in these states dropped 61% in 2005 and business in these states represented just 1.5% of Infinity’s total personal auto gross written premium. The increase in the loss and LAE ratio in the Non-Focus States is primarily attributable to unfavorable development on prior accident periods in New York and Louisiana, as well as catastrophe losses in Louisiana.
The combined ratio in the commercial vehicle business decreased 0.6 points with a 1.2 point decline in the loss and LAE ratio, offset by a 0.6 point increase in underwriting expenses. In the fourth quarter of 2004, Infinity strengthened reserves on the commercial vehicle business resulting in a higher loss and LAE ratio compared to the fourth quarter of 2005.
Overall, the statutory combined ratio for the year ended December 31, 2004, decreased 3.9 points compared to 2003. In 2004, Infinity had $14.5 million of favorable development on prior accident period loss and LAE reserves, primarily attributable to California, compared to $11.7 million of unfavorable development in 2003, primarily attributable to New York. Catastrophe related losses were $1.6 million during the 2004 compared with $3.1 million during 2003.
The statutory combined ratio for personal auto insurance for the Top Five Focus States decreased 3.2 points compared to 2003. The loss and LAE ratio dropped 4.7 points primarily as a result of favorable development on prior accident period loss and LAE reserves in California. The underwriting expense ratio for the Top Five Focus States increased 1.4 points compared to 2003 primarily as a result of increased commissions paid to agents and brokers.
The twelve Remaining Focus States’ combined ratio increased 11.0 points, primarily from a 10.7 point increase in the loss and LAE ratio. Approximately 5.3 points of the increase is a result of unfavorable development on prior accident period loss and LAE reserves in Alaska and Missouri. The remaining increase is primarily attributable to an increase in the loss and LAE ratios in Arizona and Texas. Premiums grew 26.4% and 37.3%, respectively, in these two states in 2004 substantially as a result of new writings, which typically have higher loss and LAE ratios than renewal business. Overall, Infinity raised rates 4.4% in the twelve Remaining Focus States, with double-digit increases in several states, to address the increase in combined ratio.
The combined ratio in the commercial vehicle business increased 13.9 points in 2004 primarily as a result of an 11.2 point increase in the loss and LAE ratio. In the fourth quarter of 2004, Infinity strengthened reserves on the commercial vehicle business which resulted in the higher loss and LAE ratio.
Investment income is composed primarily of gross investment revenue, investment management fees and expenses and interest expense incurred on the Quota Share Agreements, as shown in the following table:
Net investment income increased $8.5 million for the twelve-month period ended December 31, 2004 from 2003. This increase was due to (i) the decrease in interest expense associated with the Quota Share Agreements of $4.8 million for the twelve-month period ended December 31, 2004 versus the corresponding 2003 period, due to the lower utilization of the Quota Share Agreements in 2004 as compared to 2003 and (ii) higher gross investment income from a 13.1% increase in average invested assets, partially offset by a decrease in Infinity’s weighted-average gross investment yield from 5.5% to 5.1% for the twelve-month periods ended December 31, 2003 and 2004, respectively.
Infinity recorded realized gains on sales and disposals and impairments for unrealized losses deemed other-than-temporary as follows:
Net realized gains on sales increased in 2005 and 2004 compared to 2003 as Infinity sold securities to utilize a portion of the capital loss carryforward.
The following table reconciles the Company’s GAAP and effective tax rate for the periods ending December 31, 2005, 2004 and 2003.