The following table sets forth selected consolidated financial data with respect to the Company for the periods indicated. The balance sheet and income statement data have been derived from the audited financial statements of the Company. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s consolidated financial statements and notes thereto included elsewhere in this Report.
Insurance Operations Loss & Loss Adjustment Expense Ratio 69.3% 69.9% 58.0% Expense Ratio 11.7 18.7 23.1
Year Ended December 31, 2002 to Year ended December 31, 2001
Net Premiums Earned. “Net premiums earned” are that portion of net premiums written which applies to the expired portion of the policy period. Net premiums earned increased 4.7% from $63 million in 2001 to $65.9 million in 2002. The principal factors accounting for the increase were an increase in general liability primary premiums of $24.3 million and an increase in program business premiums of $808,000. These increases were partially offset by a decrease in net premiums earned for workers’ compensation, general liability reinsurance, commercial lines and surety of 56.5% from $38.9 million in 2001 to $16.9 million in 2002. These results were in line with the Company’s strategy to focus on its more profitable lines of insurance business.
Net Investment Income. Net investment income increased 10% from $3.7 million in 2001 to $4.0 million in 2002 due to higher levels of invested assets generated from positive cash flows from operations. The average annual pre-tax yield on investments was 5% in 2001 and 4.3% in 2002. The average annual after-tax yield on investments was 3.7% in 2001 and 3.2% in 2002.
Brokerage Commission Income and Management Fees. Income from insurance brokerage operations and management fees decreased 66.1% from $3.9 million in 2001 to $1.3 million in 2002. This decrease is the result of a change in the manner fees are realized from the Company’s risk retention group affiliate. Previously, the risk retention group affiliate paid a fixed management fee plus a commission based on a percentage of the premiums produced. Effective January 1, 2002, the risk retention group pays fees based on its portion of costs allocated against its portion of premiums written. This change was implemented to coincide with the creation of an internal pooling agreement between the Company (including its subsidiaries) and the risk retention group. The result of this change will initially lower the commission income and management fees paid to the Company by the risk retention group affiliate, but the net premiums earned retained by the Company will increase which the Company will earn as revenue over the life of the underlying policies as opposed to earning the commissions and fees at the time such policies are written.
Net Realized Gains. Net realized gains from the sale of investments increased from a gain of $652,000 in 2001 to a gain of $710,000 in 2002. These gains were primarily realized from the sale of bonds in the Company’s investment portfolio.
Real Estate Income. Real estate sales at the Harbour Village project increased 87.9% from $27.6 million in 2001 to $51.8 million in 2002. The sales in 2002 were realized from the closing of 160 condominium units and 62 boat slips and the sales in 2001 were realized from the closing of 102 condominium units and 59 boat slips. See Exhibit 99 for further information regarding Harbour Village. .
Payroll and Other Expenses. Payroll and other expenses increased 30.1% from $15.1 million in 2001 to $19.6 million in 2002 due to higher payroll and legal expenses, a $2.5 million impairment charge to notes receivable, and a $1.1 million expense of reinsurance recoverables. The $2.5 million charge for impairment to notes receivable is the result of the Company obtaining an updated appraisal, which shows a decrease in the market value of the property due to current economic conditions, for the collateral supporting the loans. The $1.1 million expense in 2002 of reinsurance recoverables relates to the Berkley arbitration dispute, and is in recognition of a settlement offer that the Company made to Berkley. See Item 3. “Legal Proceedings” with respect to the Company’s pending material arbitration dispute with Berkley.
Expense due to Rescission. Expense due to rescission litigation was $1.6 million in 2002 as compared to $600,000 in 2001. Of the $1.6 million of expense recognized, $565,000 was for legal fees, and $1 million was related to amounts held in escrow for the acquisition as a result of the Court’s granting of defendants’ summary judgment motions in part of the lawsuit.
Income Taxes. Federal and state income tax expense was $919,000 in 2002 as compared to $1.2 million in 2001. The effective tax rate increased to 27% for 2002 from 22% in 2001. This increase is a result of higher levels of taxable income in the Company’s insurance and real estate subsidiaries.
Year Ended December 31, 2001 to Year ended December 31, 2000
Net Premiums Earned. Net premiums earned increased 135.8% from $26.7 million in 2000 to $63.0 million in 2001. The principal factors accounting for the increase were an increase of general liability reinsurance premiums of $4.2 million, an increase in workers’ compensation primary premiums of $6.1 million, an increase in general liability primary premiums of $17.6 million, an increase in commercial lines premiums of $2.6 million, and an increase in program business premiums of $3.9 million.
Net Investment Income. Net investment income increased 40.1% from $2.6 million in 2000 to $3.7 million in 2001 as a result of increased levels of invested assets generated from increased cash flows from operations. The average annual pre-tax yield on investments was 4.8% in 2000 and 5% in 2001. The average annual after-tax yield on investments was 4.0% in 2000 and 3.7% in 2001.
Brokerage Commission Income. Income from insurance brokerage operations decreased 26.7% from $3.3 million in 2000 to $2.4 million in 2001 due to reduced levels of insurance premiums being produced through the Company’s risk retention group affiliate, and increased levels of insurance premiums being produced by the Company’s excess and surplus lines carrier insurance company (which are not recognized as brokerage commission income).
Real Estate Income. Real estate sales at the Harbour Village project were $27.6 million in 2001. These sales were realized from the closing of 102 condominium units and 59 boat slips in 2001. See Exhibit 99 included in this Report for further information regarding Harbour Village.
Acquisition Expenses. Acquisition expenses increased from $3.7 million to $10.4 million as a result of increased net earned premiums. Premium tax expense also increased to $3.7 million from $948,000 due to higher volumes of direct premiums earned.
Income Taxes. Federal and state income taxes increased from a benefit of $1.2 million in 2000 to an expense of $1.2 million in 2001 as a result of increased levels of income in the Company’s U.S. insurance and real estate subsidiaries.
The Company historically has met its cash requirements and financed its growth principally through cash flows generated from operations. During the past decade, the Company has operated in a soft market cycle which was characterized by excess insurance capacity and declining insurance premium rates; however, commencing in fiscal year 2000 the Company has operated in a hardening market with increased insurance premium rates for workers’ compensation and excess and surplus lines. The Company’s primary sources of cash flow are proceeds from the sale or maturity of invested assets, premiums written, investment income, income from real estate development sales, commission income, management fees and reinsurance recoverables from reinsurers. The Company’s short-term cash requirements are primarily for claims payments, reinsurance premiums, commissions, salaries, employee benefits, real estate development expenses, other operating expenses, and the purchase of investment securities, which have historically been satisfied from operating cash flows. Due to the uncertainty regarding settlement of unpaid claims, the long-term liquidity requirements of the Company may vary, and the Company has attempted to structure its investment portfolio to take into account the historical payout patterns. The Company also purchases reinsurance to mitigate the effect of large claims and to help stabilize demands on its liquidity. Notwithstanding the Company’s dispute with one of its former reinsurers, Berkley Insurance Company, as described in Item 3. of this Report, management believes that the Company’s current cash flows are sufficient for the short-term needs of its insurance business and the Company’s invested assets are sufficient for the long-term needs of its insurance business.
On a consolidated basis, net cash provided from operations was $28.1 million for the twelve months ended December 31, 2001 and $34.3 million as of December 31, 2002. The positive cash flows for said periods were primarily attributable to net premiums written, net earnings and sales of real estate. Because workers’ compensation and general liability claims may be paid over an extended period of time, the Company has established loss reserves for such lines of business. The assets supporting the Company’s reserves continue to earn investment income until claims payments are made.
The accounting policies described below are those the Company considers critical in preparing its financial statements. These policies include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used. The descriptions below are summarized and have been simplified for clarity. A more detailed description of the significant accounting policies used by the Company in preparing its financial statements is included in Note (1) of Notes to the Consolidated Financial Statements.
Reinsurance. One of the Company's former reinsurers, Berkley Insurance Company, has disputed its obligations under several reinsurance treaties entered into during the "soft reinsurance market" that existed in 1998 and 1999. As of December 31, 2002, unreimbursed paid claims totaled $14.9 million and additional ceded case and incurred but not reported reserves totaled approximately $19.6 million. A reserve of $1.1 million for this dispute has been established because of the conditions set forth in Statement of Financial Accounting Standards ("SFAS") No. 5, Accounting for Contingencies. If any of these factors change in the future, the Company may have to establish additional reserves at that time, which could be material. See Item 3. "Legal Proceedings" for a discussion of the Company's pending material reinsurance recoverables dispute with Berkley Insurance Company, one of the Company's former reinsurers.
Unpaid Losses Loss Adjustment Expenses. The Company is required to estimate its liability for loss and loss adjustment expenses. The estimated liability for unpaid losses and loss adjustment expenses recorded on the Company’s balance sheet at the end of any given period should be adequate to cover all future payments required to be made on account of insured events that occurred on or before the balance sheet date. However, because the future cannot be predicted with certainty, the actual future payments are usually different from the previously recorded estimates, and sometimes the differences may be material. These differences are included in the Company’s results of operations in the future periods in which they become known.
American Safety is incorporated under the laws of Bermuda and, under current Bermuda law, is not obligated to pay any taxes in Bermuda based upon income or capital gains. American Safety has received an undertaking from the Minister of Finance in Bermuda pursuant to the provisions of The Exempted Undertakings Tax Protection Act 1966, which exempts American Safety and its shareholders, other than shareholders ordinarily resident in Bermuda, from any Bermuda taxes computed on profits, income or any capital asset, gain or appreciation, or any tax in the nature of estate, duty or inheritance until March 28, 2016. The Company, exclusive of its United States subsidiaries, does not consider itself to be engaged in a trade or business in the United States and accordingly does not expect to be subject to direct United States income taxation. The Company’s U.S. subsidiaries are subject to taxation in the United States.
The combined ratio of an insurance company measures only the underwriting results of insurance operations and not the profitability of the overall company. The Company’s reported combined ratio for its insurance operations may not provide an accurate indication of the Company’s overall profitability from insurance and reinsurance programs due to the exclusion of fee and commission income and expenses generated in related management and agency subsidiaries. Depending on the Company’s mix of business going forward, the combined ratio may fluctuate from time to time and may not reflect the overall profitability of the Company’s insurance and reinsurance programs.