Leased Properties. The Company leases space for its principal offices and for some of its insurance operations in an office building located in Atlanta, Georgia, from Delta Life Insurance Company under leases which expire at various times through May 31, 2012. Under the current terms of the leases, the Company occupies approximately 65,489 square feet of office space. Delta Life Insurance Company, the owner of the building, is controlled by J. Mack Robinson, Chairman of the Board of Directors and the largest shareholder of the Company. The terms of the leases are believed by Company management to be comparable to terms which could be obtained by the Company from unrelated parties for comparable rental property.
Includes a $10,709 impairment charge in 2005 for automotive sector fixed maturity investments. See Note 2 of Notes to Consolidated Financial Statements.
Atlantic American is an insurance holding company whose operations are conducted through a group of regional insurance companies: American Southern Insurance Company and American Safety Insurance Company (together known as “American Southern”); Association Casualty Insurance Company and Association Risk Management General Agency, Inc. (together known as “Association Casualty”); Georgia Casualty & Surety Company (“Georgia Casualty”); and Bankers Fidelity Life Insurance Company (“Bankers Fidelity”). Each operating company is managed separately based upon the geographic location or the type of products offered and is evaluated on its individual performance. Management has conformed information systems, policies and procedures, products, marketing and managerial responsibilities between Association Casualty and Georgia Casualty to create a southern “regional” property and casualty operation and increase efficiencies.
Unpaid loss and loss adjustment expenses comprised 45% of the Company’s liabilities at December 31, 2006. This obligation includes estimates for: 1) unpaid losses on claims reported prior to December 31, 2006, 2) development on those reported claims, 3) unpaid ultimate losses on claims incurred prior to December 31, 2006 but not yet reported and 4) unpaid loss adjustment expenses for reported and unreported claims incurred prior to December 31, 2006. Quantification of loss estimates for each of these components involves a significant degree of judgment and estimates may vary, materially, from period to period. Estimated unpaid losses on reported claims are developed based on historical experience with similar claims by the Company. Development on reported claims, estimates of unpaid ultimate losses on claims incurred prior to December 31, 2006 but not yet reported, and estimates of unpaid loss adjustment expenses, are developed based on the Company’s historical experience, using actuarial methods to assist in the analysis. The Company’s actuarial staff develops ranges of estimated development on reported and unreported claims as well as loss adjustment expenses using various methods including the paid-loss development method, the reported-loss development method, the paid Bornhuetter-Ferguson method, the reported Bornhuetter-Ferguson method, the Berquist-Sherman method and a frequency-severity method. Any single method used to estimate ultimate losses has inherent advantages and disadvantages due to the trends and changes affecting the business environment and the Company’s administrative policies. Further, a variety of external factors, such as legislative changes, medical cost inflation, and others may directly or indirectly impact the relative adequacy of liabilities for unpaid losses and loss adjustment expenses. The Company’s approach is to select an estimate of ultimate losses based on comparing results of a variety of reserving methods, as opposed to total reliance on any single method. Unpaid loss and loss adjustment expenses are reviewed periodically for significant lines of business, and when current results differ from the original assumptions used to develop such estimates, the amount of the Company’s recorded liability for unpaid loss and loss adjustment expenses is adjusted. In the event the Company’s actual reported losses in any period are materially in excess of the previous estimated amounts, such losses, to the extent reinsurance coverage does not exist, would have a material adverse effect on the Company’s results of operations.
Deferred acquisition costs comprised 5% of the Company’s total assets at December 31, 2006. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to expense in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any given previous calendar year.
Refer to Note 1 of “Notes to Consolidated Financial Statements” for details regarding the Company’s significant accounting policies.
A more detailed analysis of the individual operating entities and other corporate activities is provided in the following discussion.
Gross written premiums at American Southern decreased $6.5 million, or 10.5%, during 2006 as compared to 2005. The decrease in gross written premiums was primarily due to the cancellation of several commercial programs, including the low-value dwelling property business in the second half of 2005 and the joint venture with AAA Carolinas to market automobile insurance to club members, which was terminated on October 1, 2005. Also contributing to the decrease in gross written premiums was the termination of the relationship with one of the company’s agents who had previously produced approximately $1.6 million in annualized general liability business. Partially offsetting this decrease in gross written premiums were increased business writings in the surety line of business.
Ceded premiums increased $0.2 million, or 1.8%, during 2006 as compared to 2005. The increase in ceded premiums was due to changes in certain provisions in the company’s reinsurance treaty agreements relating to certain accounts.
Net earned premiums increased $3.4 million, or 7.0%, during 2005 over 2004 due primarily to the increased business writings in the general liability and surety lines of business in 2004 and 2005. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2005 are related to policies written during both 2004 and 2005.
The combined ratio for American Southern decreased to 90.7% in 2006 from a combined ratio of 93.6% in 2005. The loss ratio decreased to 46.3% in 2006 from 48.2% in 2005. The decrease in the loss ratio was primarily attributable to the cancellation of several commercial programs, including the low-value dwelling property business, combined with favorable loss experience in the commercial automobile line of business. The expense ratio decreased to 44.4% in 2006 from 45.4% in 2005 due primarily to lower profit margins on the business with variable commissions. Approximately 88% of American Southern’s business provides for contractual commission arrangements, which compensate the company’s agents in relation to the loss ratios of the business they write. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with American Southern.
The following table summarizes, for the periods indicated, Association Casualty’s premiums, losses, expenses and underwriting ratios:
Excludes $16.2 million and $22.2 million in written premiums ceded to Georgia Casualty in 2005 and 2004, respectively.
Written premiums of $0.7 million in 2005 and $5.9 million in 2004 assumed from Georgia Casualty under a quota share reinsurance agreement and eliminated in consolidation. This agreement was terminated effective August 31, 2005.
Ceded premiums at Association Casualty increased $4.9 million, or 86.5%, during 2006 as compared to 2005. Excluding catastrophe reinsurance rates, which increased 117.0% in 2006 over 2005, general reinsurance rates increased 7.9% during 2006 as compared to 2005. In addition to the overall increase in reinsurance rates, the increase in ceded premiums was also due to the increase in retained business and the risk characteristics related thereto. Prior to September 1, 2005, the business underwritten by Georgia Casualty on behalf of Association Casualty was ceded 100% to Georgia Casualty rather than to a third party reinsurer. As a result of the third party cessions in 2006, ceded premiums increased correspondingly.
Gross written premiums at Association Casualty decreased $2.4 million, or 8.5%, during 2005 as compared to 2004. The decrease in gross written premiums was primarily attributable to the termination of the quota share reinsurance agreement with Georgia Casualty in 2005. In addition, Association Casualty experienced an increased level of price competition in the Texas marketplace resulting in a decline in Texas direct written premiums. Direct written premiums in other Southeastern states partially offset declines in Texas direct written premiums.
Ceded premiums at Association Casualty increased $1.0 million, or 20.9%, during 2005 as compared to 2004. Excluding assumed written premiums of $0.7 million and $5.9 million in 2005 and 2004, respectively, that were not subject to reinsurance, premiums ceded as a percentage of direct written premiums increased to
Net earned premiums decreased $1.7 million, or 7.5%, during 2005 as compared to 2004 primarily due to the termination of the quota share reinsurance agreement discussed previously.
The combined ratio for Association Casualty decreased to 101.5% in 2005 from 102.2% in 2004. The loss ratio decreased to 59.2% in 2005 from 60.8% in 2004. The decrease in the loss ratio was primarily due to a decline in the overall number of claims reported in 2005 and the severity of those claims as compared to 2004. However, Association Casualty’s loss ratio during 2005 was impacted by an increasing number of construction defect claims on liability policies, which increased loss adjustment expenses and produced a higher than targeted loss ratio. The expense ratio increased to 42.3% in 2005 from 41.4% in 2004 primarily due to an increase in premium tax rates. Effective September 1, 2005, Association Casualty no longer ceded any portion of its business to Georgia Casualty. This business, now retained by Association Casualty, had premium tax rates that approximate up to 4% compared to its previous average rate of 2.8%. Also contributing to the increase in the expense ratio was the decrease in net earned premiums coupled with a consistent level of fixed expenses.
The following table summarizes, for the periods indicated, Georgia Casualty’s premiums, losses, expenses and underwriting ratios:
Includes $16.2 million and $22.2 million in written premiums assumed from Assocation Casualty in 2005 and 2004, respectively.
Gross written premiums at Georgia Casualty decreased $27.7 million, or 57.2%, during 2006 as compared to 2005. The decrease in gross written premiums was attributable to several factors. As discussed previously, effective September 1, 2005, Georgia Casualty no longer assumed new business writings from Association Casualty and, as a result, written premiums decreased $15.3 million. Also contributing to the decrease in gross written premiums was the non-renewal of targeted classes of property business as well as the reassessment of coastal property exposures, both of which began in 2005. Georgia Casualty has ceased writing policies with significant heavy automobile exposures and has significantly increased its required buffer zone away from wind prone coastal exposures. These initiatives, coupled with an increased level of price competition in the marketplace, resulted in a significant decrease in gross written premiums during 2006.
Ceded premiums at Georgia Casualty decreased $11.9 million, or 57.4%, during 2006 as compared to 2005. The decrease in ceded premiums was primarily attributable to the significant decline in gross written premiums. Also contributing to the decrease in ceded premiums were significant 2005 adjustments to umbrella and catastrophe ceded premiums that did not recur during the comparable periods of 2006.
Ceded premiums at Georgia Casualty decreased $2.7 million, or 11.6%, during 2005 as compared to 2004. The decrease in ceded premiums was primarily due to the non-recurring accrual of an arbitration award of $3.1 million during 2004 which resulted from a dispute with one of Georgia Casualty’s reinsurers. Also contributing to the comparative reduction was the termination of the quota share reinsurance agreement, discussed previously, and a negotiated rate adjustment to a broker’s commission, both of which resulted in a $5.8 million reduction in 2005 ceded premiums. Additionally, in 2005, Georgia Casualty accrued hurricane related expenses of $0.9 million in catastrophic reinsurance reinstatement premiums, compared to $1.4 million in 2004, which consisted of $0.5 million in catastrophic reinsurance reinstatement premiums and a $0.9 million adjustment to the reinsurance provisional rate accrual. Offsetting the decrease in ceded premiums were increased rates as a result of more recent contract negotiations that became effective on January 1, 2005. Ceded premiums increased by approximately $3.2 million due to 2005 rate increases. Prior to 2005, Georgia Casualty’s primary working layer reinsurance contract provided for variable pricing based upon the company’s actual loss experience; beginning in 2005 all of the company’s reinsurance contracts provided for fixed rate pricing. Georgia Casualty accrued additional reinsurance charges in 2005 related to prior years’ reinsurance contracts with experience rated variable pricing based on current year development of prior accident year claims.
The combined ratio for Georgia Casualty increased to 143.8% in 2006 from 123.9% in 2005. The loss ratio decreased to 77.5% in 2006 from 81.6% in 2005. The decrease in the loss ratio was due to numerous large losses from fires, fatalities, and tornados incurred by Georgia Casualty during 2005, which did not recur in 2006. Also in 2005, Georgia Casualty incurred $1.0 million in net hurricane related losses, before consideration of state windstorm assessments related thereto. The magnitude and frequency of these losses had a significant impact on the loss ratio during 2005, and did not recur in 2006. In addition, Georgia Casualty has benefited from the extensive re-underwriting of its book of business that began in the latter part of 2005. The expense ratio increased to 66.3% in 2006 from 42.3% in 2005. The increase in the expense ratio was primarily attributable to a $2.2 million charge related to an assessment from the Mississippi Windstorm Underwriting Association and a $1.0 million increase in the second injury trust fund assessment accrual, both of which were expensed in 2006. Also contributing to the increase in the expense ratio was the significant decrease in net earned premiums described above.
related losses compared to $1.4 million in 2004. However, Georgia Casualty’s loss ratio during 2005 was impacted by a significant increase in both the frequency and severity of claims particularly in the first quarter of 2005. In 2005, Georgia Casualty incurred numerous large claims related to losses from fires, fatalities, and tornados as discussed previously above. The expense ratio decreased to 42.3% in 2005 from 45.7% in 2004. The decrease in the expense ratio was primarily due to a consistent level of fixed expenses coupled with an increase in net earned premiums.
Premium revenue at Bankers Fidelity decreased $7.0 million, or 10.6%, during 2006 as compared to 2005. The most significant decrease in premiums was in the Medicare supplement line of business, where premiums decreased $6.5 million, or 12.6%, due to the continued decline in new business levels and non-renewal of certain policies that resulted from increased competition. Increased competition includes not only traditional insurance company competitors but also the federal government as it provides incentives directly and indirectly to seniors to exit traditional Medicare programs and choose instead Medicare Advantage and other similar plans which result in much different economics to the insured. In 2006, the company’s key states in terms of premium revenue were Georgia, Pennsylvania, Ohio, Utah and West Virginia, which collectively accounted for approximately 56% of total earned premium for 2006. The Medicare supplement line of business in these states increased approximately $0.1 million as compared to 2005. Premiums from the life insurance line of business decreased $0.6 million, or 5.5%, during 2006 due to the continued decline in sales related activities.
Premium revenue at Bankers Fidelity increased $0.5 million, or .7%, during 2005 as compared to 2004. Premiums from the Medicare supplement line of business increased $1.8 million, or 3.7%, in 2005 over 2004 and accounted for 78% of total 2005 earned premium. In 2005, the company’s five key states in terms of premium revenue were consistent with those in 2006 and accounted for approximately 57% of total earned premium for 2005. The Medicare supplement line of business in these states increased approximately $0.5 million as compared to 2004. Significant rate increases on existing Medicare supplement business implemented in varying amounts by state and plan in 2004 resulted in increased revenues in 2005. In addition, during 2004, Bankers Fidelity purchased a block of Medicare supplement business with an estimated annualized premium of $4.5 million, which increased premium revenue during 2005. Partially offsetting the 2005 increase in Medicare supplement premium was a decline in new business levels and existing policies that resulted from increased competition. Premiums from the life insurance line of business decreased $1.3 million, or 10.3%, during 2005 due to a decline in sales related activities.
Benefits and losses decreased $4.4 million, or 9.4%, during 2006 as compared to 2005 and increased $0.5 million, or 1.2% during 2005 over 2004. As a percentage of earned premiums, benefits and losses were 71.3% in 2006 compared to 70.4% in 2005 and 70.0% in 2004. The increase in the loss ratio in 2006 was primarily due to the continued aging of the life business.
Underwriting expenses decreased $1.0 million, or 5.1%, during 2006 as compared to 2005, and decreased slightly during 2005 from 2004. The decrease in underwriting expenses during 2006 was directly related to the decline in premium revenues. As a percentage of earned premiums, these expenses were 31.7% in 2006 compared to 29.8% in 2005 and 30.1% in 2004. The increase in the expense ratio during 2006 was primarily due to a consistent level of fixed underwriting and other expenses in conjunction with a decrease in premium revenues.
The Company had net realized investment gains of $6.7 million in 2006 compared to net realized investment losses of $10.5 million in 2005 and net realized investment gains of $2.2 million in 2004. The increase in net realized gains in 2006 was primarily due to the sale of a portion of the Company’s automotive sector investments (bonds of GM and Ford), a portion of the Company’s investment in equity securities of Wachovia Corporation, and the sale of a real estate partnership interest, all of which resulted in realized investment gains totaling $6.7 million. During the years ended December 31, 2005 and 2004, the Company recorded investment impairments due to other than temporary declines in values, which reduced reported realized investment gains, related to the following investments:
Interest expense of $4.6 million increased $1.0 million, or 27.5%, during 2006 as compared to 2005. The increase in interest expense during 2006 was due primarily to an increase in interest rates. During 2006, the Company’s outstanding debt had a variable interest rate tied to three-month London Interbank Offered Rate (“LIBOR”), which increased throughout 2006. Also, on February 28, 2006, the Company entered into a $3.0 million term loan credit agreement with Wachovia Bank, N.A. (“Wachovia”), which resulted in a higher average debt level and increased interest expense during 2006 as compared to the prior year. In the fourth quarter of 2006, the Company entered into a new credit agreement containing a revolving credit facility (the “Revolver”). Borrowings under the Revolver were used to repay the amounts outstanding under the Company’s prior term loans with Wachovia (as described below in “Liquidity and Capital Resources”).
Interest expense of $3.6 million increased $0.5 million, or 17.6%, during 2005 as compared to 2004. The increase in interest expense during 2005 was due to an increase in interest rates. During 2005, the Company’s outstanding debt had a variable interest rate tied to three-month LIBOR, which increased throughout 2005. In the third quarter of 2004 and during 2005, the Company repaid $4.8 million in principal on a then-existing term loan to Wachovia, which helped to offset the increase in interest expense by reducing the average debt level.
Other expenses (commissions, underwriting expenses, and other expenses) decreased $1.6 million, or 2.1%, in 2006 as compared to 2005. The decrease in other expenses during 2006 was primarily attributable to a reduction in commission expenses that resulted directly from a decline in premium revenue. The decrease in premium revenue that occurred in 2006 was primarily due to the non-renewal of targeted classes of property business, the reassessment of coastal property exposures, lower sales activity, and an increased level of price competition. Partially offsetting the decrease in other expenses during 2006 was a $2.2 million charge related to a Mississippi windstorm assessment which was not covered by reinsurance and a $1.0 million second injury trust fund accrual adjustment, both of which occurred in the Company’s property and casualty operations. On a consolidated basis, as a percentage of earned premiums, other expenses increased to 46.7% in 2006 from 41.3% in 2005. The increase in the expense ratio during 2006 was primarily due to a consistent level of fixed expenses coupled with a decrease in premium revenues. In the fourth quarter of 2006, the Company completed a reassessment of all positions in the property and casualty operations. As a result of such analysis, there was a right sizing of the workforce and $0.1 million of severance expense was incurred.
Other expenses (commissions, underwriting expenses, and other expenses) increased $3.6 million, or 5.2%, in 2005 as compared to 2004. The increase in other expenses during 2005 was primarily attributable to increased acquisition costs at American Southern. Agents’ variable commissions at American Southern increased $0.8 million during 2005 due primarily to lower loss ratios. The majority of American Southern’s business is structured in a way that agents are rewarded or penalized based upon the loss ratio of the business they submit to the company. In periods where the loss ratio decreases, commissions and underwriting expenses will increase and conversely in periods where the loss ratio increases, commissions and underwriting expenses should decrease. Fixed commissions at American Southern also increased $0.4 million during 2005 primarily as a result of the increased surety bond business, which has a higher commission rate than other lines of business. In addition, the deferral of acquisition costs at American Southern in 2005 decreased $0.9 million from 2004 and, as a result, increased other expenses during 2005. The decrease in deferred acquisition costs at American Southern was primarily due to a significantly lower level of premium growth in 2005 than that which occurred in 2004. The Company also experienced a significant increase in expenses related to Sarbanes-Oxley compliance work and audit fee accruals. These expenses increased $1.3 million, or 207.9%, in 2005 as compared to 2004. On a consolidated basis, as a percentage of earned premiums, other expenses increased to 41.3% in 2005 from 40.8% in 2004.
the tax sharing agreements in 2006, 2005, and 2004, respectively. Dividends were paid to Atlantic American by its subsidiaries totaling $9.2 million in 2006, $13.2 million in 2005, and $5.8 million in 2004. As a result of the Parent’s tax loss carryforwards, which totaled approximately $11.9 million at December 31, 2006, it is anticipated that the tax sharing agreements will continue to provide the Parent with additional funds with which to meet its cash flow obligations.
The Company has two statutory trusts which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trusts and investing the gross proceeds of the trust preferred securities in Junior Subordinated Debentures. The outstanding $41.2 million of Junior Subordinated Debentures have a maturity of thirty years from their original date of issuance, are callable, in whole or in part, only at the option of the Company five years after their respective dates of issue and quarterly thereafter, and have an interest rate of three-month LIBOR plus an applicable margin. The margin ranges from 4.00% to 4.10%. At December 31, 2006, the effective interest rate was 9.43%. The obligations of the Company with respect to the issuances of the trust preferred securities represent a full and unconditional guarantee by the Parent of each trust’s obligations with respect to the trust preferred securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer Junior Subordinated Debenture interest payments, which would result in a deferral of distribution payments on the related trust preferred securities.
The Company intends to pay its obligations under the Credit Agreement and the Junior Subordinated Debentures using dividend and tax sharing payments from the operating subsidiaries, or from potential future financing arrangements. In addition, the Company believes that, if necessary, at maturity, the Credit Agreement can be refinanced with the current lender, although there can be no assurance of the terms or conditions of such a refinancing, or its availability.
At December 31, 2006, the Company had two series of preferred stock outstanding, substantially all of which is held by affiliates of the Company’s chairman and principal shareholders. The outstanding shares of Series B Preferred Stock (“Series B Preferred Stock”) have a stated value of $100 per share; accrue annual dividends at a rate of $9.00 per share and are cumulative; in certain circumstances may be convertible into an
aggregate of approximately 3,358,000 shares of common stock; and are redeemable solely at the Company’s option. The Series B Preferred Stock is not currently convertible. At December 31, 2006, the Company had accrued, but unpaid, dividends on the Series B Preferred Stock totaling $13.3 million. On September 30, 2006, the Company issued and sold 70,000 shares of its Series D Preferred Stock, par value $1.00 per share (“Series D Preferred Stock”) to Gulf Capital Services, Ltd., an affiliate of the Company’s Chairman, for an aggregate purchase price of $7.0 million. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances the shares of Series D Preferred Stock may be convertible into an aggregate of approximately 1,754,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. As of December 31, 2006, the Company had accrued but unpaid dividends on the Series D Preferred Stock of $0.1 million.
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115.” This statement permits entities to choose, at specified election dates, to measure eligible items at fair value (i.e., the fair value option). Items eligible for the fair value option include certain recognized financial assets and liabilities, rights and obligations under certain insurance contracts that are not financial instruments, host financial instruments resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument, and certain commitments. Business entities are required to report unrealized gains and losses on items for which the fair value option has been elected in net income. The fair value option: (a) may be applied instrument by instrument, with certain exceptions; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, although early adoption is permitted under certain conditions. The Company does not currently expect to apply the fair value option to any eligible items.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS No. 87, 88, 106, and 132(R).” SFAS No. 158 requires the full recognition of the overfunded or underfunded status of a defined benefit pension plan as an asset or liability along with a corresponding after-tax adjustment to accumulated other comprehensive income (loss) included in shareholders’ equity. Under previous accounting standards, information about the then-current funded status of such plan was reported in the notes to the financial statements. The recognition and
the disclosure requirements of SFAS No. 158 are effective for fiscal years ending after December 15, 2006. Adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. SFAS No. 157 provides guidance on measuring fair value when required under existing accounting standards and establishes a hierarchy that prioritizes the inputs to valuation techniques. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of Accounting Principles Board (“APB”) Opinion No. 20 and SFAS No. 3”. SFAS No. 154 applies to all voluntary changes in accounting principles and changes the requirements of accounting for and reporting a change in accounting principle and is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless such application is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income, in the period of the change, the cumulative effect of change to the new accounting principle. Adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123R, which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires all companies to recognize compensation costs for share-based payments to employees based on the grant-date fair value of the award for financial statements. The pro forma disclosures previously permitted under SFAS No. 123 are no longer an alternative to financial statement recognition. The transition method included a prospective or retrospective adoption option. The Company adopted SFAS No. 123R during the first quarter of 2006 using the prospective method. Adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
Insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such losses and expenses, are known. Consequently, the Company attempts, in establishing its premiums, to anticipate the potential impact of inflation. If, for competitive reasons, premiums cannot be increased to anticipate inflation, this cost would be absorbed by the Company. Inflation also affects the rate of investment return on the Company’s investment portfolio with a corresponding effect on investment income.
Interest payable is based on interest rates as of December 31, 2006 and assumes that all debt remains outstanding until its stated contractual maturity. The interest rates on outstanding bank debt and trust preferred obligations are variable and are equal to three-month LIBOR plus an applicable predetermined margin.
Future policy benefits relate to life insurance policies on which the Company is not currently making payments and will not make future payments unless and until the occurrence of an insurable event, such as a death or disability, or the occurrence of a payment triggering event, such as a surrender of a policy. Occurrence of any of these events is outside the control of the Company and the payment estimates are based on significant uncertainties such as mortality, morbidity, expenses, persistency, investment returns, inflation and the timing of payments. For regulatory purposes, the Company does perform cash flow modeling of such liabilities, which is the basis for the indicated disclosure; however, due to the significance of the assumptions used, the amount presented could materially differ from actual results.
Company’s actual financial condition, results of operations and stock price could differ materially from those expressed in any forward-looking statements made by the Company. Undue reliance should not be placed upon forward-looking statements contained herein. The Company does not intend to publicly update any forward-looking statements that may be made from time to time by, or on behalf of, the Company.
Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2006
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2006
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Atlantic American Corporation and subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
At December 31, 2006, the Parent had five insurance subsidiaries, Bankers Fidelity Life Insurance Company (“Bankers Fidelity”), American Southern Insurance Company and its wholly-owned subsidiary, American Safety Insurance Company (together known as “American Southern”), Association Casualty Insurance Company and Georgia Casualty & Surety Company (“Georgia Casualty”), in addition to two non-insurance subsidiaries, Association Risk Management General Agency, Inc., and Self-Insurance Administrators, Inc. (“SIA, Inc.”). Association Casualty Insurance Company and Association Risk Management General Agency, Inc. are together termed “Association Casualty.”
The Company’s investments in both fixed maturity securities, which include bonds and redeemable preferred stocks, and equity securities, which include common and non-redeemable preferred stocks, are classified as “available-for-sale” and, accordingly, are carried at fair value with the after-tax difference from
Basic earnings per common share are based on the weighted average number of common shares outstanding during each period. Diluted earnings per common share are based on the weighted average number of common shares outstanding during each period, plus common shares calculated for stock options and share awards outstanding using the treasury stock method and assumed conversion of the Series B and Series D Preferred Stock, if dilutive. Unless otherwise indicated, earnings per common share amounts are presented on a diluted basis.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”) using the modified prospective transition method. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. The adoption of SFAS 123R did not have a material impact on the Company’s consolidated statements of operations or net income (loss) per share. Prior to January 1, 2006, stock options were reported under the recognition and measurement principles of APB Opinion No. 25 instead of the fair value approach recommended in SFAS No. 123 as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. Accordingly, no stock-based employee compensation cost attributable to stock options was reflected in net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Pro forma net income (loss) and net
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115.” This statement permits entities to choose, at specified election dates, to measure eligible items at fair value (i.e., the fair value option). Items eligible for the fair value option include certain recognized financial assets and liabilities, rights and obligations under certain insurance contracts that are not financial instruments, host financial instruments resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument, and certain commitments. Business entities are required to report unrealized gains and losses on items for which the fair value option has been elected in net income. The fair value option: (a) may be applied instrument by instrument, with certain exceptions; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, although early adoption is permitted under certain conditions. The Company does not currently expect to apply the fair value option to any eligible items.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 provides guidance for how errors should be evaluated to assess materiality from a quantitative perspective. SAB No. 108 permits companies to initially apply its provisions by either restating prior financial statements or recording the cumulative effect of initially applying the approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment to retained earnings. The guidance provided by SAB No. 108 was considered and did not have an effect on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. SFAS No. 157 provides guidance on measuring fair value when required under existing accounting standards and establishes a hierarchy that prioritizes the inputs to valuation techniques. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.
In September 2005, the AICPA issued Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs (“DAC”) in Connection with Modifications or Exchanges of Insurance Contracts”, (“SOP 05-1”). SOP 05-1 provides guidance on accounting by insurance enterprises for DAC on internal replacements of insurance. An internal replacement is a modification in product benefits, features, rights or coverages 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. Modifications that result in a replacement contract that is substantially changed from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized DAC, unearned revenue liabilities and deferred sales inducements from the replaced contract must be written-off. Modifications that result in a contract that is substantially unchanged from the replaced contract should be accounted for as a continuation of the replaced contract. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. The Company will adopt SOP 05-1 on January 1, 2007 and does not expect the effect of the adoption to be material.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and SFAS No. 3.” SFAS No. 154 applies to all voluntary changes in accounting principles and changes the requirements of accounting for and reporting a change in accounting principle and is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless such application is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income, in the period of the change, the cumulative effect of change to the new accounting principle. Adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123R, which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires all companies to recognize compensation costs for share-based payments to employees based on the grant-date fair value of the award for financial statements. The pro forma
Bonds and short-term investments having an amortized cost of $17,856 and $17,861 were on deposit with insurance regulatory authorities at December 31, 2006 and 2005, respectively, in accordance with statutory requirements.
Market changes in interest rates and credit spreads result in changes in the fair values of investments and are accumulated and reported as unrealized gains and losses. The majority of the unrealized losses at both December 31, 2006 and 2005 were primarily attributable to increases in interest yields on comparable investments.
Excluding U.S. Treasury securities and obligations of U.S. Government agencies and authorities, the change in value of which is deemed solely related to interest rate movements, the Company held investments in less than 30 issuers which had unrealized investment losses at December 31, 2006 and 2005, respectively. As of December 31, 2006, the Company had investments of $777 and $424, respectively, in the common stocks of each of Gray Television and Triple Crown Media, with temporary impairments not exceeding 13% of the carrying value of each invesment. Both of the companies were subject to a common restructuring during the year ended December 31, 2006. During December 31, 2005, the Company had investments exceeding $1,000 in the redeemable preferred stocks of JP Morgan Chase and Viacom with temporary impairments not exceeding 7% of the carrying value of each investment. The Company continues to monitor these, and all other investments, but believes the impairments to be temporary.
Includes automotive sector impairments of $10,709 in 2005, primarily from holdings in General Motors and related entities.
As part of the Company’s ongoing investment review, the Company has reviewed its investment portfolio and concluded that there were no additional investments with other than temporary impairments as of December 31, 2006 or 2005. The evaluation for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. As a result of issuers’ continued satisfaction of the investment obligations in accordance with their contractual terms, if applicable, and management’s expectation that they will continue to do so, also if applicable, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that the unrealized losses on investments at December 31, 2006 and 2005 were temporary.
The amortized cost and carrying value of fixed maturities and short-term investments at December 31, 2006 by contractual maturity were as follows. Actual maturities may differ from contractual maturities
The Company’s investment in the common stock of Wachovia Corporation exceeded 10% of shareholders’ equity at December 31, 2006. The carrying value of this investment at December 31, 2006 was $19,910 with a cost basis of $3,513.
The Company’s bond portfolio included 90% investment grade securities at December 31, 2006 as defined by the NAIC.
Annualized premiums for accident and health insurance policies were $47,326 and $52,763 at December 31, 2006 and 2005, respectively.
Deferred tax liabilities and assets at December 31, 2006 and 2005 were comprised of the following:
On December 22, 2006, the Company entered into a reducing revolving credit facility (the “Revolver”) with Wachovia Bank, National Association (“Wachovia”) pursuant to which the Company was able to, subject to the terms and conditions thereof, initially borrow or reborrow up to $15,000 (the “Commitment Amount”). The Commitment Amount is incrementally reduced every six months beginning on July 1, 2007. Borrowings under the Revolver were used to refinance amounts outstanding under the Company’s prior term loans with Wachovia, which were terminated upon the closing of the agreement relating to the Revolver, and are to be used for general corporate purposes. The interest rate on amounts outstanding under the Revolver is, at the option of the Company, equivalent to either (a) the base rate (which equals the higher of the Prime Rate or 0.5% above the Federal Funds Rate, each as defined) or (b) the London Interbank Offered Rate (“LIBOR”) determined on an interest period of 1-month, 2-months, 3-months or 6-months, plus an Applicable Margin (as defined). The Applicable Margin varies based upon the Company’s leverage ratio (funded debt to total capitalization, each as defined) and ranges from 1.75% to 2.50%. Interest on amounts outstanding is payable quarterly. If not sooner repaid in full, the Revolver requires the Company to repay $500 in principal on each of June 30 and December 31, 2007 and 2008, $1,000 and $1,500 in principal on June 30 and December 31, 2009, respectively, with one final payment of $10,500 in principal at maturity on June 30, 2010. The Revolver requires the Company to comply with certain covenants, including, among others, ratios that relate funded debt to both total capitalization and earnings before interest, taxes, depreciation and amortization, as well as the maintenance of minimum levels of tangible net worth. The Company must also comply with limitations on capital expenditures, certain payments, additional debt obligations, equity repurchases and redemptions, as well as minimum risk-based capital levels. Upon the occurrence of an event of default, Wachovia may terminate the Revolver and declare all amounts outstanding due and payable in full. As of December 31, 2006, the Revolver’s outstanding balance was $12,750 and the effective interest rate was 7.37%.
The estimated fair value and related carrying value of the Company’s rate collar at December 31, 2006 was a liability of approximately $165.
In accordance with the Company’s 1992 Incentive Plan, the Board of Directors was authorized to grant up to 1,800,000 stock options or share awards. The Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company’s common stock and other stock unit awards; (e) deferred shares of common stock; or (f) all or any combination of the foregoing to officers and key employees. Stock options granted under this plan expire five or ten years from the date of grant, as specified in an award agreement. Vesting occurs at 50% upon issuance of an option, and the remaining portion vests in 25% increments in each of the following two years. In accordance with the Company’s 1996 Director Stock Option Plan, a maximum of 200,000 stock options were authorized to be granted that fully vest six months after the grant date. In accordance with the Company’s 2002 Incentive Plan (the “2002 Plan”), the Board of Directors was authorized to grant up to 2,000,000 stock options or share awards. Subject to adjustment as provided in the 2002 Plan, the Board of Directors is authorized to grant: (a) incentive stock options; (b) non-qualified stock options; (c) stock appreciation rights; (d) restricted shares; (e) deferred shares; and (f) performance shares and/or performance units. Further, the Board may authorize the granting to non-employee directors of stock options and/or restricted shares. A total of 21,923, 21,923 and 63,063 restricted shares were issued to the Company’s Board of Directors under the 2002 Plan in 2006, 2005 and 2004, respectively. As of December 31, 2006, an aggregate of thirty-eight employees, officers and directors held options under the three plans.
The weighted average fair value of options granted is determined on the date of grant using the Black-Scholes option pricing model, which requires the input of subjective assumptions, including the expected volatility of the stock price. No options were granted in 2006, 2005 or 2004.
The Company initiated an employees’ savings plan qualified under Section 401(k) of the Internal Revenue Code in May 1995. The plan covers substantially all of the Company’s employees, except employees of American Southern. Under the plan, employees generally may elect to contribute up to 16% of their compensation to the plan. The Company makes a matching contribution on behalf of each employee in an amount equal to 50% of the first 6% of such contributions. The Company’s matching contribution is in Company common stock and had a value of approximately $255, $269, and $241 in 2006, 2005, and 2004, respectively.
The weighted-average assumptions used to determine the benefit obligation at December 31, 2006 and 2005 were as follows:
Included in the above is one plan which is unfunded. The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for this plan were $1,986, $1,586, and $0, respectively, as of December 31, 2006 and $1,803, $1,367, and $0, respectively, as of December 31, 2005.
Net periodic pension cost for the Company’s qualified and non-qualified defined benefit plans for the years ended December 31, 2006, 2005 and 2004 included the following components:
The weighted-average assumptions used to determine the net periodic benefit cost for the years ended December 31, 2006, 2005 and 2004 were as follows:
The Company expects to contribute $184 for all defined benefit plans in 2007.
Estimated future benefit payments as of December 31, 2006 were as follows:
The Company had 134,000 shares of Series B Preferred Stock (“Series B Preferred Stock”) outstanding at December 31, 2006 and 2005, having a stated value of $100 per share. All of the shares of Series B Preferred Stock are held by affiliates of the Company’s Chairman. Annual dividends on the Series B Preferred Stock are $9.00 per share and are cumulative. Dividends accrue whether or not declared by the Board of Directors. The Series B Preferred Stock is not currently convertible, but may become convertible into shares of the Company’s common stock under certain circumstances. In such event, the Series B Preferred Stock would be convertible into an aggregate of approximately 3,358,000 shares of the Company’s common stock at a conversion rate of $3.99 per share. The Series B Preferred Stock is redeemable solely at the option of the Company. As of December 31, 2006 and 2005, the Company had accrued but unpaid dividends on the Series B Preferred Stock of $13,266 and $12,060, respectively.
On September 30, 2006, the Company issued and sold 70,000 shares of Series D Preferred Stock, par value $1.00 per share (“Series D Preferred Stock”) to Gulf Capital Services, Ltd., an affiliate of the Company’s Chairman, for an aggregate purchase price of $7,000. The outstanding shares of Series D Preferred
In 2005, all outstanding options were excluded from the earnings per common share calculation since their impact was antidilutive. Average outstanding options of 59,000 were excluded from the earnings per common share calculation in 2004 since their impact was antidilutive. Further, the assumed conversion of the
Series B Preferred Stock was excluded from the earnings per common share calculation for 2005 and 2004 since its impact was antidilutive.
Automotive sector impairments of $10,709 were recorded in the first quarter of 2006 for statutory purposes.
In the normal course of business the Company has engaged in transactions with its Chairman and his affiliates from time to time. These transactions include the leasing of office space as well as certain investing and financing activities.
The Company leases approximately 65,489 square feet of office and covered garage space from an entity which is an affiliate of the Company and its Chairman. During the years ended December 31, 2006, 2005, and 2004, the Company paid $1,069, $1,065 and $1,048, respectively, under these leases.
Certain financing for the Company has been provided by affiliates of the Company’s Chairman, in the form of investments in the Series B and the Series D Preferred Stock (See Note 10).
The Company has made mortgage loans to finance properties owned by Leath Furniture, LLC (“Leath”), which, prior to July 11, 2006, was owned by an affiliate of the Chairman. At December 31, 2006 and 2005, the balance of mortgage loans owed by Leath to the Company’s insurance subsidiary was $1,378 and $1,941, respectively. For 2006, 2005, and 2004, interest paid by Leath on the mortgage loans totaled $184, $250, and $285, respectively.
Certain members of management are shareholders and on the Board of Directors of Triple Crown Media, Inc (“Triple Crown”) and Gray Television, Inc. (“Gray”). On August 3, 2005, Gray announced a plan to spin-off its newspaper publishing and wireless businesses to its shareholders. The new company formed as a result of the spin-off, Triple Crown, then acquired Bull Run Corporation (“Bull Run”). In connection with the spin-
In 1998, American Southern formed the American Auto Insurance Agency (the “Agency”) in a joint venture with Carolina Motor Club, Inc. to market personal automobile insurance to the members of the automobile club. American Southern at all times held a 50% interest in the joint venture, accounted for using the equity method and reflected as an operating activity, and underwrote a majority of the standard automobile business written by the Agency. This program, which began writing business in 1999, had gross written premiums of approximately $2,550, $8,615 and $8,517 in 2006, 2005, and 2004, respectively. The Company has, in the past funded its pro rata share of operations. Effective October 1, 2005, this joint venture was terminated due to unfavorable underwriting results and, consequently, a significant decrease in gross written premiums occurred during 2006.
The Company’s comprehensive income (loss) consists of net income (loss), unrealized gains and losses on securities available for sale, fair value adjustments from the ownership of derivative financial instruments and minimum additional pension liability, net of applicable income taxes. Other than net income (loss), the other components of comprehensive income (loss) for the years ended December 31, 2006, 2005 and 2004 were as follows:
Includes a $10.7 million impairment charge for automotive sector fixed maturity securities.