(2) Effective November 30, 2001, the Insurance Company terminated the sponsored defined benefit plan. As of January 1, 2001, the Insurance Company had estimated that plan assets would exceed the projected benefit
(6) The ratio of net premiums written divided by ending statutory surplus.
Methods Used to Estimate Loss & Loss Adjustment Expense Reserves. We applied the following general methods in projecting loss and loss adjustment expense reserves:
For the property lines of business including special property and personal and commercial auto physical damage as well as the personal and commercial auto liability lines of business we relied on the incurred Bornhuetter-Ferguson method for accident years 2004 to 2006 while the incurred loss development method was used for accident years prior to 2004.
In 2006, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $5,224,000 which represents 40.4% of the net loss and LAE reserves as of the beginning of the year. During 2006, all product lines experienced favorable development as follows: homeowners-$1,340,000,
calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years and does not present accident year loss development. The portion of the table titled “Gross liability end of year” shows the impact of reinsurance for the years shown, reconciling the net reserves in the upper portion of the table to gross reserves. In evaluating the re-estimated liability and cumulative redundancy (deficiency), it should be noted that each data point 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 this table.
Investments. At December 31, 2006 and 2005, all of the Company’s investments are classified as available-for-sale and are those investments that would be available to be sold in response to the Company’s liquidity needs, changes in market interest rates and asset-liability management strategies, among others. Available-for-sale investments are recorded at fair value, with the corresponding unrealized appreciation or depreciation, net of deferred income taxes and any corresponding deferred tax asset valuation allowance, reported as a component of accumulated other comprehensive income or loss until realized.
Direct premiums written for the commercial segment decreased 2.0%. The decline is due to an 8.7% decrease in commercial package (CPP) premium volume which is more susceptible to competitive pricing in the current soft market. Given the Company’s commitment to maintaining its underwriting discipline several larger commercial accounts were lost as a result of competitive pricing that was deemed unacceptable and inappropriately priced given the risk level of the exposure. Despite growth in other commercial products including businessowners (BOP) up 5.4%, commercial auto up 2.3% and workers compensation up 4.4%, these were not enough to offset the decline in the CPP product line. Despite the continued soft market in commercial throughout 2006 our in-force policy count did increase 4.0% and was a result of continued focus on maintaining our renewals and the introduction of our web based rating platform-Fremont Complete for the BOP line in early 2006.
Net premiums earned increased $493,000 due to a combination of normal volume growth, offset by an increase in current year ceded premiums earned coupled with the impact from the quota share agreement which occurred during 2005. Net premiums earned for 2005 included $1,400,000 related to the quota share reinsurance agreement which was placed into runoff on December 31, 2003. As noted above, during 2005 the Company recognized $1,400,000 of profit commission under the quota share reinsurance agreement which reduced both ceded premiums written as well as ceded premiums earned and conversely increased both net premiums written and earned. Net premiums earned for 2005 excluding the quota share impact would have been approximately $37,356,000 resulting in an increase of approximately $1,894,000 as compared to 2006. The change in net premiums earned was affected by an increase of $3,094,000 due to the overall increase in direct premiums earned offset by growth in ceded premiums earned under the Company’s ongoing reinsurance agreements of approximately $1,201,000.
The commercial segment’s loss and LAE decreased $2,386,000 or 50.4% in 2006 while the loss and LAE ratio dropped from 58% in 2005 to 30.7% in 2006. The improvement was concentrated in the workers’ compensation and commercial multi-peril product lines. Loss and LAE in the workers compensation product line decreased approximately $1,357,000 which included favorable reserve development of approximately $715,000 concentrated in accident years 2002 through 2005. The rest of the decrease was due to higher incurred loss and LAE in 2005 as a result of reserve strengthening which occurred during 2005. During 2005 the Company strengthened its reserves for the workers compensation line so that the ultimate loss estimates were more in line with industry averages resulting in an increase of approximately $904,000 in loss and LAE in 2005. During 2006 as prior years’ claims continued to develop and settle the ultimate losses are settling for less than estimated. Loss and LAE for the commercial multi-peril product lines decreased approximately $977,000 during 2006 which included favorable reserve development of approximately $1,247,000 primarily from accident years 2003 through 2005. The favorable reserve development on prior accident years was offset by an increase in 2006 accident year loss and LAE for the commercial multi-peril product line. The increase is driven by a higher expected loss ratio for the commercial multi-peril product lines as a result of the current soft market conditions and relatively flat rate increases experienced during 2006.
The decline in the rate of return on average invested assets was driven by the aforementioned decrease in gross investment income from the equity portfolio. However, as noted above, the decrease was recouped through an increase in net realized gains from the equity portfolio of approximately $220,000.
The decrease in net realized gains from the fixed maturity portfolio is due to less activity during 2006. During 2005 the Company focused on reducing the duration in the fixed maturity portfolio in order to temper the fluctuations in the market value of the portfolio. This resulted in a higher volume of selling activity resulting in net realized gains on the sale of fixed maturity securities of $269,000. The increase in net realized gains on the sale of equity securities is driven by an increase in capital gains distributions from mutual funds held by the Company.
Consolidated Results of Operations. The following table shows the underwriting gain or loss as well as other revenue and expense items included in our consolidated statements of income for the years ended December 31, 2005 and 2004. The Company’s underwriting gain or loss consists of net premiums earned less loss and LAE and policy acquisition and other underwriting expenses. The Company’s underwriting performance is the most important factor in evaluating the overall results of operations given the fluctuations which can occur in loss and LAE due to weather related events as well as the uncertainties involved in the process of estimating reserves for losses and LAE. The underwriting results and the fluctuations in other revenue and expense items are discussed in greater detail below.
Direct premiums written for the commercial segment decreased .5%. The decrease is due to declines in premium volume in product lines considered to be commercial supporting lines of business such as commercial auto and workers compensation offset by premium growth in the core commercial product lines of business owners (BOP) and commercial package (CPP). While the commercial market remained soft throughout 2005, the Company has been successful writing new policies on small commercial exposures within the Company’s target market which focuses on small business operations. The two core commercial product lines of BOP and CPP make up 28.0% and 51.5%, respectively, of the commercial segment’s direct premiums written. BOP direct premium written was up 9.3% driven by new business premium volume which was up 28.5% and renewal premium volume which was up 4.5%. CPP direct premium written was up 2.3% driven by new business premium volume which was up 47% offset by a decrease of 4.5% in renewal premium volume. Current pricing levels were maintained for both BOP and CPP in 2005 even as the market softened. The supporting commercial product lines of workers compensation and commercial auto experienced a decrease in direct premiums written of 17.8% and 14.7%, respectively, which offset the growth in the core commercial products during 2005.
Net premiums earned by major business segment for the years ended December 31 was as follows:
Net premiums earned increased $3,903,000 as a result of overall volume growth coupled with an increase of $8,589,000 due to the decline in earned premium ceded to the reinsurer under the quota share reinsurance contract which was placed into runoff on January 1, 2004. The increase was offset by higher ceded premiums earned of $932,000 under the Company’s other reinsurance agreements.
for 2005 were approximately $22,006,000 compared to $26,393,000 in 2004, a decrease of $4,387,000 or 16.6%. The decrease in direct incurred losses and LAE is due to a decline in claim severity coupled with redundant development on prior year reserves. Offsetting the drop in direct incurred losses and LAE was a decline in ceded incurred loss and LAE, or the amount ceded to reinsurers under the Company’s various reinsurance agreements. During 2005, the Company ceded to reinsurers $1,372,000 in incurred losses and LAE compared to $9,420,000 in 2004, a decrease of $8,047,000 or 85.4%. The decline in ceded incurred losses and LAE from 2005 to 2004 is due to the impact of the runoff of the quota share reinsurance agreement ($4,605,000), an increase in the Company’s excess of loss reinsurance retention level from $125,000 in 2004 to $150,000 in 2005 ($624,000) which translates into the Company retaining an increased level of losses and LAE, a decline in the severity of losses that exceeded the Company’s excess of loss retention in 2005 as compared to 2004 ($1,067,000), fewer severe weather related losses in 2005 ($500,000) and redundant development on prior year reserves ($1,250,000).
The Company’s net loss and LAE ratio declined to 53.4% in 2005 compared to 62.7% in 2004 as a result of the quota share runoff, overall favorable loss experience during 2005 as compared to 2004 as well as redundant development on prior year reserves. As noted above, the Company’s net premium earned increased $8,589,000 due to the decline in earned premium ceded under the quota share agreement. While at the same time loss and LAE increased only $4,605,000 due to the decline in ceded loss and LAE under the quota share agreement.
The increase in net realized gains is due to more selling activity during 2005 compared to 2004. During 2005, the Company continued to shift its equity portfolio from common stocks to mutual funds resulting in net realized gains from the sale of equity securities of $439,000 offset by realized losses of $100,000 related to two equity investments that the Company deemed to be other than temporarily impaired. During the year ended December 31, 2005 the Company focused on reducing the duration in the fixed maturity portfolio in order to temper the fluctuations in the market value of the portfolio. This resulted in net realized gains on the sale of fixed maturity securities of $269,000 during the year ended December 31, 2005.
Other Income, Net. Other income, net which includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income and expense items increased 3.1% to $397,673 in 2005 compared to $385,670 in 2004.
Cash flow used in investing activities was $5,258,000 and $8,875,000 during the years ended December 31, 2006 and 2005, respectively, a decrease of $3,617,000. During 2006, net cash invested into the Company’s investment portfolio was $3,972,000 compared to $8,372,000 which was placed into the portfolio during 2005. At December 31, 2006, the Company is maintaining a higher cash and cash equivalent balance due to anticipated cash flow requirements during 2007, specifically the maturity of our surplus notes in September 2007 which amount to $2,890,000. As a result, the Company did not place as much cash into the investment portfolio during 2006 as compared to 2005. Despite the decrease in cash placed into the investment portfolio during 2006, the Company invested approximately $1,302,000 in capital expenditures, the majority of which related to Fremont Complete, the Company’s web based rating platform. As of December 31, 2006, product lines that are available through Fremont Complete include personal auto and business owners. During 2007, the Company expects to expand the product lines available through Fremont Complete to include homeowners, mobilowners and marine which will require additional investment.
2006 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal and interest payments on outstanding surplus notes. Additional information regarding these obligations is provided in Note 9-Surplus Notes and Note 11-Lease Agreements to the financial statements of the Company. The table below does not include contractual obligations with respect to our employee benefit plans, which are described more fully in Note 10-Employee Retirement Plans to the Company’s financial statements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fremont Michigan InsuraCorp, Inc. at December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Notes 1 and 10 to the consolidated financial statements, the Company changed its method of accounting for defined benefit pension and other postretirement plans as of December 31, 2006, to adopt Financial Accounting Standards Board Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”
Insurance premium revenue is recognized on a pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in-force. Generally, premiums are collected in advance of providing risk coverage, minimizing the Company’s exposure to credit risk. Premiums due from policyholders are net of an allowance for doubtful accounts of $32,913 and $79,443 at December 31, 2006 and 2005, respectively.
The Company presents other comprehensive income or loss as a component of stockholders’ equity on the consolidated statements of stockholders’ equity and comprehensive income. For the years ended December 31, 2006, 2005, and 2004 the components of other comprehensive income consisted of the following:
Losses and loss adjustment expense (“LAE”) reserves represent the estimated liability for reported losses and loss adjustment expenses and actuarial estimates for incurred but not reported losses and loss adjustment expenses based upon the Company’s actual experience, assumptions and projections as to claims frequency, severity, inflationary trends and settlement payments. The reserve for losses and loss adjustment expenses is intended to cover the ultimate net cost of all losses and loss adjustment expenses incurred but unsettled through the balance sheet date. The reserves are reported gross of any amounts recoverable from reinsurers and are reduced for anticipated salvage and subrogation. The methods of making estimates and establishing these reserves are reviewed regularly, and resulting adjustments are reflected in income currently. The liability for losses and loss adjustment expenses is necessarily an estimate and while it is believed to be adequate, the ultimate liability could exceed or be less than such estimate. The anticipated recoverable salvage and subrogation at December 31, 2006 and 2005 was approximately $208,000 and $223,000, respectively.
Deferred federal income tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amount of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”). This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123. This standard became effective for the Company as of January 1, 2006 and applies to all awards granted, modified, cancelled or repurchased after that date as well as the unvested portion of prior awards. The adoption did not have a material effect on the consolidated financial statements as the Company previously accounted for stock-based compensation using the fair value method, as prescribed by SFAS 123.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 will
be effective for the Company beginning January 1, 2007. Based on the Company’s initial analysis of FIN 48 management does not believe that FIN 48 will have a material impact on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“Statement 157”). Statement 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. Statement 157 applies under other accounting pronouncements that require fair value measurement in which the FASB concluded that fair value was the relevant measurement, but does not require any new fair value measurements. Statement 157 will be effective for the quarter ended March 31, 2008. The Company is currently evaluating the impact Statement 157 will have on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“Statement 159”). This statement, which is expected to expand fair value measurement, permits entities to choose to measure many financial instruments and certain other items at fair value. Statement 159 will be effective for the quarter ended March 31, 2008. The Company is currently assessing the impact Statement 159 may have on the consolidated financial statements.
The cost or amortized cost and estimated fair value of fixed maturities at December 31, 2006, by contractual maturity, are shown below. Expected maturities on certain corporate and mortgage-backed investments may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Net realized gains (losses) on investments for the years ended December 31, 2006, 2005 and 2004 are summarized as follows:
As of December 31, 2006, the portfolio included 14 fixed maturity investments and 1 equity investment in an unrealized loss position for less than 12 months and 68 fixed maturity investments in an unrealized loss position for more than 12 months, none of which were trading below 90% of cost or amortized cost. All of the fixed maturity investments in an unrealized loss position and assigned a rating by commercial credit rating companies are rated investment grade investments. While all of these investments are monitored for potential
impairment, the Company’s experience indicates that they generally do not present as great a risk of impairment, as fair value often recovers over time. These investments have generally been adversely affected by the downturn in the financial markets and overall economic conditions. Management believes that the analysis of each of these investments support the view that these investments were not other-than-temporarily impaired.
At December 31, 2006, fixed maturities with a carrying value approximating $404,000 were on deposit with regulatory authorities, as required by law.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. The Company determines the amount and scope of reinsurance coverage to purchase each year based on an evaluation of the risks accepted, consultation with reinsurance professionals and a review of market conditions, including availability and cost. The Company utilizes three primary categories of treaty reinsurance coverage, as well as facultative coverage, to reduce the impact of major losses. The treaty reinsurance includes multi-line excess of loss, catastrophic excess of loss and quota share coverages.
During 2006 and 2005 casualty and workers compensation excess of loss coverage provided up to $4,850,000 over the $150,000 retention. During 2004 casualty and workers compensation excess of loss coverage provided up to $4,875,000 over the $125,000 retention.
An additional workers compensation catastrophe excess of loss program provided an additional $5,000,000 in 2006, 2005 and 2004 of coverage to cover a catastrophic event.
In addition to ceding a significant portion of its risks to the reinsurer, the agreement also allows the Company to reduce its financial leverage and to realize immediate reimbursement for related upfront acquisition costs, thus adding to its financial capacity. The following table illustrates the effects of the multi-line quota share agreement in effect during 2005 and 2004 on selected financial information of the Company (in thousands):
The Company utilizes facultative reinsurance to provide additional underwriting capacity, to mitigate the effect of individual losses and to reduce net liability on individual risks. Coverage is determined on each individual risk. In 2006, the Company obtained coverage ranging from $850,000 up to $4,000,000 for certain commercial properties it insured. In 2005, the Company obtained coverage for commercial properties it insured in excess of $1,000,000. During 2005 the range of coverage was from $100,000 up to $3,925,000. In 2004, the Company obtained coverage for commercial properties it insured in excess of $2,500,000. During 2004 the range of coverage was from $500,000 up to $5,000,000.
The Company receives a ceding commission in conjunction with certain reinsurance activities. These ceding commissions are offset against direct commission expense and were $181,749, $124,274, and $72,302 in 2006, 2005 and 2004, respectively.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. At December 31, 2006, the Company had recoverables of $7,883,000. This balance was comprised of $853,000 for paid losses and $7,030,000 for unpaid losses ceded to the reinsurers. At December 31, 2005, the Company had recoverables of $7,287,000. This balance was comprised of $1,353,000 for paid losses and $5,934,000 for unpaid losses ceded to the reinsurers. The Company holds collateral in the form of letters of credit, trust accounts or funds withheld accounts for amounts recoverable from reinsurers that are not considered authorized insurers by the State of Michigan Office of Financial and Insurance Services. At December 31, 2006, the Company had 5 reinsurance recoverable amounts from reinsurers whose individual recoverable balance exceeded 5% of the total recoverable amount. The amount due from these 5 reinsurers accounts for 92% of the total recoverable.
The effect of reinsurance on premiums written and earned for the years ended December 31, 2006, 2005 and 2004, are as follows:
Losses and loss adjustment expenses reported on the statement of operations are net of ceded amounts of approximately $4,780,000, $1,372,000 and $8,935,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Income tax expense is computed under the liability method, whereby deferred income taxes reflect the estimated future tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and those for income tax purposes. A valuation allowance is required to be established against a deferred tax asset if it is “more likely than not” that the related tax benefits will not be realized.
Based upon management’s assessment of all available evidence, including the Company’s cumulative net income for recent fiscal years, estimates of current and future profitability and the overall prospects of our business, it has been determined that as of December 31, 2006 it is more likely than not that sufficient taxable income will exist in the periods of reversal in order to realize the recorded net deferred tax asset.
The following table shows the allocation of the change in the deferred tax valuation allowance for the years ended December 31, 2006 and 2005.
At December 31, 2006 and 2005, property and equipment consisted of the following:
In 2005, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $2,355,000 which represents 24.1% of the net loss and LAE reserves as of the beginning of the year. There were no significant changes in the key assumptions utilized in the analysis and calculations of the Company’s reserves during 2005. As a result of the adverse development experienced during 2003 the Company has placed an emphasis on the claim reserving process to ensure that we are establishing adequate reserves reflecting our best estimate of the ultimate loss. The favorable development in 2005 was primarily in the homeowner and personal auto product lines. The homeowner’s line, which is the Company’s largest product line, experienced redundant development of approximately $1,904,000 primarily in the accident years of 2004, 2003 and 2002 as a result of lower than expected losses on both incurred but not reported and existing case reserves as of December 31, 2004. The personal auto line experienced redundant development of approximately $426,000 primarily in the 2004 accident year. The Company began writing personal auto policies in 1999. Given that this
is a newer product line for the Company our initial ultimate loss estimates on undeveloped years are based more on estimated industry loss ratios as opposed to our actual historical loss ratios. As the 2004 accident year continues to develop the Company has experienced redundant development on settled claims which has resulted in a decrease in the ultimate loss ratio as compared to the ultimate ratio used at December 31, 2004.
In 2004, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $666,000 which represents 10.9% of net loss and LAE reserves as of the beginning of the year. The favorable development was concentrated in the commercial segment’s product lines of commercial multiple peril and workers compensation which experienced favorable development of $1,076,000 primarily in accident years 2000, 2002 and 2003. In 2003 the Company strengthened its reserves in the commercial segment because the Company’s actuarial projections indicated higher ultimate losses on prior accident years driven primarily by the volatility in claim development within the newer product lines in the commercial segment. Throughout 2004 the development on commercial losses was less than what was expected as the settlement of reported cases has been favorable. The homeowner and farm product lines experienced adverse development of $344,000 resulting from the normal claims review process, and not from changes in key assumptions or reserving methods.
The outstanding balance at December 31, 2006 and 2005 of $2,890,000 included approximately $1,955,000 of surplus notes held by related parties consisting of non-employee directors, agents of the Company and an investment broker who provided services to the Company. Interest expense on surplus notes held by related parties was approximately $137,000 in 2006, $137,000 in 2005, and $223,000 in 2004.
The Company provides certain postretirement health care benefits for retired employees. Prior to December 31, 2004, substantially all employees became eligible for these benefits upon reaching retirement age, as defined, while employed by the Company. In December 2004 the Company’s board of directors approved an amendment to the plan effective December 31, 2004 which significantly reduced the number of eligible participants in the plan, discontinued future eligibility for all other employees and reduced the level of health care benefits for future retirees determined to be eligible as of December 31, 2004. The plan amendment resulted in a reduction to the accumulated projected benefit obligation at December 31, 2004 of $2,003,943 of which $486,915 reduced the unrecognized transition obligation while the remaining credit balance of $1,517,028 represents the unrecognized reduction to prior service cost as a result of the plan amendment. The balance of the unrecognized reduction to prior service cost will be amortized over 17.7 years which represents the average future lifetime of retirees and fully eligible active participants at the date of the amendment.
As noted in Note 1 the Company adopted the provisions of Statement 158 as of December 31, 2006. The initial recognition of the funded status of the Company’s defined benefit postretirement plan resulted in an increase in shareholders’ equity of $524,978, which was net of tax expense of $270,443. The table below reflects the incremental effect of applying Statement 158 on individual line items in the consolidated balance sheet as of December 31, 2006:
At December 31, 2006 the funded status of $1,961,826 is recognized in the accompanying balance sheet as accrued expenses and other liabilities. At December 31, 2005 the accrued benefit cost of $2,746,417 is included in accrued expenses and other liabilities in the accompanying balance sheet.
The Company uses a December 31 measurement date for its other postretirement plan. As this plan is not pre-funded, no contributions other than those necessary to cover benefit payments are anticipated. At December 31, 2006, the Company’s expected future benefit payments are as follows:
For measurement purposes as of December 31, 2006, 2005 and 2004 the annual rate of increase in the per capita cost of covered health care benefits assumed for the subsequent year was 8.5%, 9.0% and 9.5%, respectively. Each year the rate was assumed to decrease by 0.5% per year until the ultimate rate of 5.5% was reached.
The Company leases various vehicles under non-cancelable operating lease agreements which began to expire in 2006 and continue to expire in 2007. Rental expense was approximately $48,000, $38,000 and $57,000 in 2006, 2005 and 2004, respectively.
Future minimum lease payments required under the vehicle leases as of December 31, 2006 are as follows:
During 2003, the Company issued a $140,000 mortgage receivable to an agent of the Company. The note requires a monthly payment, including interest at 6%, of $1,003, which is based on a 20 year amortization. The note includes a 5 year balloon payment, which becomes due January 2009. During 2006, 2005 and 2004, the agent earned $73,292, $72,800 and $74,700, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.
Various agents of the Company participated in the surplus note offerings and held surplus notes at December 31, 2006 and 2005, as disclosed in Note 9-Surplus Notes. The terms and conditions of the agency agreements between the agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays the agencies commissions on business produced. The agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. For the years ending December 31, 2006, 2005 and 2004 agents holding surplus notes earned regular and profit sharing commissions of approximately $223,000, $236,000 and $1,800,000, respectively.
The Company defines its operations as property and casualty insurance operations. The Company writes four major insurance lines exclusively in the State of Michigan: Personal Lines, Commercial Lines, Farm and Marine. The separate financial information of these four major insurance lines is consistent with the way results are regularly evaluated by management in deciding how to allocate resources and in assessing performance. All
The Company does not allocate assets, net investment income, net realized gains (losses) on investments, other income (expense), interest expense or demutualization expenses to its product lines. The accounting policies of the operating segments are the same as those described in Note 1-Summary of Significant Accounting Policies.
The Company has two stock-based compensation plans which are described below. The compensation cost for these plans that has been charged against income for the years ended December 31, 2006, 2005 and 2004 was $43,867, $37,391 and $7,916, respectively. The total income tax benefit recognized in the statement of operations for stock-based compensation was $14,915, $12,713 and $2,691 for the years ended December 31, 2006, 2005 and 2004, respectively.
volatility in 2006 is based on historical volatility of the Company’s stock. The expected volatilities in 2005 and 2004 are based on historical volatility of similar publicly traded entities following a comparable period in their lives subsequent to their initial public offering. The expected term is an estimate based on expected behavior of the group of optionees. The risk free rate for the periods within the contractual life of the option is based on U.S. Treasury Strips in effect at the time of grant.
The weighted-average grant-date fair value of options granted in 2006, 2005 and 2004 was $11.72, $5.29 and $2.41, respectively. The total intrinsic value of options exercised in 2006 was $17,370. No options were exercised during 2005 or 2004.
A summary of the status of the Company’s nonvested options as of December 31, 2006 and changes during the year ended December 31, 2006 is presented below:
An unaudited summary of the Company’s 2006 and 2005 quarterly performance is as follows: