Infinity’s insurance subsidiaries lease approximately 900,000 square feet of office and warehouse space in numerous cities throughout the United States. All but two of these leases expire within ten years. The most significant leased office spaces are located in Birmingham, Alabama (Infinity’s principal office); suburban Atlanta, Georgia; Irving, Texas and suburban Los Angeles, California. See Note 13 of the Consolidated Financial Statements for further information about leases.
At December 31, 2002, AFG transferred the NSA Group to Infinity. Financial information for periods prior to the date of transfer represents the combined information of the NSA Group. Infinity also acquired the Assumed Agency Business from GAI through a reinsurance transaction effective January 1, 2003. The historical financial information shown below as of and for the year ended December 31, 2002 was derived from audited financial statements. The Infinity financial data as of and for the twelve-month periods ended December 31, 2006, 2005, 2004 and 2003, include the results of the Assumed Agency Business. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related notes.
(a) The increase in earned premium in years 2004 and 2005 is a result of the discontinuation of the Quota Share Agreements as more fully discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(b) Common shares outstanding exclude non-vested restricted shares 45, 90 and 134 as of December 31, 2005, 2004 and 2003, respectively. All shares were vested as of December 31, 2006.
Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations
Gross written premiums in 2006 were relatively flat compared with that of 2005, declining only 0.2%. Gross premiums in Infinity’s 19 Focus states grew 12.0% during the last six months of 2006 as compared to the last six months of 2005 after declining 8.0%
Overall, market conditions remained competitive during 2006 for Infinity. Rather than experiencing significant rate reductions, companies continued to compete for business by increasing advertising and competing for agents’ attention with incentives. Infinity expects that companies will continue to aggressively advertise and some competitors will take modest rate reductions in order to generate top-line growth over the next twelve months. Infinity will continue to monitor its competitive position, rate adequacy and growth opportunities on a state-by-state basis while striving to maintain a desirable combination of profitability and growth.
Management believes that Infinity’s relatively low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity. For example, approximately 91% of policies included within the nonstandard book of business include only the state-mandated minimum policy limits for bodily injury and property damage, which somewhat mitigates the challenge of estimating average severity. These low limits tend to reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout.
The Company’s management believes that the historical magnitude of adjustments to ultimate losses on an accident year basis are indicative of the sensitivity of currently held loss reserves to changes in underlying assumptions. Over the past five accident years (the years for which data is readily available), excluding the effect of corporate litigation costs, the combined effects of adjustments to the initial estimate for average ultimate claims frequency and severity have ranged from (5.2)% to 4.5% (averaging (0.4)%).
Applying the five-year historical variances calculated above to the current 2006 accident year’s estimate of ultimate losses, excluding corporate litigation losses, would yield an indication of sensitivity to held reserves from $(26.0) million to $22.2 million, or about (4.4)% to 3.7% of held reserves, generating an impact to after-tax income of $16.9 million to $(14.4) million, respectively. The final outcome may fall below or above these amounts.
Corporate litigation losses represent estimates of losses incurred from actual or threatened litigation by claimants alleging improper handling of claims by the Company, which are commonly known as “bad faith” claims. Oftentimes, the onset of such litigation, subsequent discovery, settlement discussions, trial and appeal may occur several years after the date of the original claim. Because of the infrequent nature of such claims, each case is accrued based on its own merit based on SFAS 5 requirements that such accrual be probable and estimable. As such, no estimate is permissible under FASB 5 for IBNR for threatened litigation yet to occur on accidents with dates prior to the balance sheet date. Consequently, the effect of setting accruals for such items likely will result in unfavorable reserve development in the reserve table below.
The following is a reconciliation of Infinity’s net liability to the gross liability for unpaid losses and LAE (in millions).
* 2002 includes $126 resulting from the addition of the Assumed Agency Business.
The following table presents (in millions) the development of loss reserves for the Assumed Agency Business through December 31, 2002. Development for 2003 for the Assumed Agency Business is included in the Infinity table above. Under the reinsurance agreement entered into with GAI, Infinity’s insurance subsidiaries assumed the net reserves from GAI. Accordingly, gross reserves and net reserves are the same.
During calendar year 2005, Infinity experienced $17.0 million of favorable reserve development, primarily from continued favorable development in the California business.
During calendar year 2004, Infinity experienced $4.7 million of favorable reserve development, primarily from continued favorable development in accident year 2003 on claim frequency on the California book of business, offset partially by continued unfavorable development in accident years 2000-2002 primarily from LAE on the declining New York book of business.
historical operating, balance sheet and cash flow data contained in issuer SEC filings
the ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value
Infinity continually evaluates potential liabilities and reserves for litigation using the criteria established by Statement of Financial Accounting Standard (“SFAS”) No. 5, “Accounting for Contingencies.” Under this guidance, reserves for loss may only be recorded if the likelihood of occurrence is probable and the amount is reasonably estimable. Management considers each legal action and records reserves for losses in accordance with this guidance. Infinity believes the current assumptions and other considerations used to estimate potential liability for litigation are appropriate. Certain claims and legal actions have been brought against Infinity for which, under the rules described above, no loss has been accrued. While it is not possible to know with certainty the ultimate outcome of these claims or lawsuits, management does not expect them to have a material effect on Infinity’s financial condition or liquidity.
Infinity is organized as a holding company with all of its operations being conducted by its insurance subsidiaries. Accordingly, Infinity will have continuing cash needs for administrative expenses, the payment of interest on borrowings, shareholder dividends, share repurchases and taxes. Administrative expenses at the holding company have averaged approximately $6.7 million annually since 2004.
At December 31, 2006, Infinity had $200 million principal of senior notes due 2014, bearing a fixed 5.5% interest rate (the “Senior Notes”) outstanding. Interest payments on the Senior Notes of $5.5 million are due each February and August through maturity in February 2014. (See Note 3 of the Consolidated Financial Statements for more information on the Senior Notes).
In February 2007, Infinity increased its quarterly dividend to $.090 per share from $.075 per share. On an annual basis, Infinity’s dividend payments will be approximately $7.1 million.
In January 2005, the Board of Directors authorized a share repurchase program whereby the Company may repurchase up to an aggregate amount of $50 million of its outstanding common shares through December 31, 2006. This program was completed on December 28, 2006. During 2006, Infinity repurchased 1,178,300 shares at an average cost of $41.53. During 2005, Infinity repurchased 29,720 shares at an average cost of $33.59.
Funds to meet these expenditures come primarily from dividends from the insurance subsidiaries, as well as cash and investments held at the holding company. In 2006, Infinity’s insurance subsidiaries paid Infinity $160.0 million in ordinary dividends. In 2007, Infinity’s insurance subsidiaries may pay to Infinity up to $113.8 million in ordinary dividends without prior regulatory approval. As of December 31, 2006, Infinity had $237 million of cash and investments.
Infinity has a $50 million revolving credit facility which expires on August 31, 2008, that includes requirements to meet certain financial and other covenants. As of December 31, 2006, Infinity was in compliance with all covenants under the agreement. Under this agreement, there were no borrowings outstanding at December 31, 2006 or December 31, 2005.
Additionally, Infinity leases fleet vehicles for a minimum term of 12 months. After the minimum term, the lease becomes month-to-month. As of December 31, 2006, the total remaining minimum lease payments under the fleet operating lease were approximately $2.1 million.
Infinity’s consolidated investment portfolio at December 31, 2006 contained $1.3 billion in fixed maturity securities and $55.5 million in equity securities, all carried at fair value with unrealized gains and losses reported as a separate component of shareholders’ equity on an after-tax basis. At December 31, 2006, Infinity had pretax net unrealized losses of $7.8 million on fixed maturities and pretax net unrealized gains of $2.4 million on equity securities.
Approximately 94% of the fixed maturities that Infinity held at December 31, 2006 were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. The average credit rating of Infinity’s fixed maturity portfolio was Aa3 at December 31, 2006. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. Management believes that a high quality investment portfolio is more likely to generate a stable and predictable investment return.
The average duration of Infinity’s fixed maturity portfolio was 3.5 years at December 31, 2006.
The following table presents the yields of Infinity’s investment portfolios as reflected in the financial statements.
The table below sets forth the scheduled maturities of fixed maturity securities at December 31, 2006 based on their fair values (in thousands). 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.
shifts in market yield curves on Infinity’s fixed maturity portfolio and long-term debt. It is assumed that the effects are realized immediately upon the change in interest rates. The hypothetical changes in market interest rates do not reflect what could be deemed best or worst case scenarios. Variations in market interest rates could produce significant changes in the timing of repayments due to prepayment options available. For these reasons, actual results might differ from those reflected in the table.
The following table provides information about Infinity’s fixed maturity investments at December 31, 2006 which are sensitive to interest rate risk. The table shows expected principal cash flows 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. MBS and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
Credit risk is managed by diversifying the portfolio to avoid concentrations in any single industry group or issuer and by limiting investments in securities with lower credit ratings. The average credit quality rating for Infinity’s fixed maturity portfolio was Aa3 at December 31, 2006. Non-performing fixed maturities, securities that have not produced investment income during the previous twelve months, were $2.1 million or 0.17% of the $1.3 billion portfolio as of December 31, 2006.
Gross written premiums for the year ended December 31, 2006 declined 0.2% compared to 2005. By excluding the Assumed Agency Business, which is in runoff, gross written premiums would reflect a growth of 4.5%. During the first six months of 2006, competitor actions, such as new rate filings and aggressive marketing, resulted in Infinity’s products being less competitive and an 8.9% decline in gross written premiums compared to the same period in 2005. However, California’s implementation of electronic enforcement of compulsory insurance laws and actions taken by Infinity in California and its other focus states to stimulate gross written premium growth in the second half of 2006 led to gross written premium growth of 10.2% during the last six months of 2006 compared to the last six months of 2005. During 2006, Infinity implemented 52 rate revisions in various states with an overall rate impact of a modest 0.8% increase. Infinity’s policies-in-force at December 31, 2006 increased 6.7% as compared to December 31, 2005 as a result of the strong gross written premium growth during the second half of 2006.
As a result of a new credit-based product introduced in mid-2005 and a modest increase in advertising, gross written premiums and policies-in-force in Georgia increased 5.7% and 2.6%, respectively, in 2006 as compared to 2005.
Although gross written premiums and policies-in-force in Florida declined 5.8% and 0.9%, respectively, during 2006 as compared to 2005, gross written premiums in Florida grew 7.1% during the last six months of 2006 as compared to the same period of 2005. During the last nine months of 2005, Infinity implemented rate increases, totaling 15%, to address increasing combined ratios in Florida. New business during the first six months of 2006 declined as a result of these rate actions. During the third quarter, several competitors in Florida also increased rates and as a result, Infinity’s programs became more competitive.
Gross written premiums and policies-in-force in Connecticut continued to decline, down 27.0% and 24.2%, respectively, compared to 2005. The decline in gross written premiums in Connecticut was a result of selling the renewal rights on the runoff GAI book of business to an unaffiliated insurance company in that state. The runoff of this book of business will be completed at the end of the second quarter of 2007. Infinity’s ongoing book of business in Connecticut grew 73.8% during 2006 as compared to 2005 as a result of the Low Cost product, which was introduced in the market during February 2006.
Personal auto premiums and policy counts declined at December 31, 2005 in both Pennsylvania and Connecticut compared to December 31, 2004. The gross written premium decline in Pennsylvania of 14.8% was a result of certain competitors taking rate decreases and implementing aggressive commission incentives. In Connecticut, Infinity worked throughout the year to get a replacement product for the business written through GAI and assumed by Infinity approved by the Department of Insurance. This product was approved early in the third quarter. However, gross written premiums declined during the year as Infinity was not accepting new business in the old program. In the fourth quarter of 2005, Infinity sold the renewal rights on the old Connecticut program to an unaffiliated insurance carrier. However, Infinity will continue to focus on growth in Connecticut through its recently filed new programs.
In the 14 Remaining Focus States, personal auto gross written premiums and policies-in-force grew 26.4% and 17.7% compared to December 31, 2004, respectively. Eight of the fourteen states had positive premium growth for the year, with Alabama, Arizona, Missouri, Ohio, South Carolina, Texas and Virginia all posting double-digit growth.
Gross written premiums in Infinity’s commercial vehicle business continued to grow in 2005. Premium and policies-in-force growth of 8.5% and 7.4%, respectively, was primarily driven by increases in California, Florida and Texas.
Classic Collector gross written premiums and policies-in-force grew 5.1% and 0.5%, respectively, during 2005, primarily from growth in California, Florida and Pennsylvania. The growth in Other gross written premiums is attributable to a change in the reinsurance agreement on the homeowners business. Beginning in 2005, GAI eliminated its reinsurance program and cedes 100% of the homeowners business to Infinity. However, Infinity’s net retention of 10% has not changed as the company put in place its own reinsurance agreement.
The statutory combined ratio represents the sum of the following ratios: (i) losses and LAE incurred as a percentage of net earned premiums and (ii) underwriting expenses incurred as a percentage of net written premiums. Certain expenses are treated differently under statutory and GAAP accounting principles. Under GAAP, commissions, premium taxes and other variable costs incurred in connection with writing new and renewal business are capitalized as deferred policy acquisition costs and amortized on a pro rata basis over the period in which the related premiums are earned; on a statutory basis these items are expensed as incurred. Costs for computer software developed or obtained for internal use are capitalized under GAAP and amortized over their useful life, rather than expensed as incurred, as required for statutory purposes. Additionally, bad debt charge-offs on agent balances and premium receivables are included only in the GAAP combined ratios.
Improvements in both the loss and LAE and underwriting ratios contributed to the 8.6 point improvement in the 14 Remaining Focus States combined ratio. The loss and LAE ratio improved 7.8 points in part from improving loss frequency trends in Arizona. In addition, during 2006, South Carolina had favorable development on prior accident period loss reserves. Included in the 2006 underwriting expense ratio is a one time benefit of $1.9 million related to a refund from the South Carolina reinsurance facility. Excluding this amount, the underwriting ratio for the 14 Remaining Focus States would be 24.8%, a 0.6 point increase over the 24.2% in 2005. The increase in the underwriting ratio is primarily attributable to an increase in advertising.
An increase in the loss and LAE ratio, offset by a decrease in the underwriting ratio, resulted in a modest 2.1 point increase in the combined ratio for the Top Five Focus States compared to that in 2004. The 3.0 points increase in the loss and LAE ratio was primarily attributable to an increase in the loss and LAE ratios in Florida. The book in Florida has grown substantially as a result of new business writings, which typically have higher loss and LAE ratios than renewal business. In light of the increase in the loss and LAE ratio in Florida, Infinity took several rate adjustments in this state with an overall effect of a 15.0% increase. The underwriting expense ratio fell 0.9 points compared to 2004 as a result of the benefit of increased premium volume over which to spread fixed expenses.
Other income for the twelve-month period ended December 31, 2006 declined $1.7 million from 2005, primarily due to the continued decline of finance charge income from the Assumed Agency Business that is in runoff. Other income for the twelve-month period ended December 31, 2005 decreased $2.9 million from 2004, primarily due to reduced finance charge income and due to nonrecurring 2004 gains of $2.2 million for the sale of property and management fee income. Management anticipates a continued decline in future years’ finance charge income due to an expected continued decrease in the Assumed Agency Business.
In October 2006, Infinity announced plans to consolidate certain of its customer service, centralized claims and information technology back-office operations. The objective of the restructuring is to improve service levels and to more consistently and cost effectively manage the operations. During the fourth quarter of 2006, Infinity recorded a $4.8 million, pretax, charge related to severance costs. None of these severance costs have been paid as of December 31, 2006. In 2007, Infinity expects to incur additional costs as the facilities affected by the restructuring are sublet or closed.
Consolidated Statements of Earnings: Years ended December 31, 2006, 2005 and 2004