Infinity’s insurance subsidiaries lease approximately 656,000 square feet of office and warehouse space in numerous cities throughout the United States. Most of these leases expire within 6 years. The most significant leased office spaces are located in suburban Atlanta, Georgia; Birmingham, Alabama (Infinity’s principal office); Irving, Texas; Windsor, Connecticut; and Los Angeles, California.
(b) The decline in earned premiums during 2002 reflects the inclusion of the Assumed Agency Business in the reinsurance agreement discussed above effective January 1, 2002.
(c) The results of the Assumed Agency Business’s operations and its balance sheet data are included in the Infinity figures as of and for the twelve-month periods ended December 31, 2004 and 2003.
Increased earnings and returns were substantially a result of continued improvement in underwriting profitability. Gross of the American Re agreement, GAAP Combined Ratios, which are the ratios of the sum of losses, loss adjustment expenses and underwriting expenses to net earned premiums, improved by 4.5 points from 2003 to 2004. Approximately 3.0 points of this was a result of $15 million of favorable loss reserve development from prior accident years, as compared with $14 million of unfavorable development in 2003. Underwriting margins for both 2003 and 2004 were substantially better than average over the last five to ten years. Since 2002, Infinity and other industry participants have enjoyed increases in insurance rates charged to policyholders, as well as lower claims frequencies (i.e. number of claims per insurance policy issued) and moderate claims severities (i.e. average cost per claim).
Premiums written gross of all reinsurance for 2004 actually fell 4.1% as compared with that in 2003. As of December 31, 2004, Infinity had 713,000 policies in force, a 0.3% increase over that at December 31, 2003. In 2001, Infinity instituted a program to shed under-performing business in several states where it either lacked critical mass to operate efficiently or where the regulatory and competitive environments impeded Infinity from achieving adequate returns. For these Non-Focus States, premiums written for the twelve months ended December 31, 2004 and policies in force at December 31, 2004 fell 47.7% and 31.6%, respectively, as compared with the same periods one year prior. Moreover, since 2002 Infinity has undertaken a program to roll out its three-tiered product structure to agents in its seventeen Focus States. In addition, during this same period, Infinity appointed new agents or re-appointed agents (with whom it had existing agreements for the previous generation of products) to market the most recent generation of products. As a result of these efforts, in the Focus States, Infinity’s premiums written for the twelve months ended December 31, 2004 and policies-in-force at December 31, 2004 increased 3.0% and 3.4%, respectively, as compared with the same periods in 2003.
The preparation of financial statements requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change and thus impact amounts reported in the future. Management believes that the establishment of insurance reserves, the determination of “other than temporary” impairment on investments, and accruals for litigation are the areas where the degree of judgment required to determine amounts recorded in the financial statements make the accounting policies critical.
Insurance reserves, or “Unpaid Losses and LAE,” are management’s best estimate of the ultimate amounts that will be paid for all claims that have been reported up to the date of the current accounting period but that have not yet been paid, plus an estimate of claims that have occurred but have not yet been reported to the Company (“incurred but not reported”, or “IBNR”), and the expenses to be paid to settle claims.
Whether the unrealized loss is credit-driven or a result of changes in market interest rates,
historical operating, balance sheet and cash flow data contained in issuer SEC filings,
At December 31, 2004 Infinity had $200 million principal of senior notes due 2014, bearing a fixed 5.5% interest rate (the “Senior Notes”). Interest payments due in 2005 are $11.0 million. (Refer to Note 4 of the Consolidated Financial Statements for more information on the Senior Notes).
Also in January 2005, Infinity announced its intent to repurchase up to $50 million of its common stock in the open market or through privately negotiated transactions over the next three years.
Management believes that cash and investment balances and cash flows generated from operations are adequate to meet the future liquidity needs for Infinity and its insurance subsidiaries.
Infinity and its insurance subsidiaries’ contractual obligations as of December 31, 2004 are (in thousands):
The contractual obligations under the long-term debt category above include payments of interest.
Infinity’s investment portfolio at December 31, 2004 contained $1,304.1 million in fixed maturity securities and $25.0 million in equity securities, all carried at market value with unrealized gains and losses reported as a separate component of shareholder’s equity on an after-tax basis. At December 31, 2004, Infinity had pretax net unrealized gains of $43.2 million on fixed maturities and $3.5 million on equity securities.
Investments in mortgage-backed securities (“MBSs”) represented approximately one-fifth of Infinity’s fixed maturities at December 31, 2004. MBSs are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. When these prepayments occur faster than planned, market rates are usually lower for new investments than those that were prepaid. Prepayments on MBSs were approximately $34 and $45 million for the twelve months ended December 31, 2004 and December 31, 2003, respectively. Approximately 96% of Infinity’s MBSs are rated “AAA” and all but one are investment grade.
Individual portfolio securities are sold creating gains or losses as market opportunities exist. Since all of these securities are carried at market value on the balance sheet, there is virtually no effect on liquidity or financial conditions upon the sale and ultimate realization of unrealized gains and losses. The average duration of Infinity’s fixed maturity portfolio was 4.1 years at December 31, 2004.
The table below sets forth the scheduled maturities of fixed maturity securities at December 31, 2004 based on their market values (in millions). Securities that do not have a single maturity date are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
The following table provides information about Infinity’s fixed maturity investments at December 31, 2004 and 2003, which are sensitive to interest rate risk. The table shows expected principal cash flows (in millions) by expected maturity date for each of the five subsequent years and collectively for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. MBSs and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
Net earned premiums and combined ratios for the NSA Group and the Assumed Agency Business were (in millions):
(a) Excludes $48.0 million in unearned premiums transferred to Infinity with the Assumed Agency Business on January 1, 2003.
Net earned premiums for the Assumed Agency Business were essentially unchanged for 2004 as compared with that in 2003. Excluding the effect of the Quota Share Agreements, however, earned premiums fell from $132.2 million in 2003 to $93.2 million in 2004, or a reduction of 29.5%. Gross written premiums fell from $111.1 million (excluding the $48 million transfer of unearned premiums related to the transfer of the book of business from AFG at January 1, 2003) to $74.2 million in 2004, or a decrease of 33.2%. The decrease of premiums is a result of a deliberate effort by Infinity to reduce the writings in Non-Focus States. For 2004, gross written premiums in these states for the Assumed Agency book fell 52.0% as compared with the premiums written in all of 2003. Of the business in the Focus States, the business in Connecticut represented 60% of the total for the year 2003. Written premiums on this business declined 16.7% to $42.0 million in 2004 as compared with that in 2003, as a result of delays Infinity experienced in getting new programs approved by that state’s department of insurance. The loss and LAE ratio for the Assumed Agency Business fell 11.9 points to 69.5% in 2004 as compared with 81.4% in 2003. Excluding the effect of the Quota Share Agreements, the loss and LAE ratio was 69.5% in 2004, about 4.9 points lower than 2003’s 74.4%. The decrease was a result of the decline in business in unprofitable Non-Focus states as well as continued improvement in claims frequencies as experienced by the overall Infinity business as well as the personal auto insurance industry during 2004 (The Assumed Agency Business had $4 million of favorable reserve development in both 2004 and 2003). The expense ratio for the Assumed Agency book of business increased to 31.1% from 28.0% in 2004 and 2003, respectively. Excluding the effect of the Quota Share Agreements, the expense ratios for 2003 and 2004 were 29.6% and 33.4%, an increase of 3.8 points, stemming primarily from the reduction of premiums over which to spread fixed costs associated with the book.
The NSA Group’s net earned premiums fell $40.3 million, or 6.2%, in the twelve-month period ended December 31, 2003 compared to the twelve-month period ended December 31, 2002 primarily as a result of actions taken to discontinue writing inadequately priced business in certain focus states. Earned premiums excluding the effect of the Inter-Ocean reinsurance agreement declined 12% to $833 million, due primarily to a reduction in business volume partially offset by rate increases. The loss and LAE ratio improved by 2.3% points for the twelve-month period ended December 31, 2003 from the same period in 2002. Excluding the effects of the Inter-Ocean reinsurance agreement, the loss and LAE ratio improved 1.7% points. The expense ratio improved by 1.9% points in 2003
The Assumed Agency Business’s net earned premiums decreased $14.1 million, or 13.2%, for the twelve-month period ended December 31, 2003 compared to the twelve-month period ended December 31, 2002 primarily as a result of a reduction in business volume. Earned premiums excluding the effect of the Inter-Ocean reinsurance agreement declined $29.9 million, or a reduction of 18.4%, due primarily to a reduction in business volume partially offset by rate increases. The loss and LAE ratios for the Assumed Agency Business improved from 84.9% during the twelve-month period ended December 31, 2002 to 81.4% as a result of increases in rates, lower frequency of claims per auto insured and moderate increases in the average cost per claim as well as a reduction in business in the Non-Focus States. Excluding the effects of the Inter-Ocean reinsurance agreement, the loss and LAE ratio improved from 77.8% to 74.4%. The expense ratio increased 3.6% points from 24.4% for the twelve-month period ended December 31, 2002 to 28.0% for the same period in 2003. Excluding the effects of the Inter-Ocean reinsurance agreement, the expense ratio increased by 1.3% points from 28.3% for the twelve months of 2002 to 29.6% for 2003. This increase was attributable to a charge of $4.0 million from an increase in the rate of amortization of deferred acquisition costs following a periodic review of the deferability of specific acquisition costs. Excluding this charge, the expense ratio fell 1.7% points for the twelve-month period ended December 31, 2003 from the same period in 2002.
Investment income is composed primarily of gross investment revenue, investment management fees and expenses and interest expense incurred on the Quota Share Agreements, as shown in the following table (in millions):
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Net investment income increased $8.5 million for the twelve-month period ended December 31, 2004 from the corresponding 2003 period. This increase was due to (i) the decrease in interest expense associated with the Quota Share Agreements of $4.7 million for the twelve-month period ended December 31, 2004 versus the corresponding 2003 period, due to the lower utilization of the Quota Share Agreements in 2004 as compared to 2003 and (ii) higher gross investment income from a 11.4% increase in average invested assets, partially offset by a decrease in Infinity’s weighted-average gross investment yield from 5.5% to 5.1% for the twelve-month periods ended December 31, 2003 and 2004, respectively.
Other income decreased $5.3 million for the twelve-month period ended December 31, 2004 from the corresponding 2003 period, primarily due to a nonrecurring gain of $6.7 million on the commutation of service and indemnity agreements with AFG in 2003. Other income increased $8.1 million for the twelve-month period ended December 31, 2003 from the corresponding 2002 period, primarily due to the aforementioned $6.7 million gain and increased finance and service charge income.
Corporate general and administrative expenses include costs associated with the new public company beginning in February 2003. Other expenses increased $1.8 million for the twelve-month period ended December 31, 2003 to 2004 due to increased bad debt expense on uncollectible premiums, and increased litigation expenses during 2004, partially offset by a loss recorded in 2003 on an office sublease. Other expenses fell $4.4 million for the twelve-month period ended December 31, 2003 from the same period in 2002 due primarily to a $5.3 million litigation settlement in 2002.