You should read the following selected consolidated financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this report.
Includes a pre-tax loss of $2.1 million from the commutation of two reinsurance agreements in 2003.
Includes favorable loss reserve development for the years ended December 31, 2007, 2006, 2005, 2004 and 2003 of $36.5 million, $14.2 million, $24.7 million, $8.3 million, and $1.0 million, respectively.
Underwriting and other expenses not directly associated with policy acquisition divided by net premiums earned.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the accompanying notes appearing elsewhere in this report.
Our results of operations are affected by the following business and accounting factors and critical accounting policies:
premiums we earn from the sale of workers’ compensation insurance policies and from the portion of the premiums assumed from the National Workers’ Compensation Reinsurance Pool (“NWCRP”) and other state mandated involuntary pools, which we refer to as gross premiums, less the portion of those premiums that we cede to other insurers, which we refer to as ceded premiums. We refer to the difference between gross premiums and ceded premiums as net premiums; and
insurance losses and LAE relating to the insurance policies we write directly and to the portion of the losses assumed from the state mandated involuntary pools, including estimates for losses incurred during the period and changes in estimates from prior periods, which we refer to as gross losses and LAE, less the portion of those insurance losses and LAE that we cede to our reinsurers, which we refer to as ceded losses and LAE. We refer to the difference as net losses and LAE;
dividends paid to policyholders, primarily in administered pricing states where premium rates are set by the regulators;
interest expense under our bank credit facility and surplus notes issued to third parties.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on the amounts reported in the future. We view as our critical accounting policies the estimates and assumptions used in establishing our loss reserves, reinsurance, reinsurance recoverables, premium revenues, deferred policy acquisition costs, valuation of investments, dividends to policyholders, and income taxes.
future claim payments and LAE in addition to case reserves due to unforeseen or unknown events;
development in excess of claim reserves on claims that have been reported to us.
The range of estimates for IBNR as of December 31, 2007 produced by the various separate actuarial reserving methods we reviewed ranged from $42.4 million above the point estimate (for the reserve development method) and $30.2 million below the point estimate (for the paid loss development method). This range does not necessarily constitute a range of reasonable estimates and does not imply that each of these loss estimates is equally likely. No one actuarial reserving method has consistently been found to be more predictive than any other.
We and our independent actuarial firm prepare IBNR estimates using nine separate actuarial methods. Each of these methods arrives at a different estimate of IBNR by assigning different weights to assumptions based upon three factors affecting the claim closure process: (1) claim payment and reporting patterns (loss development patterns); (2) expected ultimate net loss ratios; and (3) average claim costs and claim frequency. Each of these assumptions changes depending on the state and accident year being examined. In most cases the assumptions do not change between successive actuarial reviews.
Incurred Bornhuetter-Ferguson Method - A method assigning partial weight to the initial expected losses (calculated from the initial expected loss ratio) and partial weight to observed incurred losses. The weights assigned to the initial expected losses decrease as the accident year matures.
Paid Development Method - A method using historical, cumulative paid losses by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years.
Historically, our point estimate generally follows a weighting of the four methods described above. The weights we observe are:
Reserve estimates derived using the Bornhuetter-Ferguson methods are driven by our assumptions related to the expected loss ratio and the expected reporting or payment pattern for losses, while reserve estimates derived using the loss development methods are solely driven by our assumptions related to the expected reporting and payment patterns, and are not at all affected by our assumptions related to the expected loss ratio. Reporting and payment pattern refers to the estimated percentage of the ultimate losses for a particular state that have been reported or paid at a particular valuation date. The table below quantifies the impact that reasonably likely changes in these three variables-the expected loss ratio, the expected payment pattern and the expected reporting pattern for losses-would have on the recorded net and gross reserves for losses and LAE at December 31, 2007. Due to the selection of weights in the table above, changes in the initial expected loss ratio do not have an effect on accident years prior to 2001.
As summarized in the tables above, we estimated the sensitivity of the reserve estimates to three items:
1. Changes in the initial expected loss ratio-We varied the initial expected loss ratio utilized in the Bornhuetter-Ferguson methods by + / - 10% (e.g., if the initial expected loss ratio was 60% for a particular state and accident year, we calculated the sensitivity of reserves to a change in loss ratio of 6% = 10% ´ 60%). Changes in the initial expected loss ratio affect the results of the two Bornhuetter-Ferguson methods.
2. Changes in the paid loss development pattern-We varied the paid loss development pattern by + / - 10% (e.g., if paid losses were expected to develop by 50% for a particular state and accident year, we calculated the sensitivity of reserves to a change in paid loss development factors of 5.0% = 10% ´ 50%). Changes in the paid loss development factors affect the results of the Paid Loss Bornhuetter-Ferguson Method and the Paid Loss Development Method.
Fixed maturity investments are designated at purchase as held-to-maturity or available-for-sale. Held-to-maturity investments are reported at amortized cost. Securities classified as available-for-sale are reported at fair value with unrealized appreciation and depreciation, net of deferred taxes, on our balance sheet in accumulated other comprehensive income as a separate component of stockholders’ equity. We have historically held until maturity those securities designated as held-to-maturity and intend to maintain our investment guidelines so that we would do so in the future.
An estimated provision for our dividends to policyholders is accrued as the related premiums are earned. We offer dividend programs to our policyholders in Florida and Wisconsin, where rates are set by state insurance regulators, and in Georgia, Texas and Virginia, to a lesser extent. These dividends are not guaranteed and are required to be approved by the boards of directors of our insurance subsidiaries. The boards of directors may base their decisions to pay dividends on many factors, including (1) an individual policyholder’s net loss ratio, (2) the insurance subsidiary’s overall net loss ratio and (3) the terms of the individual policyholder’s dividend plan. The type of dividend plan is stated in the policy and, other than with respect to flat dividend policies in Wisconsin, has a direct relationship to the amount of losses incurred under that policy. The prior loss experience of the policyholder is a key element in the estimation of our dividend liability.
Gross Premiums Written. Gross premiums written is the sum of direct premiums written and assumed premiums written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten by our insurance subsidiaries. Assumed premiums written represent our share of the premiums assumed from state mandated involuntary pools. We use gross premiums written, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.
Net Premiums Earned. Net premiums earned represents that portion of net premiums written equal to the expired portion of the time for which the insurance policy was in effect during the financial year and is recognized as revenue. It represents the portion of premium that belongs to us on the part of the policy period that has passed and for which coverage has been provided. Net premium earned is used to calculate the net loss, policy acquisition expense, underwriting and other epense and dividend ratios, as indicated below.
Like many insurance companies, we analyze our loss ratios on a calendar year basis and on an accident year basis. A calendar year loss ratio is calculated by dividing the losses and LAE incurred during the calendar year, regardless of when the underlying insured event occurred, by the premiums earned during that calendar year. The calendar year net loss ratio includes changes made during the calendar year in reserves for losses and LAE established for insured events occurring in all prior periods. A calendar year net loss ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers.
While calendar year loss ratios are useful in measuring our profitability, we believe that accident year loss ratios are more useful in evaluating our underwriting performance for any particular year because an accident year loss ratio better matches premium and loss information. Furthermore, accident year loss ratios are not distorted by adjustments to reserves established for insured events that occurred in other periods, which may be influenced by factors that are not generally applicable to all years. The loss ratios provided in this report are calendar year loss ratios, except where they are expressly identified as accident year loss ratios. See “-Results of Operations,” “Business-Overview” and “-Regulation.”
Underwriting and Other Expense Ratio. The underwriting and other expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of underwriting and other expenses to net premiums earned. For underwriting and other expense ratio purposes, underwriting and other expenses of an insurance company exclude investment expenses and dividends to policyholders.
Return on Equity. This percentage is the sum of return on equity (“ROE”) from underwriting, ROE from investing, the ROE impact of debt and ROE from other income, multiplied by one minus the effective tax rate. ROE from underwriting is calculated as one minus the combined ratio, representing our underwriting profit percentage, multiplied by our operating leverage (annualized net premiums earned divided by average equity). ROE from investing is calculated by multiplying the investment yield for the period by our investment leverage (average investments divided by average equity). The ROE impact of debt is calculated by multiplying the effective interest rate on debt for the period by our financial leverage (average debt divided by average equity). We use return on equity to measure our growth and profitability. We can compare our return on equity to that of other companies in our industry to see how we are performing compared to our competition.
Gross premiums written decreased $3.4 million, or 1.2% in 2006 as compared to 2005. Direct premiums written decreased $3.5 million, while assumed premiums written increased $0.1 million. The decrease in direct premiums written is primarily driven by decreases in direct written premiums in Florida ($8.4 million), Indiana ($6.8 million), and Tennessee ($3.3 million), offset by increases in Texas ($5.0 million), Illinois ($3.3 million), Wisconsin ($2.9 million), North Carolina ($2.5 million), and Virginia ($1.5 million). All other states combined decreased by $0.2 million. The decrease in Florida premiums is the result of a rate decrease during the year, with the number of policies written in Florida remaining relatively flat. For all other states with significant changes in direct premiums written, the change in the number of policies was consistent with the change in direct premiums written. The overall number of policies written decreased 2.2% during the year.
Net premiums written decreased $2.9 million, or 1.1% in 2006 as compared to 2005. This decrease is the result of the decrease in gross premiums written. The retention in our 2006 and 2005 excess-of-loss treaties was unchanged at $2.0 million.
Gross premiums earned decreased $40.0 million, or 14.4% in 2007 as compared to 2006. This decrease is primarily the result of a decrease in direct earned premiums, with the largest decreases being in Florida ($31.8 million), Indiana ($6.9 million), Tennessee ($2.2 million), Wisconsin ($2.0 million) and Kentucky ($1.4 million), offset by increases in Illinois ($2.8 million) and Georgia ($1.2 million), combined with other smaller changes. Assumed premiums earned also decreased by $1.9 million, as a result of the decrease in assumed premiums written.
Net premiums earned decreased $37.1 million, or 13.9% in 2007 as compared to 2006. This decrease is primarily the result of the decrease in gross premiums earned. The change in gross premiums earned was partially offset by a $2.9 million decrease in ceded premiums earned, caused by a decrease in the reinsurance premiums rates from 4.5% of direct premiums on the 2005 treaties to 3.2% on the 2006 and 2007 treaties. As the 2005 treaty was settled on a run-off basis, the rate on the 2005 treaty continued to impact ceded premiums earned in 2006.
Net premiums earned increased $9.9 million, or 3.8 % in 2006 as compared to 2005. This increase is in part attributable to the elimination of the quota share reinsurance on all new and renewal business after July 1, 2004. During 2006 the activity on quota share treaties was minimal and attributable to premium audits performed on prior year policies. In 2005, $7.3 million of earned premiums was ceded under quota share reinsurance agreements The remaining increase in 2006 net premiums earned is primarily the result of the reduction in the excess-of-loss reinsurance contractual rate from 4.5% of direct premiums written in 2005 to 3.2% in 2006. The rate decrease in the excess-of-loss reinsurance is due to the elimination of ceding commission in the 2006 contract.
Net investment income increased $6.7 million or 61.7% in 2006 as compared to 2005. The increase is attributable to two factors. First, the investment portfolio increased $94.1 million over December 31, 2005. The additional funds available for investment were provided by $48.0 million of net initial public offering proceeds, and $54.2 million of net cash provided by operating activities. Additionally, at December 31, 2006, the yield to maturity on the portfolio increased to 5.4% from 4.9% in the prior year.
Losses and loss adjustment expenses increased $20.0 million, or 13.9% in 2006 as compared to 2005. Loss and loss adjustment expenses were 61.4% and 56.0% of net premiums earned in 2006 and 2005, respectively. The primary causes of the increased loss ratios are the reduction of the redundancy as well as an increase in catastrophic claims and an overall increase in severity during 2006. Reflected in our losses and LAE in 2006, is a $14.2 million redundancy, net of reinsurance, for years prior to 2006. Excluding assumed business, this redundancy was attributable to prior accident year reserve decreases in Florida ($10.9 million), Tennessee ($7.2 million), Indiana ($4.3 million), and Texas ($3.7 million), offset by increases in North Carolina ($4.7 million), and Wisconsin ($3.8 million), with the remaining offset being attributable to other states and assumed business. Reflected in our losses and LAE in 2005, was a $24.7 million redundancy, net of reinsurance, for years prior to 2005. Additionally, as of December 31, 2006, the current accident year loss ratio, excluding the involuntary pool and ULAE, increased to 63.4% from 61.3% for the prior accident year. Contributing to the higher accident year loss ratio were increases in South Carolina (to 124.2% from 66.9% at December 31, 2005), Virginia (to 95.1% from 56.5%), Georgia (to 80.3% from 60.7%), and North Carolina (to 91.5% from 67.5%). These increases were offset by decreases in net accident year loss ratios for Tennessee (to 79.3% from 101.6%) and Texas (to 39.2% from 44.6%). Loss and LAE on involuntary pools increased to 1.2% of net premiums earned from 0.8% as of December 31, 2005. Additionally, adjusting and other expense was 3.9% of net premiums earned in 2006, and 3.7% for 2005.
Policy acquisition expenses decreased $8.4 million, or 16.9% in 2007 as compared to 2006. Policy acquisition expenses decreased to 18.0% from 18.6% of net premiums earned in 2007 and 2006, respectively. This decrease is primarily the result of a decrease in assessments, offset by an increase in the general and administrative component of policy acquisition expenses. Commissions and premium taxes as a percentage of net premiums earned were relatively consistent between 2007 and 2006. Assessments, including guaranty fund credits which reduce premium tax expense, represented 1.4% of net premiums earned, compared to 2.9% for 2006. The decrease in assessments is a result of decreases in subsequent injury fund and guaranty fund assessment expenses. The decrease in subsequent injury fund assessment expense is primarily the result of decreases in Florida ($1.4 million) and South Carolina ($0.7 million) subsequent injury fund assessments, offset by an increase in the Georgia assessment ($0.8 million). The decrease in the Florida subsequent injury fund assessment is a result of the decrease in Florida direct premiums written. The South Carolina subsequent injury fund assessment decreased due to current year redundancies and a decrease in the current accident year loss ratio to 72.0% in 2007 from 126.2% in 2006. The subsequent injury fund assessment for Georgia increased as a result of a rate increase in 2007 from 2006, partially offset by redundancies in 2007. The decrease in guaranty fund assessment expense is primarily the result of decreases related to Wisconsin ($0.9 million), Florida ($0.5 million) and Tennessee ($0.4 million). In all three of these states, information obtained in the current year regarding insolvencies in the states lead us to believe that accruals held in the prior year could be removed or reduced. The general and administrative expense component of policy acquisition expense represented 4.6% of net premiums earned, compared to 3.9% in 2006. The increase in general and administrative expenses is the result of an increase in employee time spent prior to or at policy initiation. Note that while commissions were flat in 2007 as compared to 2006, there was a decrease in direct commissions that was offset by a decrease in ceded commissions. The decrease in direct commissions resulted from a decrease in direct premiums earned and a decrease in the commission payable accrual. The decrease in the ceding commission received is the result of receiving no ceding commission on the 2007 and 2006 excess-of-loss reinsurance treaties, compared to the 35% commission received on the 2005 treaty, which was in run-off through 2006.
Policy acquisition expenses decreased $2.0 million, or 3.8% in 2006 as compared to 2005. Policy acquisition expenses were 18.6% and 20.1% of net premiums earned in 2006 and 2005, respectively. This decrease is the result of decreases in premium taxes and assessments, partially offset by increases in commissions and the general and administrative expense component of policy acquisition expenses. Premium taxes represented 1.6% of net premiums earned, compared to 1.9% for 2005. This decrease is the result of the application of state income tax credits allowed on the Florida premium tax return in the current year. Assessments represented 3.0% of net premiums earned, compared to 6.5% for 2005. This is due in part to a approximately 30% decrease in the South Carolina SDTF rate during the third quarter of 2006, and a 90% increase in the rate in the third quarter of 2005. Additionally, in 2006 the rate used for the 2005 premium assessment by the Florida Guarantee Fund assessment was reduced to zero from the original 2% accrued during 2005. The Florida Workers’ Compensation Insurance Guarantee Association did not assess the 2005 premiums in 2005; however, it reserved the right to assess the 2005 premiums in 2006 if any solvency issues arose that required additional cash flow for the Association. As no assessment was made during 2006 for premiums written in 2005, and the time period in which the Association was able to assess the 2005 premiums has passed, the accrual for assessment on the 2005 premium was reduced to zero. These decreases were partially offset by an increase in commissions. The commissions increase is the result of receiving no ceding commission to offset commission expense on the 2006 excess-of-loss treaty, compared to a 35% commission received on the 2005 treaty. In 2005, ceding commissions reduced policy acquisition expenses by $7.4 million, which decreased the expense ratio by 2.9%. In 2006, ceding commission was reduced to $1.9 million, which decreased the expense ratio by 0.7%. The general and administrative expenses associated with policy acquisition costs represented 3.9% of net premiums earned, compared to 3.4% for 2005. This increase is primarily the result of an increase in the payroll expense attributed to underwriting in 2006.
Dividends to policyholders increased $1.4 million, or 14.2% in 2007 as compared to 2006. Dividends to policyholders were 4.9% and 3.7% of net premiums earned in 2007 and 2006, respectively. The increase in dividends to policyholders is a result of a refinement in the dividend accrual calculation, an increase in percentage of direct written premiums on dividend plans, and the accrual of $0.5 million of Florida excessive profits dividends. Excluding Florida excessive profits dividends, the percentage of direct premiums written in Florida on a dividend plan increased to 46.8% in 2007 from 37.8% in 2006. The percentage of direct premiums written in Wisconsin on a dividend plan increased to 90.7% in 2007 from 84.1% in 2006. The company wide direct premiums written on a dividend plan increased to 27.5% in 2007 from 25.7% in 2006. The accrual of Florida excessive profits was the result redundancies booked during the quarter that increased the Company’s profits in Florida for the years 2004 through 2006 combined.
Interest expense increased $0.8 million, or 28.6% in 2006 as compared to 2005. The increase is attributable to an interest rate increase of approximately 1% on our $38.3 million of variable rate debt. Additionally, during 2006, interest expense increased as the result of accruing approximately $0.3 million of interest in connection with an interest bearing payable.
Net income increased $2.3 million or 13.7% in 2007 as compared to 2006. A decrease in loss and LAE of $37.1 million, a decrease in policy acquisition expenses of $8.4 million and an increase in net investment income of $2.6 million, offset by a decrease in net premiums earned of $37.1 million, an increase in underwriting and other expenses of $3.8 million, an increase in federal and state income taxes of $3.2 million, and a increase in dividends to policyholders of $1.4 million, primarily comprised the change.
Net income decreased $0.2 million or 1.3% in 2006 as compared to 2005. Increases in net premiums earned and net investment income of $9.9 million and $6.7 million respectively, and a decrease in underwriting and acquisition expenses of $4.2 million, were offset by an increases in loss and loss adjustment expenses and dividends of $20.0 million and $1.3 million, respectively.
We are a holding company and our insurance subsidiaries are the primary source of funds for our operations. We have historically received dividend payments solely from Pinnacle Administrative Company (“Pinnacle Administrative”) and Pinnacle Benefits, Inc (“Pinnacle Benefits”). These dividend payments are funded by fee payments under service agreements between Pinnacle Administrative and Pinnacle Benefits and our insurance subsidiaries. Fee payments under the service agreements are subject to review by the Florida OIR, as are dividend payments by our insurance subsidiaries. There are no restrictions on the payment of dividends by our non-insurance subsidiaries, Pinnacle Administrative, Pinnacle Benefits and AmSERV, Inc., other than customary state corporation laws regarding solvency. The cash requirements of these non-insurance subsidiaries are primarily for the payment of salaries, employee benefits and other operating expenses.
The primary source of cash flow for Pinnacle Benefits and Pinnacle Administrative is service fees paid by our insurance subsidiaries. Our insurance subsidiaries’ primary cash sources are insurance premiums, investment income and the proceeds from the sale, redemption or maturity of invested assets. The cash requirements of the insurance subsidiaries are primarily for the payment of losses and LAE, dividends, guaranty fund and second-injury fund assessments, commissions, reinsurance premiums, premium taxes, services fees, interest on surplus notes and purchase of investment securities. We maintain cash reserves to meet our obligations that comprise current outstanding loss and LAE, reinsurance premiums and administrative expenses. Due to the uncertainty regarding the timing and amount of settlement of unpaid losses, the liquidity requirements of the insurance subsidiaries vary. The insurance subsidiaries’ investment guidelines and investment portfolio take into account historical payout patterns. If loss payments were to accelerate beyond our ability to fund them from current operating cash flows, we would need to liquidate a portion of our investment portfolio and/or arrange for financing. For example, several catastrophic injuries occurring in a relatively short period of time could cause such a liquidity strain. Our insurance subsidiaries have historically purchased excess reinsurance to mitigate the effects of large losses and to help stabilize liquidity. These reinsurance agreements require initial outlays of reinsurance premiums, based on premiums written, which is in advance of our receipt of cash premiums, and the reinsurers reimburse us after losses and LAE are paid by us. These reinsurance agreements exclude coverage for losses arising out of terrorism and nuclear, biological and chemical attacks.
For statutory purposes, these surplus notes are considered as a component of AmCOMP Preferred’s policyholders’ surplus. For GAAP and income tax purposes, the surplus notes are considered debt. The issuance of the surplus notes required Florida OIR approval. Additionally, all future principal and interest payments require the approval of the Florida OIR.
On September 4, 2007, the Company obtained a commitment for a $30 million secured non-revolving line of credit from Regions Bank. Under the terms of the commitment for the loan, the interest rate is a floating rate of 160 basis points over LIBOR. Advances under the commitment will be available for up to two years from the date of closing. Fundings under the commitment will have a seven-year fully amortizing term and can be repaid at any time without penalty. The loan has no fees associated with it other than a ¼% non-usage fee per annum pro-rated for the amount of loan principal which is not drawn down by AmCOMP. Any advances under the line of credit are to be collateralized by the stock of a wholly-owned insurance subsidiary of AmCOMP and certain intercompany surplus notes. The loan is designated for strategic and general corporate purposes. At AmCOMP’s request Regions Bank extended the closing date of the commitment through June 15, 2008.
As a result of raising $32.0 million from surplus notes issued by one of our insurance subsidiaries, we eliminated the need for quota share reinsurance on new and renewal business since July 1, 2004. In addition, we increased our retention in our excess of loss reinsurance program to $2.0 million in 2005 and thereafter.
The amount and types of investments that may be made by our insurance subsidiaries are regulated under the Florida Insurance Code and the rules and regulations promulgated by the Florida OIR. As of December 31, 2007 and December 31, 2006, our insurance subsidiaries’ combined portfolio consisted entirely of investment grade fixed-income securities. As of December 31, 2007, our investments (excluding cash and cash equivalents) had an average duration of 4.1 years, and the bond portfolio was heavily weighted toward short- to intermediate-term securities.
Our insurance subsidiaries employ Regions Bank to act as their independent investment advisor. Regions Bank follows the insurance subsidiaries’ written investment guidelines based upon strategies approved by our insurance subsidiaries’ boards of directors. Our insurance subsidiaries have no investments in common stock (other than AmCOMP Preferred’s investment in AmCOMP Assurance and certain institutional money market accounts), preferred stock, real estate, asset-backed securities (other than mortgage-backed) or derivative securities. Regions Bank has discretion to enter into investment purchase transactions within our insurance subsidiaries’ investment guidelines. In the case of sales of securities prior to maturity or the acquisition of securities that differ from the types of securities already present in the portfolio, Regions Bank is required to obtain approval from our insurance subsidiaries’ executive officers, who report regularly to our insurance subsidiaries’ investment committees, prior to executing the transactions. Regions Bank’s fee is based on the amount of assets in the portfolio and is not dependent upon investment results or portfolio turnover.
Standard & Poor’s highest rating is “AAA” and signifies that a company’s capacity to meet its financial commitment on the obligation is extremely strong, followed by “AA” (very strong), “A” (strong) and “BBB” (adequate). Ratings may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. Moody’s Investors Service, Inc.’s highest rating is “Aaa” (best quality), followed by “Aa” (high quality), “A” (strong) and “Baa” (adequate). For investments with split ratings, the higher rating has been used.
The table below sets forth the maturity profile of our bond portfolio at amortized cost and fair market values as of December 31, 2007:
We continuously monitor our portfolio to preserve principal values whenever possible. An investment in a fixed maturity security is impaired if its fair value falls below its book value. All securities in an unrealized loss position are reviewed to determine whether the impairment is other-than-temporary. Factors considered in determining whether a decline is considered to be other-than-temporary include length of time and the extent to which fair value has been below book value, the financial condition and near-term prospects of the issuer, and our ability and intent to hold the security until its expected recovery.
At December 31, 2007, there were no investments in fixed maturity securities with individual material unrealized losses. One other-than-temporary impairment totaling $0.1 million and three other-than-temporary impairments totaling approximately $0.2 million were recorded on our investments during the years ended December 31, 2007 and 2006, respectively. All the unrealized losses on the fixed maturity securities are interest rate related.
In July 2006, FASB issued FIN 48. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation establishes a “more likely than not” recognition threshold for tax benefits to be recognized in the financial statements. The “more likely than not” determination is to be based solely on the technical merits of the position. This interpretation was adopted by the Company on January 1, 2007. As of the adoption date and as of December 31, 2007, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.
Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts, issued September 2005, became effective January 1, 2007. SOP 05-1 provides guidance on accounting for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverage that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The adoption of SOP 05-01 did not have a material impact upon adoption.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AmCOMP Incorporated and Subsidiaries as of December 31, 2007, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
February 28, 2008, except for Note 19, as to which the date is March 4, 2008
We have audited the accompanying consolidated balance sheet of AmCOMP Incorporated and subsidiaries (the "Company") as of December 31, 2006, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2006. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
Organization-AmCOMP Incorporated and subsidiaries (collectively, the “Company”) consist of the following entities at December 31, 2007, 2006 and 2005:
AmCOMP Incorporated (“AmCOMP”), a holding company incorporated on December 28, 1995;
Pinnacle Administrative, Inc. (“Pinnacle Administrative”), a wholly owned administrative services company providing sales and marketing, underwriting, policyholder service, data processing, and accounting services;
Pinnacle Benefits, Inc. (“Pinnacle Benefits”), a wholly owned claims processing company;
Use of Estimates-The preparation of consolidated financial statements requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Such estimates and assumptions could change in the future as more information becomes known that could affect the amounts reported herein.
Basis of Presentation-The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of AmCOMP, AmCOMP Preferred, Pinnacle Administrative, Pinnacle Benefits, AmCOMP Assurance, and AmServ. All intercompany accounts and transactions have been eliminated in consolidation.
Premiums Receivable-Premiums receivable consist primarily of premium-related balances due from policyholders. The balance is shown net of the allowance for doubtful accounts. Receivables due from insureds are written off when a determination has been made that a specific balance will not be collected based upon the collection efforts of Company personnel. An estimate of amounts that are likely to be written off is established as an allowance for doubtful accounts as of the balance sheet date. The estimate is primarily comprised of specific balances that are considered probable to be written off after all collection efforts have ceased, as well as historical trends and an analysis of the aging of the receivables.
Property and Equipment-Property and equipment is stated on the basis of cost net of accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives, generally 3 to 7 years for financial reporting purposes. Depreciation expense was $1.6 million, $1.7 million and $2.1 million for the years ended December 31, 2007, 2006 and 2005, respectively. Accumulated depreciation was $12.1 million and $12.8 million at December 31, 2007 and 2006, respectively. During the year ended December 31, 2007, the Company purchased $0.9 million worth on computer equipment under a capital lease.
Goodwill-Goodwill is reviewed for impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. No impairment has been recorded by AmCOMP in 2007, 2006 or 2005.
Policyholder Dividends-Policyholder dividends are recognized over the effective period of the related policies and are restricted in certain instances to limitations imposed by the Board of Directors (see Note 9).
Second Injury Fund Assessments and Recoveries- Many states have laws that established second injury funds to reimburse employers and insurance carriers for workers’ compensation benefits paid to employees who are injured and whose disability is increased by a prior work-related injury. The Company accrues a liability for second injury fund assessments as net premiums are written or as losses are incurred based on individual state guidelines, and for premium based assessments, we defer these costs and recognize them as an expense as the related premiums are earned. The Company recognizes recoveries from the second injury funds when they are received (see Note 3).
Guaranty Fund Assessments- Most states have guaranty fund laws under which insurers doing business in the state are required to fund policyholder liabilities of insolvent insurance companies. The Company accrues a liability for estimated assessments as net premiums are written and defers these costs and recognizes them as an expense as the related premiums are earned. The Company is continually notified of assessments from various states relating to insolvencies in that particular state; however, there are no expense accruals recorded when the Company is unable to estimate the potential future assessment.
Earnings Per Share-The Company computes earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128. In the calculation of basic earnings per share, the dilutive effects of options, warrants, and convertible securities are excluded from the calculation. Diluted earnings per share consider the effects of dilutive convertible securities and stock options.
Concentrations of Credit Risk-Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, investments, premiums receivable, and reinsurance recoverables (see Notes 4, 5, and 6). Concentrations of credit risk with respect to premiums receivable are limited due to the large number of entities comprising the Company’s customer base.
Prior to January 1, 2006, the Company accounted for stock-based compensation to employees using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and related interpretations and disclosure requirements established by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transitions and Disclosures (“SFAS 148”). Accordingly, compensation cost for stock options issued to employees was measured as the excess, if any, of the estimated market price of the Company’s stock at the date of grant over the amount an employee must pay for the stock.
The fair value for those options was estimated at the date of grant using the minimum value option pricing model with the following assumptions: risk-free interest rates equal to the five-year U.S. Treasury Bill rate on the grant date; expected dividend yield of 0%; expected life equal to the life of the options between four and five years; and stock price on the date of grant.
See Note 15 for additional information regarding the Company’s stock-based compensation plans and the assumptions used to calculate the fair value of stock-based awards.
Segment Reporting-The Company operates in a single industry segment, property and casualty insurance specializing in workers’ compensation insurance.
Additionally, AmCOMP Preferred and AmCOMP Assurance are required to comply with NAIC risk-based capital (“RBC”) requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating conditions.
As of December 31, 2007 and 2006, AmCOMP Preferred’s and AmCOMP Assurance’s total adjusted capital is above all regulatory action levels.
Statutory-basis net income (loss) for AmCOMP Preferred and AmCOMP Assurance for the years ended December 31, 2007, 2006 and 2005 is as follows (in thousands):
Stock insurance companies are subject to Florida statute 627.215 and applicable regulations related to Florida excess profits for workers’ compensation insurance companies. Florida excessive profits are calculated based upon a complex statutory formula which is applied over rolling three year periods. Companies are required to file annual excess profits forms, and they are required to return so-called “Florida excessive profits” to policyholders in the form of a cash refund or credit toward the future purchase of insurance. To date, we have not been required to return excess profits. See note 17. As of December 31, 2007, the Company had accrued $0.5 million for estimated additional Florida excessive profits based on its statutory underwriting results for the 2004, 2005 and 2006 years.
Guaranty Fund Assessments- Most states have guaranty fund laws under which insurers doing business in the state are required to fund policyholder liabilities of insolvent insurance companies. Generally, assessments are levied by guaranty associations within the state, up to prescribed limits, on all insurers doing business in that state on the basis of the proportionate share of the premiums written by insurers doing business in that state in the lines of business in which the impaired, insolvent or failed insurer is engaged. The Company accrues a liability for estimated assessments as direct premiums are written and defers these costs and recognizes them as an expense as the related premiums are earned. The Company is continually notified of assessments from various states relating to insolvencies in that particular state; however, the Company estimates the potential future assessment in the absence of an actual assessment. Guaranty fund assessment expenses were ($1.6) million, $1.5 million and $4.0 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company has deferred approximately $1.0 million and $1.2 million as of December 31, 2007 and 2006, respectively, related to guaranty fund assessments, which is included in deferred policy acquisition costs. Additionally, guarantee fund receivable assets of $1.5 million and $2.4 million as of December 31, 2007 and 2006, respectively, are included in other assets, as they can be used as a credit against future premium taxes owed. Maximum contributions required by law in any one state in which we offer insurance vary between 0.2% and 2.0% of direct premiums written.
Second Injury Fund Assessments and Recoveries - Many states have laws that established second injury funds to reimburse employers and insurance carriers for workers’ compensation benefits paid to employees who are injured and whose disability is increased by a prior work-related injury. The source of these funds is an assessment charged to workers’ compensation insurance carriers doing business in such states. Assessments are based on paid losses or premium surcharge mechanisms. Several of the states in which we operate maintain second injury funds with material assessments. The Company accrues a liability for second injury fund assessments as net premiums are written or as losses are incurred based on individual state guidelines, and for premium based assessments, we defer these costs and recognize them as an expense as the related premiums are earned. Second Injury Fund assessment expense was $3.0 million, $4.6 million, $11.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company has deferred approximately $1.5 million and $1.8 million as of December 31, 2007 and 2006, respectively, related to second injury fund assessments, which is included in deferred policy acquisition costs.
The Florida SDTF currently has significant unfunded liabilities. It is not possible to predict how the Florida SDTF will operate, if at all, in the future after further legislative review. Changes in the Florida SDTF’s operations could decrease the availability of recoveries from the Florida SDTF, increase Florida SDTF assessments payable by AmCOMP and/or result in the discontinuation of the Florida SDTF and thus could have an adverse effect on AmCOMP’s business, financial condition, and its operations. Under current law, future assessments are capped at 4.52% of net written premiums, and no recoveries can be made for losses or submitted on claims occurring after January 1, 1998.
Other Assessments- Various other assessments are levied by states in which the Company transacts business, and are primarily based on premiums written or collected in the applicable state. The total expense related to these assessments was $0.9 million, $1.2 million and $1.3 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company has deferred approximately $0.2 million and $0.3 million as of December 31, 2007 and 2006, respectively, related to these assessments, which are included in deferred policy acquisition costs.
Liabilities for assessments are expected to be paid over the next five years. Guarantee fund receivable assets are expected to be realized over the next five to ten years.
The amortized cost and estimated fair values of investments in fixed maturity securities, segregated by available-for-sale and held-to-maturity, at December 31, 2007 are summarized by maturity as follows (in thousands):
At December 31, 2007 and 2006, bonds with an amortized cost of $7.9 million and $13.2 million and a fair value of $9.0 million and $14.0 million, respectively, were on deposit with various states’ departments of insurance in accordance with regulatory requirements. Additionally, as of December 31, 2007, $6.0 million of cash, representing a matured security not yet reinvested, was on deposit with a department of insurance. At December 31, 2007 and 2006, bonds with an amortized cost of $6.5 million and $6.0 million and a fair value of $6.6 million and $5.9 million, respectively, were held in a reinsurance trust to the benefit of members of the Orion Insurance Group in accordance with the terms of a reinsurance agreement between the Company and the Orion Companies.
Proceeds from the sale of available-for-sale fixed maturity securities during the years ended December 31, 2007, 2006 and 2005 were $23.1 million, $5.3 million and $33.4 million, respectively. Gross gains of less than $0.1 million, less than $0.1 million, and $0.2 million were realized in the years ended December 31, 2007, 2006 and 2005 respectively. Gross losses of $0.4 million, $0.2 million and $0.6 million were realized in the years ended December 31, 2007, 2006 and 2005, respectively, on those sales.
In addition to the stated specific retentions and limits shown and consistent with common industry practice, our excess reinsurance contracts contain several other limitations to claim payouts. Some of the more significant limitations include limitations to the payout for any one claimant, limitations to the number of reinsurance claims allowed in any one year, and exclusions for payments related to terrorism and other similarly catastrophic events.
Insurance premiums for the years ended December 31, 2007, 2006 and 2005 are summarized as follows (in thousands):
Incurred losses and loss adjustment expenses for the years ended December 31, 2007, 2006 and 2005 are summarized as follows (in thousands):
Effective January 1, 2007, the Company adopted FIN 48. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements, prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, and accounting in interim periods. The Interpretation establishes a “more likely than not” recognition threshold for tax benefits to be recognized in the financial statements. The “more likely than not” determination is to be based solely on the technical merits of the position. As of the adoption date and as of December 31, 2007, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required. We recognize income tax related interest in interest expense and penalties in income tax expense. Income tax related interest recognized in the years ended December 31, 2007 and 2006 was $0.2 million and $0.3 million, respectively. Tax related interest accrued as of December 31, 2007, and December 31, 2006 was $0.6 million and $0.4 million, respectively. Tax years 2004 through 2006 and 2003 through 2006 are subject to examination by the federal and state taxing authorities, respectively. There are no income tax examinations currently in process.
Management believes the historical experience of the Company is a reasonable basis for estimating future losses. However, future events beyond the control of management, such as changes in law, judicial interpretations of law, and inflation may favorably or unfavorably impact the ultimate settlement of the Company’s loss and loss adjustment expenses.
The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. While anticipated changes in claim costs due to inflation are considered in estimating the ultimate claim costs, the increase in average severity of claims is caused by a number of factors that vary with the individual type of policy written. Future average severities are projected based on historical trends adjusted for implemented changes in underwriting standards, policy provisions, and general economic trends. Those anticipated trends are monitored based on actual development and are modified if necessary. Changes in the Company’s estimate of reserves for losses and loss adjustment expenses are reflected in operations in the period in which the estimates are changed.
As of December 31, 2007, the Company had accrued $0.5 million for estimated additional Florida dividends based on its statutory underwriting results pursuant to Florida Statute 627.215 and applicable regulations (“Florida excessive profits”). AmCOMP’s ultimate liability will be based on its premiums earned, loss reserves and expenses compiled in accordance with the statute and regulations.
On October 12, 2000, the Company entered into a credit facility (the “Loan”) with a financial institution under which the Company borrowed $11.3 million. The Loan calls for monthly interest payments at the 30-day LIBOR rate plus a margin. The expiration date on the loan is April 10, 2010. The Loan is collateralized by $25.5 million of surplus notes issued by AmCOMP Preferred and AmCOMP Assurance and the stock of AmCOMP Preferred. During 2003, the remaining balance of the Loan was refinanced and the Company borrowed an additional $5.5 million. At December 31, 2007 and 2006, the principal balance was $4.5 million and $6.3 million respectively. The interest rate was 6.83% and 7.85% at December 31, 2007 and 2006, respectively. Interest paid during 2007, 2006 and 2005 totaled $0.4 million, $0.5 million and $0.5 million, respectively.
The Loan contains various restrictive covenants and certain financial covenants. At December 31, 2007, the Company was in compliance with all restrictive and financial covenants.
On September 14, 2004, AmCOMP Preferred issued a $10.0 million surplus note, in return for $10.0 million in cash, to Alesco Preferred Funding V, LTD, as part of a pooled transaction. The note matures in approximately 30 years and is callable by the Company after approximately five years. The terms of the note provide for quarterly interest payments at a rate 405 basis points in excess of the 90-day LIBOR. Interest paid during the years ended December 31, 2007, 2006 and 2005 totaled $1.0 million, $0.9 million and $0.7 million, respectively. Interest accrued as of December 31, 2007 and 2006 was less than $0.1 million.
Payments of principal due on the notes payable at December 31, 2007 are as follows (in thousands):
Undesignated Preferred Stock-At December 31, 2007, the board or directors had the authority to issue up to 5,000,000 shares of undesignated preferred stock and to determine the rights, preferences and privileges of the shares, without stockholder approval.
As of December 31, 2007, 1,081,314 shares of common stock were issuable and reserved for future issuance under employee stock option plans and to executives granted options outside of option plans.
During 2005, the Company repurchased 873 shares at a purchase price of $4.24. The repurchased shares are recorded as treasury stock on the consolidated balance sheets. In August 2007, the Company’s Board of Directors authorized a share repurchase program to acquire up to 1.5 million shares of the Company’s common stock. The program was intended to be implemented through purchases made from time to time in either the open market or through private transactions, in accordance with the Securities and Exchange Commission’s requirements. Repurchases under this authorization commenced in August 2007, and were suspended in December 2007, in connection with the potential acquisition of the Company by Employers Holdings, Inc. As of December 31, 2007, 559,954 shares have been repurchased pursuant to this authorization at an average cost of $9.76 per share. Additional shares may be repurchased as conditions warrant.
During 1996, the Board approved an employee stock option plan (the “1996 Plan”) and reserved 272,878 shares of the Company’s common stock, subsequently increased to 960,531 shares, for future issuance thereunder. The employee options vest over a period determined at the time of grant and are exercisable over a period of not more than 10 years at an exercise price equal to management’s estimate of the fair market value of the common stock at the date of grant in the case of incentive options and not less than 80% of such fair market value in the case of nonqualified options. In September 2005, the Board terminated the 1996 Plan, which had no effect on options outstanding thereunder.
In September 2005, the Board adopted an employee stock option plan (the "2005 Plan"), and reserved 567,586 shares with a limit of 218,302 shares per optionee per calendar year. Unless sooner terminated by the Board, the 2005 Plan terminates on September 6, 2015. The employee options vest over a period determined at the time of grant, generally 4 years, and are exercisable over a period of not more than 10 years at an exercise price at least equal to fair market value of the common stock at the date of grant.
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 2007, 2006 and 2005 (in thousands, except per share data):
On March 19, 2007, the Company received a Notice of Intent to Issue Order to Return Excessive Profit signed March 14, 2007 (the “Notice”) from the Florida OIR. The Notice indicates on a preliminary basis that Florida OIR proposes to make a finding, following its review of data submitted by the Company on July 1, 2006 for accident years 2002, 2003 and 2004, that Florida excessive profits (as defined in Florida Statute Section 627.215) in the amount of $5,663,805 have been realized by the Company. Florida excessive profits under the statute are required to be returned to policyholders under methods defined in the statute. Upon receipt of the Notice, and upon further review by the Company of the data previously submitted, the Company amended its filings to the Florida OIR responding to the Notice and amending the deductible expense items that are utilized in the calculation of Florida excessive profits. These filings amend and increase the expenses the Company believes are permitted by the statute in calculating Florida excessive profits.
The Company, through outside regulatory counsel, has submitted its amended filings to Florida OIR for the years 2002, 2003 and 2004. The amended filings report no Florida excessive profits for the reporting periods. In the event Florida OIR does not agree with the amended filings as submitted by the Company, there would be a disputed issue of material fact and law regarding the calculation of Florida excessive profits. The Company has preserved its right to an administrative hearing under the provisions of the Notice and Florida Statute Chapter 120 (the Florida Administrative Procedures Act). Under Chapter 120, the Company is entitled to a de novo proceeding on the issues described above. If the administrative ruling is adverse to the Company, the Company would have further appellate rights to the District Court of Appeal. Management of the Company believes, in part based on advice from legal counsel, that Florida excessive profits were not, in fact, earned in Florida for the years 2002, 2003, and 2004. As of December 31, 2007, no accrual for Florida excessive profits has been provided for the 2002, 2003 and 2004 years.
Pursuant to the Merger Agreement, each issued and outstanding share of common stock, $0.01 par value, of the Company, other than dissenting shares or shares owned by the Company as treasury stock, or by Employers or Merger Sub, will be converted into the right to receive $12.50 per share in cash. As part of the Merger Agreement, Merger Sub will merge with and into the Company with the Company being the surviving corporation in the merger. The Board of Directors of the Company and Employers each approved the entry into the Merger Agreement.
Employers may terminate the Merger Agreement under certain circumstances, including if the Company’s Board of Directors changes or withdraws its recommendation that the Company stockholders adopt the Merger Agreement or under other circumstances involving a competing offer to acquire the Company. In connection with such termination, the Company may be required to pay a fee of $8 million to Employers. The Company may terminate the Merger Agreement as a result of Employers’ material breach of any of its representations, warranties, covenants or agreements under the Merger Agreement. In connection with Employers’ breach of any of its covenants or agreements or of its representation and warranty that is has sufficient funds to complete the transaction, Employers may be required to pay a termination fee of $8 million to the Company.
In connection with the Merger Agreement, the Company and Employers entered into Integration Bonus and Enhanced Severance Agreements, effective as of January 10, 2008 (together, the “Severance Agreements”), with Employers and each of Debra Cerre-Ruedisili, the Executive Vice President and Chief Operating Officer of the Company, and Kumar Gursahaney, the Senior Vice President and Chief Financial Officer of the Company (the “Executives”).
In addition, provided that such Executive remains employed by the Company through the Separation Date, or is terminated by the Company or Employers other than due to death, disability or for cause at any time following the closing of the Merger, then in lieu of payments set forth in Section 7(c) of such Executive’s employment agreement, Employers will pay or will cause the Company to pay to such Executive 18 months of severance pay, each monthly payment in an amount equal to the sum of (i) one-sixth of annual salary in the case of Ms. Cerre-Ruedisili, and one-eighth of annual salary in the case of Mr. Gursahaney, each as in effect immediately prior to such termination and (ii) one-twelfth of the amount of incentive compensation and bonuses approved and accrued for such Executive in respect of the most recent fiscal year preceding such termination. The Executives will also be entitled to continued eligibility to participate in any medical and health plans or other employee welfare benefit plans that may be provided by the Company for its senior executive employees for 18 months following the Separation Date.
On March 4, 2008, a purported class-action complaint was filed in the Circuit Court of the 15th Judicial Circuit, in and for Palm Beach County, Florida, on behalf of Broadbased Equities, an alleged stockholder of the Company, and all others similarly situated. The complaint, which names as defendants the Company, the Company’s directors Fred R. Lowe, Debra Cerre-Ruedisili, Sam A. Stephens, Paul B. Queally, Donald C. Stewart and Spencer L. Cullen, Jr., and Employers, asserts claims related to the proposed transaction with Employers for breaches of fiduciary duty and, in the case of Employers, aiding and abetting such breaches, in connection with the directors’ determination to sell the Company. The complaint seeks a declaratory judgment that the defendants have breached their fiduciary duties to plaintiff and the purported class members and/or, in the case of Employers, aided and abetted such breaches, compensatory and/or rescissory damages, as well as pre and post-trial interest, as allowed by law, and the costs and disbursements of the action, including reasonable attorneys' and experts' fees and other costs. The Company believes that these claims are without merit and intends to defend this action vigorously and, therefore, no provision for this litigation has been made in the current financial statements.