Includes extra dividends of $1.25 and $.65 for 2010 and 2007, respectively.
Data is for all coverages combined, does not include fee income and is presented based upon U.S. generally accepted accounting principles.
The Company’s assets at December 31, 2011 included $85.4 million in short-term and cash equivalent investments which are readily convertible to cash without market penalty and an additional $152.0 million of fixed maturity investments (at par) maturing in less than one year. The Company believes that these liquid investments, plus the expected cash flow from current operations, are more than sufficient to provide for projected claim payments and operating cost demands. In the event competitive conditions produce inadequate premium rates and the Company chooses to further restrict volume, the liquidity of its investment portfolio would permit management to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, the Company’s reinsurance program is structured to avoid significant cash outlays that accompany large losses.
Net premiums written by the Company’s insurance subsidiaries for 2011 equaled approximately 56% of the combined statutory surplus of these subsidiaries. Premium writings of 100% to 200% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
At December 31, 2011, $84.7 million, or 27% of shareholders’ equity, represented net assets of the Company’s insurance subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company maintains a $30 million unsecured line of credit and has $10.0 million of drawings outstanding on this line at December 31, 2011, the proceeds of which were used principally for treasury stock repurchases, dividend payments and other corporate expenditures.
Direct premiums written for 2011 totaled $274.1 million, an increase of $24.4 million (10%) from 2010. The increase is primarily attributable to $23.7 million (13%) in premiums generated by fleet transportation products and $9.5 million in premiums generated by professional liability business. Premiums ceded to reinsurers on direct business increased $8.2 million (11%) during 2011 to $84.1 million, as the consolidated percentage of premiums ceded to direct premiums written remained relatively level at 30.7% for 2011 compared to 30.4 % for 2010.
Net losses on investments, before taxes, totaled $17.8 million in 2011 compared to net gains on investments of $16.5 million during 2010. The net losses in 2011 are attributable to $21.9 million in limited partnerships net losses partially offset by $4.1 million in fixed maturity and equity security net direct trading gains. Limited partnership ventures utilized by the Company are primarily engaged in the trading of public and private securities, including foreign securities and, to a lesser extent, small venture capital activities and real estate development. The aggregate of the Company’s share of losses in these entities represented a 29% decline in value for 2011 compared to an appreciation in value of 12% for 2010. To the extent that accounting rules require the limited partnerships to include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include the results as reported to the Company by the various general partners. During 2011, approximately $20.6 million (94%) of the net loss was attributable to a reduction in unrealized gains and only 6% resulted from realized transactions. Recoveries of $1.3 million on previously impaired available-for-sale securities that were sold in 2011 are included in the fixed maturity and equity security net gains stated above.
The Company produced an overall savings on the handling of prior year claims during 2011 of $9.7 million. This net savings is included in the computation of loss ratios shown in the previous table, as is the $8.8 million savings produced during 2010 on prior year claims. The $7.4 million net savings attributable to the property and casualty insurance business was distributed among all of the Company’s products, with the majority attributable to the Company's fleet transportation and personal automobile businesses, and is generally consistent with recent prior years. Because of the high limits provided by the Company to its fleet transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company's reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
Direct premiums written for 2010 totaled $249.7 million, an increase of $40.6 million (19%) from 2009. The increase is primarily attributable to $25.2 million (16%) in premiums generated by fleet transportation products and $12.7 million (67%) in premiums generated by new product lines including commercial property and business owners’ liability business. Premiums ceded to reinsurers on direct business increased $17.3 million (29%) during 2010 to $75.9 million as the consolidated percentage of premiums ceded to direct premiums written increased to 30.4% for 2010 from 28.0 % for 2009. This increase is reflective of overall product expansion within fleet transportation business, increased use of reinsurance for certain products and the Company's expansion into commercial property and business owners’ liability business.
marketing efforts in the Property and Casualty Insurance segment and from program changes, effective January 1, 2010, in the Reinsurance segment including the introduction of professional liability reinsurance.
Pre-tax investment income of $11.3 million reflects a decrease during 2010 compared to 2009 as pre-tax yields were down 21% on average reflecting continuing depressed worldwide available rates, principally on short-term investments. After tax investment income decreased by 26% during 2010, compared to the prior year.
Reinsurance ceded credits were $4.7 million (88%) higher in 2010, resulting from the Company ceding a higher percentage of the gross premium to other companies under reinsurance treaties, principally for workers’ compensation coverages. After
A portion of the Company’s fleet transportation business is produced by direct sales efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not incur commission expense on a consolidated basis. Instead, the expenses of the agency operations, including salaries and bonuses of salesmen, travel expenses, etc. are included in operating expenses. In general, commissions paid by the insurance subsidiaries to the parent company exceed related acquisition costs incurred in the production of the property and casualty insurance business. The ratio of net operating expenses of the insurance subsidiaries to net premiums earned was 31.0% in 2010 and 35.8% in 2009. Including the agency operations and corporate expenses, and after elimination of inter-company commissions, the ratio of operating expenses to operating revenue (defined as total revenue less gains (losses) on investments) was 29.5% for 2010 compared with 34.2% for 2009.
The effective federal tax rate on consolidated income for 2010 was 28.1%. The effective rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.
Approximately 72% of the Company’s assets are composed of investments at December 31, 2011. Approximately 91% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 9% of investments are composed primarily of minority interests in several limited partnerships. These limited partnerships are engaged in the trading of public and non-public equity securities and debt, hedging transactions, real estate development and venture capital investment. These partnerships, themselves, do not have readily-determinable market values. Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the partnerships. While the majority of the underlying assets at December 31, 2011 are publicly-traded securities, those which are not publically traded have been valued by the respective partnerships using their experience and judgment.
It is important to note that all available for sale securities included in the Company’s financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments, as described above, does not change these valuations but, rather, determines when a decline in value will be recognized in the income statement (other-than-temporary decline) as opposed to a charge to shareholders’ equity (temporary decline). Another aspect of this accounting policy which is important to understand is that any subsequent recovery in value of investments which have incurred other-than-temporary impairment adjustments are accounted for as unrealized gains until the security is actually disposed of or sold. At December 31, 2011, unrealized gains include $6.8 million of appreciation on investments previously adjusted for other-than-temporary impairment, compared to $8.2 million of impairment write-downs at that date. This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors which relate to an industry, in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process as described above. However, to the extent that certain declines in value are reported as unrealized at December 31, 2011, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2011, the total gross unrealized loss included in the Company’s investment portfolio was approximately $4.5 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2011, there would have been no impact on total shareholders’ equity or book value since the decline in value of these securities was already recognized as a reduction to shareholders’ equity at December 31, 2011.
The Company uses both standard actuarial techniques common to most insurance companies as well as techniques developed by the Company in consideration of its specialty business products. For its short-tail lines of business, the Company uses predominantly the incurred or paid loss development factor methods. The Company has found that the use of accident quarter loss development triangles, rather than those based upon accident year, are most responsive to claim settlement trends and fluctuations in premium exposures for its short-tail lines. A minimum of 12 running accident quarters is used to project the reserve necessary for incurred but not reported losses for its short-tail lines.
While certain of the Company’s products involve case basis reserving for allocated loss adjustment expenses, the majority of such reserves are determined on a bulk basis. The Company uses historical analysis of the ratios of allocated loss adjustment expenses paid to losses paid on closed claims to arrive at the expected ultimate incurred loss adjustment expense factors applicable to each affected product. Once developed, the factors are applied to the expected ultimate incurred losses, including IBNR, on all open claims. The resulting ultimate incurred allocated loss adjustment expense is then reduced by amounts paid to date on all open claims to arrive at the reserve for allocated loss adjustment expenses to be incurred in the future for the handling of specific claims.
For those loss adjustment expenses not specific to individual claims (general claims handling expenses referred to as unallocated loss adjustment expenses) the Company uses standard industry loss adjustment expenses paid to losses paid (net of reinsurance) ratio analysis to establish the necessary reserves. The selected factors are applied to 100% of IBNR reserves
The reserving process requires management to continuously monitor and evaluate the life cycle of claims based on the class of business and the nature of claims. As previously noted, our claims vary widely in scope and complexity. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in the Company’s fleet transportation liability policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimations, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time.
Expected loss ratios for the current book of business, particularly the Company’s fleet transportation products, where the number of accounts insured, selected self-insured retentions, policy limits and reinsurance structure may vary widely period to period
A 10 percentage point increase in the loss factors actually utilized in the Company’s reserve determination at December 31, 2011 would increase gross loss reserves by approximately $33.8 million whereas a 10 percentage point decrease would decrease gross loss reserves by approximately $32.3 million. On a net basis, a 10 percentage point increase in loss ratio would increase net loss reserves by approximately $16.0 million whereas a 10 percentage point decrease would decrease net loss reserves by approximately $18.2 million. Similarly, a 20 percentage point increase would increase gross loss reserves by approximately $69.3 million whereas a decrease would decrease gross loss reserves by approximately $57.2 million. On a net basis, a 20 percentage point increase in loss ratio would increase net loss reserves by approximately $31.5 million whereas a 20 percentage point decrease would decrease net loss reserves by approximately $27.1 million with the lower impact from loss ratio increases attributable to minimum and maximum premium rate factors included in the various reinsurance contracts.
FASB provides guidance for recognizing and measuring uncertain tax positions and prescribes a threshold condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in the financial statements. Based on this guidance, we regularly analyze tax positions taken or expected to be taken in a tax return based on the threshold condition prescribed. Tax positions that do not meet or exceed this threshold condition are considered uncertain tax positions. We accrue interest related to these uncertain tax positions which is recognized in income tax expense. Penalties, if any, related to uncertain tax positions would be recorded in income tax expenses.
Reference is made to the discussion of limited partnership investments in Critical Accounting Policies presented on page 27 of this report. All of the market risks, attendant to equity securities, apply to the underlying assets in these partnerships, and to a greater degree because of the generally more aggressive investment philosophies utilized by the partnerships. In addition, these investments are illiquid. There is no primary or secondary market on which these limited partnerships trade and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. Finally, through the application of the equity method of accounting, the Company’s share of net income reported by the limited partnerships may include significant amounts of unrealized appreciation on the underlying investments. As such, the likelihood that reported income from limited partnership investments will be ultimately returned to the Company in the form of cash is markedly lower than the Company’s other investments, where appreciation is reported only when a security is actually sold.
The Company's fixed maturity portfolio totaled $409.5 million at December 31, 2011. Approximately 68% of this portfolio is made up of U.S. Government and government agency obligations and state and municipal debt securities; 90% of the portfolio matures within 5 years; and the average contractual maturity of the Company's fixed maturity investments is approximately 3.1 years. Although the Company is exposed to interest rate risk on its fixed maturity investments, given the anticipated duration of the Company's liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, even a 100 to 200 basis point increase in interest rates would not have even a moderate impact on the Company's ability to conduct daily operations or to meet its obligations and would, in fact, result in significantly higher investment income in a relatively short period of time as short term investments and maturing bonds could be reinvested in the higher yielding securities very quickly.
The following tables present the estimated effects on the fair value of financial instruments at December 31 due to an instantaneous change in yield rates of varying magnitudes on a static balance sheet to determine the effect such a change in rates would have on current fair value. The analysis presents the sensitivity of the fair value of the Company’s financial instruments to selected changes in market rates and prices. The range of change chosen reflects the Company’s view of
The table below sets forth the amounts of the Company's contractual obligations at December 31, 2011.
In May 2011, the FASB issued updated accounting guidance that changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between GAAP and International Financial Reporting Standards. The guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. We are currently evaluating the impact that the adoption of the guidance effective January 1, 2012, will have on our consolidated financial statements. We expect no significant adjustments.
In June 2011, the FASB issued revised accounting guidance that eliminates the option to present the components of other comprehensive income as part of the statement of shareholders' equity. Instead, comprehensive income must be reported in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. The guidance will be effective for public companies during the interim and annual periods beginning after December 15, 2011. This new guidance is to be applied retrospectively. We expect no significant adjustments.
Unrealized losses in the Company’s fixed maturity portfolio are generally the result of interest rate fluctuations as well as the disruption of credit markets occasioned by financial market turmoil. The average unrealized loss for all fixed maturity securities in a loss position at December 31, 2011 is approximately 3% of original or adjusted cost. The Company does not intend to sell any fixed maturity securities and it is not more likely than not that the Company will have to sell any fixed maturity security before recovery of its amortized cost basis. For equity securities, the Company has evaluated the near-term prospects of the investment in relation to the severity and duration of the impairment and based on that evaluation the Company has the ability and intent to hold these investments until a recovery of fair value. Therefore, the Company does not believe the unrealized losses represent an other-than-temporary impairment as of December 31, 2011.
Shareholders' equity includes approximately $15,600, net of deferred federal income taxes, of undistributed earnings from limited partnerships as of December 31, 2011.
The Company’s limited partnerships include one significant investment which invests in public and private equity markets in India. This limited partnership investment’s value as of December 31, 2011 and 2010 was $23,465 and $33,197, respectively. At December 31, 2011, the Company’s estimated ownership interest in this limited partnership investment was less than 4%. The Company's share of earnings from this limited partnership investment was ($9,732), $3,521 and $10,915 in 2011, 2010 and 2009, respectively. The summarized financial information of the significant limited partnership investment as of and for the years ended December 31 is as follows:
Short-term investments at December 31, 2011 include $2,982 in time certificates of deposit by a Bermuda bank.
The Company’s fixed maturities are over 91% invested in investment grade fixed maturity investments. The Company has a total of $36,500, representing 16 different investments, of fixed maturity investments which were originally issued with guarantees by three different third party insurance companies, with the largest exposure to a single investment being $5,500. The average S&P credit rating of such investments, with consideration of the guarantee, is AA. The average S&P underlying credit rating of such investments, without consideration of the guarantee, is AA. The Company does not have any direct exposure to any guarantor.
Approximately $35,600 of fixed maturity investments (5.6% of total invested assets) consists of bonds rated as less than investment grade at year end. These investments include a diversified portfolio of over 40 investments including catastrophe bonds and have a $1,297 net unrealized loss position at December 31, 2011.
The table above shows that a savings of $9,696 was developed during 2011 in the settlement of claims occurring on or before December 31, 2010 with comparative developments for the two previous calendar years. The net savings for each year are composed of individual claim savings and deficiencies which, in the aggregate have resulted from the settlement of claims at amounts lower than previously reserved and from changes in estimates of losses incurred but not reported as part of the normal reserving process.
The major components of the developments shown above are as follows for the years ended December 31 (savings) deficiency:
Favorable loss development is influenced by the Company’s long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Loss reserves pertaining to the Company’s property reinsurance business are established largely by the ceding reinsurers although the Company may adjust such reserves if management determines that additional reserves could be necessary. Accordingly, the fluctuation in loss developments related to reinsurance will tend to be more pronounced than those experienced on directly produced business which is reserved entirely by Company personnel. In addition, changes in the Company’s net retention under reinsurance treaties will impact developments as more or less business is retained. These trends were considered in the establishment of the Company’s reserves at December 31, 2011 and 2010.
Loss reserves on certain permanent total disability workers’ compensation reserves have been discounted to present value at pre-tax rates not exceeding 3.5%. At December 31, 2011 and 2010, loss reserves have been reduced by approximately $6,642 and $6,463, respectively. Discounting is applied to these claims since the amount of periodic payments to be made during the lifetime of claimants is fixed and determinable.
Net losses and loss expenses incurred for 2011, 2010 and 2009 include approximately $88,934, $38,318, and $17,070, respectively, relating to reinsurance assumed from non-affiliated insurance or reinsurance companies.
Cash flows related to federal income taxes paid, net of refunds received, for 2011, 2010 and 2009 were $2,859, $9,000, and $6,037 respectively.
The Company’s tax positions are uncertain only as to the timing of deductibility and therefore, if recognized would have no impact on the Company’s effective tax rate. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in income tax expense and changes in such accruals would impact the Company’s effective tax rate. Amounts accrued for the payment of interest at December 31, 2011, 2010 and 2009 were not material.
A reconciliation of the beginning and ending amounts of unrecognized federal income taxes (credits), which would have no impact on the Company’s effective tax rate, excludes interest, which is treated as income tax expense under the Company’s accounting policy, is as follows:
In accordance with the terms of the 1981 Stock Purchase Plan (1981 Plan), the Company is obligated to repurchase shares issued under the 1981 Plan, at a price equal to 90% of the book value of the shares at the end of the quarter immediately preceding the date of repurchase. No shares have ever been repurchased under the 1981 Plan. At December 31, 2011, there were 124,099 shares (Class A) and 380,458 shares (Class B) outstanding which remain eligible for repurchase by the Company.
Effective May 10, 2011, the Company issued 19,558 shares of class B restricted stock to the Company’s outside directors. These restricted shares represent the annual retainer compensation for outside directors for the period July 1, 2011 through June 30, 2012 and will vest on May 10, 2012. Vesting will be accelerated only on the condition of death, disability, or change in control of the Company. Each restricted share is valued at $22.50 per share representing a total value of $440. Compensation expense related to the above stock grant is to be recognized over the period in which the directors render the services which will also coincide with the vesting period.
The following table provides certain profit and loss information for each reportable segment for the years ended December 31:
Acceptable collateral may be provided in the form of letters of credit on Company approved banks, Company approved marketable securities or cash. At December 31, 2011, the Company held collateral in the aggregate amount of $241,466.
In addition, the Company's balance sheet includes paid and estimated unpaid amounts recoverable from reinsurers under various agreements totaling $138,404 at December 31, 2011, as more fully discussed in Note D - Reinsurance. These recoverables are largely uncollateralized. The three largest estimated amounts due from individual reinsurers were $40,562, $15,722, and $13,436 at December 31, 2011.
Investments in limited partnerships include an aggregate of $37,260 invested in three limited partnerships, New Vernon India Fund, New Vernon Global Opportunity Fund and New Vernon Aegir Fund which are managed by organizations in which three directors of the Company are executive officers, directors and owners.
On October 31, 2008, the Company purchased Transportation Specialty Insurance Agency, Inc., (“TIA”) of Toledo, Ohio for a cash purchase price of $3,500. TIA is a commercial lines specialty insurance agency primarily focusing on the needs of the transportation industry including trucking independent contractors as well as fleet trucking companies. TIA is part of the Company’s property and casualty insurance segment. As part of the purchase, the Company recorded goodwill of $3,152 and intangible assets related to customer relationships and employment agreements of $179 which are included in Other Assets in the consolidated balance sheet and has recorded amortization of intangible assets of $35, $41 and $47 during 2011, 2010 and 2009, respectively.
The Company maintains a revolving line of credit with a $30,000 limit, with an expiration date of September 23, 2014. Interest on this line of credit is referenced to LIBOR and can be fixed for periods of up to one year at the Company’s option. Outstanding drawings on this line of credit were $10,000 and $15,000 as of December 31, 2011 and December 31, 2010, respectively. At December 31, 2011, the effective interest rate was 1.19%. The Company has $20,000 remaining unused under the line of credit at December 31, 2011. The current outstanding borrowings were used principally for treasury stock repurchases and extra dividend payments.
There were no significant transfers of assets between Level 1 and Level 2 during 2011, 2010 and 2009.
Net income (loss) of the insurance subsidiaries, as determined in accordance with statutory accounting practices, was ($19,120), $12,542 and $22,855 for 2011, 2010 and 2009, respectively. Consolidated statutory surplus for these subsidiaries was $313,705 and $366,461 at December 31, 2011 and 2010, respectively, of which $51,025 may be transferred by dividend or loan to the parent company during calendar year 2012 with proper notification to, but without approval from, regulatory authorities. An additional $176,580 of shareholders’ equity of such insurance subsidiaries could, under existing regulations, be advanced or loaned to the parent company with prior notification to and approval from regulatory authorities, although it is unlikely that transfers of this size would be practical.
Minimum statutory surplus necessary for the insurance subsidiaries to satisfy statutory risk based capital requirements was $84,732 at December 31, 2011.