As of September 30, 2004, the Company’s four insurance subsidiaries were rated A+ (Superior) by A.M. Best Company. Effective October 1, 2004, the Company’s four insurance subsidiaries entered into a new intercompany reinsurance pooling arrangement. Two of the Company’s insurance subsidiaries, Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company, entered into an intercompany reinsurance pooling arrangement which includes substantially all the Company’s commercial and specialty lines business. The Company’s two other insurance subsidiaries, Mobile USA Insurance Company and Liberty American Insurance Company, also entered into an intercompany reinsurance pooling arrangement which substantially includes all the Company’s personal lines segment business. As a result of this arrangement, A.M. Best Company assigned an A- (Excellent) rating to these two companies. The rating of Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company remained at A+.
During 2005, revenue growth from the sale of commercial and personal property and casualty policies was impacted by the following items:
Several products within the commercial and specialty lines segments were identified that did not meet predetermined standards for profitability and were culled resulting in approximately a $20.8 million reduction in gross written premiums;
The product mix shift in personal lines was substantially completed resulting in a $44.9 million reduction in mobile homeowners gross written premium and a $25.7 million increase in the newer construction homeowners gross written premiums;
Introduction of a number of new products, many of which were within the existing sports and fitness market niche in the commercial lines segment.
Notwithstanding the adverse impact of certain of the above items, gross written premium growth remained strong across the Company’s commercial and specialty lines business segment. The Company believes its mixed marketing platform for its product distribution and the creation of value added features not typically found in property and casualty products contribute to generating premium growth above industry averages. Written premium information for the Company’s business segments for the years ended December 31, 2005 and 2004 is as follows:
The Company also generates revenue from its investment portfolio, which approximated $1.9 billion at December 31, 2005, and generated $68.1 million in gross pre-tax investment income during 2005. The Company utilizes external independent professional investment managers with the objective of realizing relatively high levels of investment income while generating competitive after-tax total rates of return within duration and credit quality targets.
Hurricanes Dennis, Katrina, Rita and Wilma caused catastrophic losses during 2005, and the Company also suffered catastrophe losses from a number of hurricanes during 2004. These catastrophe losses, as noted in the table below, impacted both the Company’s
Under the Company’s catastrophe reinsurance programs in place for these hurricanes, the Company had a $3.5 million pre-tax per occurrence loss retention for its personal lines catastrophe losses and a $5.0 million pre-tax per occurrence loss retention for its commercial lines catastrophe losses. Under the loss occurrence provisions of the Company’s commercial lines catastrophe reinsurance program, Hurricane Katrina was treated as two separate loss occurrences. As a result, the Company estimates it has retained a $5.7 million loss. The Company’s net loss retention by hurricane is summarized in the table below:
The Company believes its core strategy of adhering to an underwriting philosophy of sound risk selection and pricing discipline enables the Company to produce loss ratios well below industry averages. The Company monitors certain measures of growth and profitability of each business unit including but not limited to: number of policies written, renewal retention ratios, new business production, pricing, risk selection and loss ratios. Other key financial metrics that are regularly monitored in evaluating financial condition and operating performance include, but are not limited to: level of expenses, investment performance, return on equity, cash flow and capital leverage.
The carrying amount for the Company’s investments approximates their estimated fair value. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from third party broker-dealers. Material assumptions and factors utilized by such broker-dealers in pricing these securities include: future cash flows, constant default rates, recovery rates and any market clearing activity that may have occurred since the prior month-end pricing period. The Company’s total investments include $3.4 million in securities for which there is no readily available independent market price.
The liability for unpaid loss and loss adjustment expenses reflects the Company’s best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. The process of establishing the liability for property and casualty unpaid loss and loss adjustment expenses is a complex and imprecise process, requiring the use of informed estimates and judgments. This liability includes an amount determined on the basis of claim adjusters’ evaluations with respect to insured events that have been reported to the Company and an amount for losses incurred that have not been reported to the Company. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. Estimates for unpaid loss and loss adjustment expenses are based on management’s assessment of known facts and circumstances, review of past loss experience and settlement patterns, and consideration of other factors such as legal, social, and economic developments. These estimates are reviewed regularly and any adjustments resulting therefrom are made in the accounting period in which the adjustment arose.
The table below classifies as of December 31, 2005 the components of the reserve for gross losses and loss expenses (“loss” or “losses”) with respect to major lines of business:
The most significant actuarial assumptions used in determining the Company’s loss reserves are:
This assumption implies that historical claim reporting, handling, and settlement patterns are predictive of future activity and can thus be utilized to forecast ultimate liabilities on unpaid claims. Since the many factors that influence claim activity can change over time and are often difficult to isolate or quantify, the rate at which claims arose in the past and the costs to settle them may not always be representative of what will occur in the future. Key objectives in developing estimates of ultimate losses are to identify aberrations and systemic changes occurring within historical experience and to adjust for them so that the future can be projected on a more reliable basis. Various diagnostic tools are employed, (e.g., ratios of claims paid-to-claims reported and analyses of average claim costs by age of development), and close communication is maintained among the Company’s actuarial, claims and underwriting departments to continually monitor and assess the validity of this assumption.
Ultimate loss ratios (ultimate losses divided by earned premiums) in the current and most recent accident years can be projected from ultimate loss ratios of prior years after adjusting for factors such as trends and pricing changes, to the extent that those factors can be quantified.
This assumption implies consistency in the loss ratio, after adjusting for inflationary factors and other trends that may be affecting losses and/or premiums. Generally accepted actuarial methods employing this expected loss ratio assumption are used to supplement loss reserve indications from standard loss development methods where the validity of the first assumption discussed is incomplete. While this assumption is also subject to validity constraints, it is generally considered to have higher reliability than the first assumption discussed for the current and more recently completed accident years, as changes in rates and pricing can be monitored and loss trends can be derived or inferred from both internal and external sources.
The Company’s methodology is to employ several generally accepted actuarial methods to determine loss reserves, each of which has its own strengths and weaknesses. These methods generally fall into one of the categories described below, or they are hybrids of one or more of them (e.g., Bornhuetter-Ferguson method which blends development and expected methods). The predictive accuracy of any of these methods may vary by line of business, age of development, and credibility of underlying historical experience data. Loss development methods tend to be more accurate where claims data are relatively stable and for older accident years within most lines of business. Expected loss methods and hybrid methods can be more appropriate for more recent accident years. Adjusted historical loss development methods are employed where volatile claims data can be largely attributed to discernable events, such as changes in claim handling procedures. Accordingly, more or less weight is placed on a particular method based on the facts and circumstances at the time the actuarially determined loss reserve estimates are made.
The Company has a loss reserve review committee consisting of the most senior members of actuarial, corporate, claims, underwriting and financial management. This committee meets monthly to review and discuss the various monthly and quarterly actuarial analyses which are performed, as well as to discuss any other factors or trends that may influence the Company’s claims activity. Generally, loss reserves are recorded in accordance with the actuarially determined estimates by line. However, based upon review performed by the loss reserve committee, the committee may make a “management adjustment” to an actuarially determined estimate for a line of business if, in the committee’s collective judgment, factors affecting ultimate losses in a line have not been fully captured or considered by actuarial methods. This may be the case with newer product lines, lines that are growing, and/or lines which may be exposed to claims with latent emergence patterns that extend beyond the credible historical period that the Company has experienced to date. Any such “management adjustment” is documented and reported to the Company’s audit committee. The Company’s loss reserve committee did not establish a
management adjustment as of December 31, 2005. Accordingly, the loss reserves recorded in the financial statements as of December 31, 2005 are equal to the actuarially determined estimate for each line of business.
The carrying amount of goodwill is subject, at a minimum, to an annual impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). This annual test is performed at December 31 of each year or more frequently if events or circumstance change that require the Company to perform the impairment analysis on an interim basis. Goodwill impairment testing requires the evaluation of the fair value of each reporting unit to its carrying value, including the goodwill, and recording of an impairment charge if the carrying amount of the reporting unit exceeds its estimated fair value. The determination of a reporting unit’s fair value is based on management’s best estimate, which includes valuation techniques such as discounted cash flows, market multiples and comparable transactions. Based upon the Company’s annual impairment test as of December 31, 2005, the Company recorded a $25.7 million impairment charge related to the write-down of the entire amount of goodwill arising from the acquisition of the Company’s personal lines segment.
The Company has no off-balance sheet arrangements (as that term is defined in Item 303(a) (4) of Regulation S-K) that have or are reasonably likely to have a current or, as of December 31, 2005, future effect on its financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors as of December 31, 2005.
Prospecting efforts by marketing personnel in conjunction with long term relationships formed by the Company’s marketing Regional Vice Presidents continue to result in additional prospects and increased premium writings, most notably for the Company’s various commercial package and non profit management liability product lines.
Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company’s field organization and preferred agents.
In-force policy counts as of December 31, 2005 versus December 31, 2004 have increased 10.0% and 18.8% for the commercial lines and specialty lines segments, respectively, primarily as a result of the factors discussed above.
The Company ceded 22% of its net written and earned premiums and loss and loss adjustment expenses for policies effective April 1, 2003 through December 31, 2003 and 10% of its commercial and specialty lines net written and earned premiums and loss and loss adjustment expenses for policies becoming effective during 2004. During the years ended December 31, 2005 and 2004, the Company ceded $(0.5) million ($0.2 million for the commercial lines segment and $(0.7) million for the specialty lines segment) and $94.5 million ($77.8 million for the commercial lines segment, $16.9 million for the specialty lines segment, and $(0.2) million for the personal lines segment) of net written premiums, respectively, and $43.7 million ($36.5 million for the commercial lines segment, $7.1 million for the specialty lines segment and $0.1 million for the personal lines segment) and $132.5 million ($103.6 million for the commercial lines segment, $23.4 million for the specialty lines segment, and $5.5 million for the personal lines segment) of net earned premiums, respectively.
On December 31, 2004, the Company terminated a quota share reinsurance agreement under which it ceded 15% of its mobile homeowners and homeowners business (personal lines segment). Upon termination, the Company increased its unearned premium reserve and net written premium by $5.7 million.
Certain of the Company’s reinsurance contracts have reinstatement provisions under which the Company must pay additional reinsurance premiums to reinstate coverage provisions upon utilization of initial reinsurance coverage. During the years ended December 31, 2005 and 2004, the Company accrued $3.7 million ($1.6 million for the commercial lines segment and $2.1 million for the specialty lines segment) and $1.1 million ($0.8 million for the commercial lines segment and $0.3 million for the specialty lines segment), respectively, of reinstatement reinsurance premium under its casualty excess of loss reinsurance treaty, as a result of changes in ultimate loss estimates. The reinstatement premium increased ceded written and earned premiums and reduced net written and earned premiums.
Net Investment Income: Net investment income approximated $63.7 million in 2005 and $43.5 million in 2004. Total investments grew to $1,935.0 million at December 31, 2005 from $1,428.2 million at December 31, 2004. The growth in investment income is primarily due to increased investments which arose from investing net cash flows provided from operating activities. The Company’s average duration of its fixed income portfolio was 4.0 years and 4.1 years at December 31, 2005 and December 31, 2004, respectively. The Company’s taxable equivalent book yield on its fixed income holdings approximated 4.8% at December 31, 2005, compared to 4.7% at December 31, 2004. The Company’s expectation is that the fixed income security taxable equivalent book yield for funds invested during 2006 will approximate 5.25% to 5.75%. This range is based on current interest rates and a continuation of the Company’s asset allocation between taxable and tax-exempt fixed income securities. Net investment income was reduced by $1.5 million and $4.9 million for the years ended December 31, 2005 and 2004, respectively, due to the interest credit on the Funds Held Account balance pursuant to the Company’s quota share reinsurance agreement (see Note 10 to the Company’s consolidated financial statements included with this Form 10-K).
The Company realized net investment gains of $4.2 million and $6.4 million from the sale of fixed maturity and equity securities, respectively, for the year ended December 31, 2004, and $6.1 million and $3.7 million in non-cash realized investment losses for fixed maturity and equity securities, respectively, as a result of the Company’s impairment evaluation. $1.4 million of the $3.7 million non-cash realized investment losses is due to a December 2004 decision to change certain of the Company’s common stock investment managers. As a result of this decision, the Company wrote down certain common stock securities since there was no longer an intent to hold the securities to recovery.
A $22.0 million reduction in hurricane catastrophe losses incurred. During the year ended December 31, 2005, the Company incurred $24.7 million of net loss and loss adjustment expenses related to Hurricanes Dennis, Katrina, Rita and Wilma. During the year ended December 31, 2004, the Company incurred $46.7 million of net loss and loss adjustment expenses related to Hurricanes Charley, Frances, Ivan and Jeanne.
This growth was offset in part as a result of Liberty American Insurance Group, Inc. suspending the acceptance of applications for new personal lines insurance policies the day prior to Hurricane Charley making landfall in Florida to restrict an increase in exposure during hurricane season. It is estimated that gross written premiums were reduced by approximately $9.5 million due to this restriction. The Company resumed underwriting new preferred homeowners business effective January 1, 2005.
The differing percentage changes in net premiums versus gross premiums for the commercial lines, specialty lines and personal lines segments during the year results primarily from the following:
A change in the Company’s reinsurance program whereby, effective April 1, 2003, the Company entered into a Quota Share reinsurance agreement covering substantially all of the Company’s lines of business. Under this agreement:
The Company ceded 22% of its net written premiums and loss and loss adjustment expenses for policies effective April 1, 2003 through December 31, 2003 and 10% of its commercial and specialty lines net written premiums and loss and loss adjustment expenses for policies effective January 1, 2004 through December 31, 2004. During the years ended December 31, 2004 and 2003, the Company ceded $94.5 million and $199.4 million of net written premiums, respectively, and $132.5 million and $116.8 million of net earned premiums, respectively.
• Certain of the Company’s reinsurance contracts have provisions whereby the Company is entitled to a return profit commission based on the ultimate experience of the underlying business ceded to the contracts. Under the terms of these contracts, the Company accrued profit commissions of $15.6 million and $10.5 million for the years ended December 31, 2004 and 2003, respectively. The profit commissions reduce ceded written and earned premiums and increase net written and earned premiums.
Net Realized Investment Gain (Loss): Net realized investment gains were $0.8 million for the years ended December 31, 2004 and 2003. The Company realized net investment gains of $4.2 million and $6.4 million from the sale of fixed maturity and equity securities, respectively, for the year ended December 31, 2004, and $6.1 million and $3.7 million in non-cash realized investment losses for fixed maturity and common stock investments, respectively, as a result of the Company’s impairment evaluation. $1.4 million of the $3.7 million non-cash realized investment losses is due to a December 2004 decision to change certain of the
Company’s common stock investment managers. As a result of this decision the Company wrote down certain common stock securities since there was no longer an intent to hold the securities to recovery.
Other Income: Other income approximated $4.4 million for the year ended December 31, 2004 and $5.5 million for the same period of 2003. Other income primarily consists of commissions earned on brokered personal lines business, and to a lesser extent brokered commercial lines business. The decrease in other income is due primarily to reduced commissions earned on brokered personal lines business due to terminations of certain brokering agreements.
Acceleration of the recognition of $26.0 million of catastrophe reinsurance premium expense, which reduced net earned premiums, due to the utilization of certain of the catastrophe reinsurance coverages. The hurricane losses and associated accelerated catastrophe reinsurance premium expense contributed 8.8 percentage points to the combined ratio.
These increases to the loss and loss adjustment expenses and/or loss ratio were offset in part by:
Additionally, during the years ended December 31, 2004 and 2003, the Company ceded $132.5 million and $116.8 million of net earned premium, respectively, and $59.7 million and $62.7 million in net loss and loss adjustment expenses, respectively, pursuant to a quota share reinsurance agreement (see Premiums).
quota share reinsurance agreement. The quota share reinsurance agreement lowered the reported expense ratio by 3.1 and 2.0 percentage points during 2004 and 2003, respectively.
The Company’s investment objectives are the realization of relatively high levels of after-tax net investment income while generating competitive after-tax total rates of return within a prudent level of risk and within the constraints of maintaining adequate securities in amount and duration to meet the Company’s cash requirements, as well as maintaining and improving the Company’s A.M. Best rating. The Company utilizes external independent professional investment managers for its fixed maturity and equity investments. These investments consist of diversified issuers and issues, and as of December 31, 2005 approximately 90.1% and 8.1% of the total invested assets (total investments plus cash equivalents) on a cost basis consisted of investments in fixed maturity and equity securities, respectively, versus 84.9% and 7.3%, respectively, at December 31, 2004.
Of the total investments in fixed maturity securities, asset backed, mortgage pass-through, and collateralized mortgage obligation securities, on a cost basis, amounted to $138.3 million, $282.3 million and $227.0 million, respectively, as of December 31, 2005 and $96.0 million, $229.6 million and $62.6 million, respectively, as of December 31, 2004.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, except interests in securitized assets, meeting predetermined thresholds to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, based upon its detailed review, or if a decline in value for an equity investment has persisted continuously for nine months, the cost basis of the security is written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other than temporary include, but are not limited to: whether the issuer is in financial distress; the performance of the collateral underlying a secured investment; whether a significant credit rating action has occurred; whether scheduled interest payments have been delayed or missed; whether changes in laws and/or regulations have impacted an issuer or industry; an assessment of the timing of a security’s recovery to fair value; and an ability and intent to hold the security to recovery. The amount of any writedown is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $2.2 million and $2.5 million for the years ended December 31, 2005 and 2004, respectively. The Company attributes these other than temporary declines in fair value primarily to issuer specific conditions, except as noted in the following paragraph.
During 2004 the Company’s Investment Committee (The “Committee”) engaged an investment consulting firm under a full service retainer relationship. The Committee initially directed the investment firm to review the Company’s common stock portfolio and managers with respect to style, diversification and performance. Based upon the results of this review and recommendations of the investment firm, the Committee conducted an investment manager search for a large cap growth and large cap value manager. Upon conclusion of the interview process the Committee decided, in December 2004, to change three of its current common stock managers and engaged a new large cap growth and large cap value manager. As a result of this decision, $1.4 million in non-cash investment losses was realized in the fourth quarter of 2004 due to writing down certain common stock securities, for which there was no longer an intent to hold such securities to recovery of cost.
The Company conducts its impairment evaluation and recognition for interests in securitized assets in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board (the “EITF”). Pursuant to this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $0 million and $7.3 million for the years ended December 31, 2005 and 2004, respectively. These non-cash realized investment losses recognized in 2004 were from investments primarily in collateralized bond obligations which were
impacted by recent years’ non investment grade default rates that were higher than historic averages and from investments in other asset backed securities which experienced extension of cash flows on the underlying collateral.
The Company’s fixed maturity portfolio amounted to $1,761.5 million and $1,299.7 million, as of December 31, 2005 and December 31, 2004, respectively, of which 99.9% and 99.3% of the portfolio as of December 31, 2005 and December 31, 2004, respectively, was comprised of investment grade securities. The Company had fixed maturity investments with gross unrealized losses amounting to $23.5 million and $4.9 million as of December 31, 2005 and December 31, 2004, respectively. Of these amounts, interests in securitized assets had gross unrealized losses amounting to $9.7 million and $1.3 million as of December 31, 2005 and December 31, 2004, respectively. The remaining unrealized losses are attributable largely to market price changes due to interest rate increases, since the investments were purchased, and are not considered to be other than temporary impairments, given the ability and intent to hold the securities to recovery. As discussed above, the Company’s impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the EITF.
The following table identifies the period of time securities with an unrealized loss at December 31, 2005 have continuously been in an unrealized loss position. None of the amounts displayed in the table are due to non-investment grade fixed maturity securities. No issuer of securities or industry represents more than 1.5% and 19.4%, respectively, of the total estimated fair value, or 2.2% and 20.9%, respectively, of the total gross unrealized loss included in the table below. As mentioned above, there are certain risks and uncertainties inherent in the Company’s impairment methodology, including, but not limited to, the financial condition of specific industry sectors and the resultant effect on any such underlying security collateral values and changes in accounting, tax, and/or regulatory requirements which may have an effect on either, or both, the investor and/or the issuer. Should the Company subsequently determine a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included in earnings as a realized loss for the period such determination was made.
$1.2 million of the $5.5 million gross loss on the sale of equity securities for the year ended December 31, 2005 was the result of the liquidation of certain of the Company’s equity portfolios following the Company’s decision to change four of its common stock investment managers. This $1.2 million realized gross loss was in addition to the previously reported $1.4 million impairment loss recognized during the three months ended December 31, 2004 upon the Company’s initial decision to change three of its common stock investment managers and no longer hold the securities to recovery. The remaining gross loss on the sale of fixed maturity and equity securities resulted from the decision to sell securities based upon an assessment of economic
conditions and ongoing portfolio management objectives of attempting to maximize the Company’s after-tax net investment income.
The Company’s financial instruments are subject to the market risk of potential losses from adverse changes in market rates and prices. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. The Company has established, among other criteria, duration, asset quality and asset allocation guidelines for managing its investment portfolio market risk exposure. The Company’s investments are held for purposes other than trading and consist of diversified issuers and issues.
Philadelphia Consolidated Holding Corp. (PCHC) is a holding company whose principal assets currently consist of 100% of the capital stock of its subsidiaries. PCHC’s primary sources of funds are dividends from its subsidiaries, and payments received pursuant to tax allocation agreements with the Insurance Subsidiaries and proceeds from the issuance of shares pursuant to the Company’s Stock Purchase and Performance Based Compensation Plans. For the year ended December 31, 2005, payments to PCHC pursuant to such tax allocation agreements totaled $77.0 million. The payment of dividends to PCHC from the insurance subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania and State of Florida. Accumulated statutory profits or policyholders’ surplus of the insurance subsidiaries from which dividends may be paid totaled $442.7 million at December 31, 2005. Of this amount, the insurance subsidiaries are entitled to pay a total of approximately $162.0 million of dividends in 2006 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida (see Business Regulation). No dividends were paid during 2005. During 2005, PCHC contributed $27.0 million to the surplus of PIIC. During 2005, there were no stock repurchases under the stock repurchase authorization. At December 31, 2005, the remaining stock repurchase authorization is $45.0 million.
The Company produced net cash from operations of $430.7 million in 2005, $390.5 million in 2004 and $298.5 million in 2003. Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses and for the purchase of investments. Cash from operations in 2005 was primarily generated from strong premium growth during such year due to increases in the number of policies written and price increases realized on renewal business. Net loss and loss expense payments were $234.7 million in 2005, $285.9 million in 2004, and $237.4 million in 2003. Net cash from operations also included cash provided from tax savings from the issuance of shares pursuant to stock based compensation plans amounting to $7.0 million, $1.0 million and $0.9 million for 2005, 2004 and 2003, respectively. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
During 2005, the Company experienced catastrophe losses attributable to Hurricanes Dennis, Katrina, Rita and Wilma. The catastrophe losses primarily impacted the Company’s personal lines segment and, to a lesser extent, its commercial lines segment. The gross catastrophe loss and loss adjustment expense estimates as a result of these hurricanes was $72.6 million for the personal lines segment and $54.2 million for the commercial lines segment. Loss estimates may still change in the future due in part to the number of claims which have not yet been completely remediated or for which the property covered by the claim has not been repaired. Under the Company’s catastrophe reinsurance programs in place at the time of these hurricane events, the Company had a $3.5 million pre-tax per occurrence loss retention for its personal lines catastrophe losses and a $5.0 million pre-tax per occurrence loss retention for its commercial lines catastrophe losses. The Company estimates its net aggregate retention losses for the four hurricane events is $24.7 million.
Two of the Company’s insurance subsidiaries are members of the FHLB. A primary advantage of FHLB membership is the ability of members to access credit products from a reliable capital markets provider. The availability of any one member’s access to credit is based upon its FHLB eligible collateral. The insurance subsidiaries in the past have utilized a portion of their borrowing capacity to purchase a diversified portfolio in investment grade floating rate securities. These purchases were funded by floating rate FHLB borrowings to achieve a positive spread between the rate of interest on these securities and borrowing rates. The Company prepaid outstanding FHLB loans during the first quarter of 2005. At December 31, 2005 the insurance subsidiaries’ unused borrowing capacity was $391.2 million. The borrowing capacity will provide an immediately available line of credit.
In the normal course of business, the Company has entered into various reinsurance contracts with unrelated reinsurers. The Company participates in such agreements for the purpose of limiting loss exposure and managing capacity constraints. Reinsurance contracts do not relieve the Company from its obligations to policyholders. To reduce the potential for a write-off of amounts due from reinsurers, the Company evaluates the financial condition of its reinsurers, principally contracts with large reinsurers that are rated at least “A” (Excellent) by A.M. Best Company, regularly monitors its reinsurance receivables and attempts to collect the obligations of its reinsurers on a timely basis. At December 31, 2005, approximately 89.7% of the Company’s reinsurance receivables are either with reinsurers rated “A” (Excellent) or better by A.M. Best Company or are fully collateralized. Approximately $18.8 million of the Company’s reinsurance receivable balances at December 31, 2005 are with Converium Reinsurance North American Inc. (“CRNA”). During the third quarter of 2004, Converium AG (Switzerland), CRNA’s parent company, placed CRNA into an orderly runoff. Of the $18.8 million of reinsurance receivable balances with CRNA, $1.8 million are for receivables on paid losses and $17.0 million are for receivables on case reserves and IBNR. The Company is monitoring CRNA’s ability to pay claims, and at this time, believes that the amounts with CRNA will be collectible.
The Insurance Subsidiaries, which operate under intercompany reinsurance pooling agreements, must have certain levels of surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners (the “NAIC”) suggest that a property and casualty insurer’s ratio of annual statutory net premium written to policyholders’ surplus should not exceed 3-to-1. The ratio of
combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders’ surplus was 1.6-to-1.0 and 1.8-to-1.0 for 2005 and 2004, respectively.
The NAIC’s risk-based capital method is designed to measure the acceptable amount of capital and surplus an insurer should have based on the inherent specific risks of each insurer. The adequacy of a company’s actual capital and surplus is evaluated by a comparison to the risk-based capital results. Insurers failing to meet minimum risk-based capital requirements may be subject to scrutiny by the insurer’s domiciliary insurance department and ultimately rehabilitation or liquidation. As of December 31, 2005, PIIC, PIC, MUSA and LAIC exceeded their minimum risk-based capital requirements of $239.0 million, $12.4 million, $7.2 million and $6.1 million, respectively, by 149%, 268%, 237% and 318%, respectively.
Although there is typically no minimum contractual commitment with insurance contracts, the cash flows displayed in the table above represent the Company’s best estimate as to amount and timing of such.
The Company anticipates that it will acquire in 2006, pursuant to the terms of a Purchase Agreement entered into in 2005, policy renewals, customer lists and other assets relating to an insurance program developed by an insurance brokerage company. The purchase price is (a) $1,500,000, of which $1,000,000 has already been paid to the seller as a deposit, and the $500,000 balance will be paid at closing under the Purchase Agreement, plus (b) an additional amount payable in four installments. The first installment will be equal to the excess of (a) 25% of the Specified Amount (as that term is hereinafter defined) over (b) $500,000, and is payable within a specified period of time after closing. The next three installments are each in the amount of 25% of the Specified Amount, and are payable on the first through third anniversaries, respectively, of the Date on which the first installment is payable. The Specified Amount is the amount of the gross written annual premiums of the policies in force (with certain exceptions) relating to the insurance program referred to above. Each of the installment payments is subject to increase or decrease, based on a formula contained in the Purchase Agreement.
On April 14, 2005 the SEC announced the adoption of a new rule that amends the compliance dates for the adoption of SFAS 123R. Under SFAS 123R, public companies would have been required to implement the standard as of the beginning of the first interim or annual period that begins after June 15, 2005. The SEC’s new rule allows public companies to implement SFAS 123R at the beginning of the next fiscal year after June 15, 2005. The Company intends to adopt the provisions of SFAS 123R effective January 1, 2006.
Consolidated Balance Sheets - As of December 31, 2005 and 2004
Consolidated Statements of Changes in Shareholders’ Equity - For the Years Ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows - For the Years Ended December 31, 2005, 2004, and 2003
Other Than Investments in Related Parties As of December 31, 2005
Supplementary Insurance Information As of and For the Years Ended December 31, 2005, 2004 and 2003
Supplementary Information Concerning Property-Casualty Insurance Operations As of and For the Years Ended December 31, 2005, 2004 and 2003
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Philadelphia Consolidated Holding Corp. and Subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective 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), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective 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). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
Philadelphia Consolidated Holding Corp. (“Philadelphia Insurance”), and its subsidiaries (collectively the “Company”) doing business as Philadelphia Insurance Companies, include four property and casualty insurance companies, Philadelphia Indemnity Insurance Company (“PIIC”) and Philadelphia Insurance Company (“PIC”), which are domiciled in Pennsylvania; and Mobile USA Insurance Company (“MUSA”) and Liberty American Insurance Company (“LAIC”), which are domiciled in Florida (collectively the “Insurance Subsidiaries”); an underwriting manager, Maguire Insurance Agency, Inc.; a managing general agency, Liberty American Insurance Services, Inc.; a premium finance company, Liberty American Premium Finance Company; and an investment subsidiary, PCHC Investment Corp. The Company designs, markets, and underwrites specialty commercial and personal property and casualty insurance products for select target industries or niches including, among others, nonprofit organizations; the health, fitness and wellness industry; select classes of professional liability; the rental car industry; automobile leasing industry; and personal property and casualty insurance products for the homeowners and manufactured housing markets. All marketing, underwriting, claims management, investment, and general administration is provided by the underwriting manager and managing general agency.
The consolidated financial statements include the accounts of the Company prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements requires making 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. Actual results could differ from those estimates. Certain prior years’ amounts have been reclassified for comparative purposes.
Fixed maturity investments, classified as Available for Sale, are carried at market value with the change in unrealized appreciation (depreciation) credited or charged directly to shareholders’ equity, net of applicable deferred income taxes. Income on fixed maturities is recognized on the accrual basis.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for asset backed, mortgage pass-through and collateralized mortgage obligation securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain asset backed, mortgage pass-through and collateralized mortgage obligation security repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Asset backed, mortgage pass-through and collateralized mortgage obligation securities, on a cost basis, amounted to $138.3 million, $282.3 million and $227.0 million, respectively, at December 31, 2005 and $96.0 million, $229.6 million and $62.6 million, respectively, at December 31, 2004.
The Company’s impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Pursuant to this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. Non-cash realized investment losses recorded for the years ended December 31, 2005, 2004 and 2003 were $0 million, $7.3 million, and $9.3 million, respectively, as a result of the Company’s impairment evaluation for investments in securitized assets.
Cash equivalents, consisting of fixed maturity investments with maturities of three months or less when purchased and money market funds, are stated at market value.
The Company performs an annual impairment analysis to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). This annual test is performed at December 31 of each year or more frequently if events or circumstance change that require the Company to perform the impairment analysis on an interim basis.
result of the impairment analysis, the Company recorded a $25.7 million impairment charge during the fourth quarter of 2005 related to the write-down of goodwill arising from the acquisition of the Company’s personal lines segment. (See Note 8)
Premiums are generally earned on a pro rata basis over the terms of the policies. Premiums applicable to the unexpired terms of the policies in-force are reported as unearned premiums. The Company records an allowance for doubtful accounts for premiums receivable balances estimated to be uncollectible. At December 31, 2005 and 2004, the allowance for doubtful accounts amounted to $0.8 million and $0.6 million, respectively.
The Insurance Subsidiaries are subject to state guaranty fund assessments, which provide for the payment of covered claims or meet other insurance obligations from insurance company insolvencies, and other assessments from state insurance facilities. Each state has enacted legislation establishing guaranty funds and other insurance activity related assessments resulting in a variety of assessment methodologies. Expense for guaranty fund and other state insurance facility assessments are recognized when it is probable that an assessment will be imposed, the obligatory event has occurred and the amount of the assessment is reasonably estimatable.
Components of comprehensive income, as detailed in the Consolidated Statements of Operations and Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising during the year was $(8.8) million, $1.9 million and $0.6 million in 2005, 2004 and 2003, respectively. The related tax effect of Reclassification Adjustments was $(3.4) million, $(0.3) million, and $(0.3) million in 2005, 2004 and 2003, respectively.
Under SAP, premiums receivable are considered nonadmitted if determined to be uncollected based upon aging criteria as defined in SAP.
Dividend Restrictions: The Insurance Subsidiaries are subject to various regulatory restrictions which limit the maximum amount of annual shareholder dividends allowed to be paid. The maximum dividend which the Insurance Subsidiaries may pay to Philadelphia Insurance during 2006 without prior approval is $162.0 million. There were no dividends paid for the years ended December 31, 2005 or 2004.
Original cost of equity securities; original cost of fixed maturities adjusted for amortization of premiums and accretion of discounts. All amounts are shown net of impairment losses.
During 2005, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $0.9 million and $5.5 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $63.6 million and $56.5 million, respectively. During 2004, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $1.3 million and $1.9 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $30.7 million and $7.5 million, respectively. During 2003, the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $0.7 million and $0.8 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $20.1 million and $4.4 million, respectively. The decision to sell these securities was based upon management’s assessment of economic conditions.
The Insurance Subsidiaries have investments, principally U.S. Treasury securities and Obligations of States and Political Subdivisions, on deposit with the various states in which they are licensed insurers. The carrying value of the securities on deposit was $15.1 million and $15.3 million as of December 31, 2005 and 2004, respectively.
Additionally, the Insurance Subsidiaries had investments, principally Mortgage Pass-Through securities, which collateralized the borrowings from the Federal Home Loan Bank of Pittsburgh, see Note 11. The carrying value of these investments was $0 million and $46.8 million as of December 31, 2005 and 2004, respectively.
Home Loan Bank of Pittsburgh. At December 31, 2005 and 2004, the carrying value of Federal Home Loan Bank of Pittsburgh common stock was $0.3 million and $1.8 million, respectively.
The Company maintains investments in trust accounts under certain reinsurance agreements with unrelated insurance companies. These investments collateralize the Company’s obligations under the reinsurance agreements. The Company possesses sole responsibility for investment and reinvestment of the trust account assets. All dividends, interest and other income, resulting from investment of these assets are distributed to the Company on a monthly basis. At December 31, 2005 and 2004, the carrying values of these trust fund investments were $1.7 million.
At December 31, 2005, costs incurred for Property and Equipment not yet placed in service was $1.3 million. Amortization of computer software was $2.6 million, $2.1 million and $1.3 million for the years ended December 31, 2005, 2004 and 2003, respectively. Depreciation expense, excluding amortization of computer software, was $2.1 million, $1.3 million and $1.4 million, for the years ended December 31, 2005, 2004 and 2003, respectively.
During the fourth quarter of 2005, the Company recorded a $25.7 million impairment charge related to the write-down of goodwill arising from the acquisition of the Company’s personal lines segment. This loss, which was the same on a pre-tax and after-tax basis, was a result of the Company’s annual evaluation of the carrying value of goodwill. The write-down was determined by comparing the fair value of the Company’s personal lines segment and the implied value of the goodwill with the carrying amounts on the balance sheet. The write-down resulted from changes in business assumptions primarily due to the following: the unprecedented hurricane activity and associated catastrophe losses experienced in 2004 and 2005; the uncertainty of 2006 catastrophe reinsurance renewal rates; the forecasted weather pattern of increased hurricane activity; the decision to change the personal lines segment business model to discontinue writing the mobile homeowners business and target new construction homeowners business; and the disruption in the Florida marketplace.
The increase for accident years 1997 through 2002 is principally attributable to case reserve development above expectations primarily across various professional liability products in the specialty lines segment and general liability and commercial automobile coverages in the commercial lines segment. The decrease for accident year 2003 is principally attributable to better than expected claim frequency, primarily for general liability and commercial automobile coverages in the commercial lines segment.
The Company entering into an agreement with U.S. Bank, N.A. d/b/a Firstar Bank (“Firstar”) relating to residual value insurance policies purchased by Firstar from the Company. Under the terms of the agreement, the Company paid Firstar $27.5 million in satisfaction of any and all claims made or which could have been made by Firstar under the residual value policies. The Company increased the gross and net reserves for loss and loss adjustment expenses from $21.7 million to $27.5 million pursuant to this agreement.
The Company had aggregate borrowings of $0 million and $33.4 million as of December 31, 2005 and 2004, respectively, from the Federal Home Loan Bank of Pittsburgh (“FHLB”). Any outstanding borrowings bear interest at adjusted LIBOR and mature twelve months or less from inception. The proceeds from any outstanding borrowings are invested in asset backed and collateralized mortgage obligation securities to achieve a positive spread between the rate of interest on these securities and the borrowing rates. Due to declining spreads, the Company prepaid all outstanding FHLB loans during the first quarter of 2005.
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2005 and 2004 are as follows (in thousands):
The following table summarizes the differences between the Company’s effective tax rate for financial statement purposes and the federal statutory rate (dollars in thousands):
The number of weighted share equivalents which are anti-dilutive, and therefore, not included in the weighted-average share equivalents outstanding calculation amounted to 372, 72 and 8,190 for the years ended December 31, 2005, 2004 and 2003, respectively.
Under the Plan, the Company may grant stock options and other equity based awards to employees and members of the Board. During 2005 the Company granted stock options and restricted stock awards to certain employees. Stock options are granted for the purchase of common stock at a price not less than the fair market value on the grant date. Stock options are primarily exercisable after the expiration of five years following the grant date and expire ten years following the grant date. Stock options are generally forfeited by participants who terminate employment prior to vesting.
The following table presents certain information regarding stock option plan transactions.
are purchased. The purchase price of shares may be paid by the employee over six years pursuant to the execution of a promissory note. The promissory note(s) are collateralized by such shares purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase Plan, the Company issued 217,806 and 139,998 shares in 2005 and 2004, respectively. The weighted-average fair value of those purchase rights granted in 2005 and 2004 was $4.13 and $2.79, respectively.
Preferred Agents Stock Purchase Plan (“Preferred Agents Plan”): The Preferred Agents Plan has been established for the benefit of eligible Preferred Agents. The aggregate maximum number of shares that may be issued pursuant to the Preferred Agents Plan is 600,000. Eligible Preferred Agents during designated offering periods may either remit cash or have the Company withhold from commissions or other compensation amounts to be used for the purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Preferred Agents Plan, the Company issued 62,997 shares in 2004. The weighted-average fair value of those purchase rights granted in 2004 was $2.79. There were no shares issued under the Preferred Agent Plan during 2005.
During the three years ended December 31, 2005, the Company repurchased 30,000 shares for approximately $0.3 million under its stock repurchase authorization. At December 31, 2005, $45.0 million remains under a $75.3 million stock purchase authorization.
The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance receivables (excluding amounts ceded to voluntary and mandatory pool mechanisms) that are with companies rated “A” (Excellent) or better by A.M. Best Company or are fully collateralized was 89.7% and 95.8% as of December 31, 2005 and 2004, respectively.
As of December 31, 2005, the Company had aggregate unsecured reinsurance receivables that exceeded 3% of shareholders’ equity from the reinsurers listed in the table below. Unsecured reinsurance receivables include amounts receivable for paid and unpaid losses and loss adjustment expenses and unearned premium less reinsurance receivables secured by collateral.
Approximately $18.8 million of the Company’s reinsurance receivable balances at December 31, 2005 are with Converium Reinsurance North American Inc. (“CRNA”). During 2004, Converium AG (Switzerland), CRNA’s parent company, placed CRNA into an orderly runoff. Of the $18.8 million of reinsurance receivable balances with CRNA, $1.8 million are receivables on paid losses, and $17.0 million are for receivables on unpaid loss and loss adjustment expenses. The Company is monitoring CRNA’s ability to pay claims, and at this time, believes that the amounts receivable from CRNA will be collectible.
The effect of reinsurance on premiums written and earned is as follows (in thousands):
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 75% of the participant’s pre-tax contribution, subject to a maximum of 6% of the participant’s eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company’s contribution upon completion of four years of service. The Company’s total contributions to the plan were $1.3 million, $1.2 million and $0.9 million for the years ended December 31, 2005, 2004, and 2003, respectively.
The Company sponsors an unfunded nonqualified key employee deferred compensation plan. Under the plan, deferred compensation benefits are provided through deferrals of base salary and bonus compensation (“Employee Deferrals”) and discretionary contributions by the Company (“Employer Contributions”) for a select group of management and highly compensated employees of the Company and its subsidiaries. Each participant is permitted to specify an investment or investments from among permissible investments which shall be the basis for determining the gain or loss adjustment applicable to such participant’s plan deferral account. A participant’s
interest in the portion of his or her plan deferral account that is attributable to Employee Deferrals are fully vested at all times. That portion of a participant’s plan deferral account attributable to Employer Contributions generally will vest over the course of a five year period beginning on the last day of the first year after the plan year for which the Employer Contribution was made. The amounts in each participant’s plan deferral account represent an obligation of the Company to pay the participant at some time in the future. The Company had a deferred compensation obligation pursuant to the plan amounting to $4.7 million and $3.2 million as of December 31, 2005 and 2004, respectively.
The Company is subject to routine legal proceedings in connection with its property and casualty insurance business. The Company also is not involved in any pending or threatened legal or administrative proceedings which management believes can reasonably be expected to have a material adverse effect on the Company’s financial condition or results of operations.
The Company currently leases office space to serve as its headquarters location and 38 field offices for its production underwriters. In addition, the Company leases certain computer equipment and licenses certain computer software. Rental expense for operating leases was $5.1 million, $4.0 million and $3.5 million for the years ended December 31, 2005, 2004, and 2003, respectively.
As of December 31, 2005 and 2004, included in Other Liabilities in the Consolidated Balance Sheets were $12.8 million and $12.4 million, respectively, of liabilities for state guaranty funds. As of December 31, 2005 and 2004, included in Other Assets in the Consolidated Balance Sheets were $0.1 million and $0.4 million, respectively, of related assets for premium tax offsets or policy surcharges, The related asset is limited to the amount that is determined based upon future premium collections or policy surcharges from policies in force.
Among other state insurance facilities, the Company is subject to assessments from Florida Citizens Property Insurance Corporation (“Florida Citizens”), which was created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. Citizens, at the discretion and direction of its Board of Governors (“Citizens Board”), can levy a regular assessment on participating companies for a deficit in any calendar year up to a maximum of the greater of 10% of the deficit or 10% of Florida property premiums industry-wide for the prior year. An insurer may recoup a regular assessment through a surcharge to policyholders. If a deficit remains after the regular assessment, Florida Citizens can also fund any remaining deficit through emergency assessments in the current and subsequent years. Companies are required to collect the emergency assessments directly from residential property policyholders and remit to Florida Citizens as collected. In addition, Florida Citizens may issue bonds to further fund a deficit. Participating companies are obligated to purchase any unsold bonds issued by Florida Citizens.
The Company continues to monitor developments with respect to various other state facilities such as the Mississippi Windstorm Underwriting Association, the Alabama Insurance Underwriting Association, and the Texas Windstorm Insurance Association. The ultimate impact of the 2005 hurricane season on these facilities is currently uncertain, but could result in the facilities recognizing a financial deficit or a financial deficit greater than the level currently estimated by the facility. They may, in turn, have the ability to assess participating insurers when financial deficits occur, adversely affecting the Company’s results of operations.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 2005 and 2004 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown (in thousands, except share and per share data):
The Company’s operations are classified into three reportable business segments which are organized around its three underwriting divisions: The Commercial Lines Underwriting Group which has underwriting responsibility for the commercial multi-peril package, commercial automobile and commercial property insurance products; The Specialty Lines Underwriting Group which has underwriting responsibility for the errors and omissions and management liability products and The Personal Lines Group which designs, markets and underwrites personal property and casualty insurance products for the homeowners and manufactured housing markets. Each business segment’s responsibilities include: pricing, managing the risk selection process, and monitoring the loss ratios by product and insured. The reportable segments operate solely within the United States and have not been aggregated.
During January 2006, the Company entered into a Reinsurance Commutation and Release Agreement effective as of January 1, 2006 with respect to the 2004 Whole Account Net Quota Share Reinsurance contract. As a result of this commutation, the Company reduced its Funds Held Payable to Reinsurer liability by approximately $39.2 million, offset by an increase to its net Unpaid Loss and Loss Adjustment Expenses by $31.9 million, an increase to its net Unearned Premiums by $0.3 million and a reduction to its previously recorded profit commission receivable by approximately $7.0 million, in each case effective as of January 1, 2006. No gain or loss was realized as a result of this commutation.