The following summary sets forth selected financial data with respect to us for the five fiscal years ended December 31, 2003. The balance sheet and income statement data have been derived from our consolidated financial statements which have been audited by Deloitte & Touche, our independent auditors. The data set forth below should be read in conjunction with the audited financial statements and notes thereto included elsewhere in this annual report. The information for the period prior to December 2, 1999 is with respect to our Delaware predecessor and its subsidiaries.
Recently, in light of our increased capital and in an effort to maximize the value of our shares, we have been looking at ways to expand our business, including possibly entering into other lines of insurance business. In 2003 we provided reinsurance of attorneys’ professional liability policies provided by Professional Direct Insurance Company. That activity was not a significant portion of our business in 2003 and was terminated at the end of the year. However, we will continue to look for other ways to expand our business to include other lines of coverage, which may include attorneys’ professional liability coverage.
Our results of operations for the years ended December 31, 2003, December 31, 2002 and December 31, 2001 are discussed below. Results in 2003 were significantly impacted by the reduction of $5.0 million in our loss reserves as a result of our actuaries gaining better information from the primary carrier with respect to its experience under the AICPA plan.
The increase in 2003 net income was primarily due to the reduction of $5.0 million in our loss reserves. Due to the uncertainty inherent in the business written, we have always adopted a very conservative policy concerning our loss reserving. In the last year, our actuary was able to obtain additional information which included breaking out loss development on CNA’s non-value, or “premier,” and “value” plans which we reinsure. Our actuary determined in the course of its analysis that experience under the CNA plans has been more favorable than industry performance reflected in the reserves we established for our reinsurance of the plans. In light of this new information, we believed it was reasonable to reduce the prior year loss reserves by $5.0 million. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our loss reserving philosophy. The Company will continue to review loss reserves in the fourth quarter of each year and, based on the actuarial projections, determine whether any amounts may be released to income. At this time the Company can not predict whether it will be able to reduce loss reserves further.
Net premiums earned increased by 23.9% in 2003 to $8,392,172 from $6,775,407 in 2002. Net premiums earned for 2002 increased by 5.9% from $6,400,322 in 2001. The increases in net premiums earned during 2003 was primarily attributable to an increase in the number of AICPA insureds and rate increases under the current AICPA Professional Liability Plan treaty compared to the same period in 2002 and due to premiums written for the attorneys’ professional liability business in the year ended December 31, 2003.
Net investment income includes amounts earned on the Company’s investment portfolio and cash equivalents, and dividends on equity investments, net of investment expenses. Net investment income decreased $392,407 or 20.8% in 2003 to $1,495,371 from $1,887,778 in 2002. Due to the possibility of improved interest rates, we maintained a higher concentration in shorter maturity fixed income securities in 2003 than in 2002. Net investment income in 2002 decreased by $233,764, or 11.0% from the $2,121,542 reported in 2001. The decrease in 2002 was due to volatile market conditions and a general decrease in interest rates.
Net realized gains and losses increased $1,939,180 in 2003 to a gain of $933,995 from a loss of $1,005,185 in 2002. Net realized gains and losses in 2002 decreased by $1,991,607 from a $986,422 gain in 2001.
Unrealized gain on investments was $6,039,616 at December 31, 2003 compared to $3,330,260 at December 31, 2002. We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at market value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The 85% increase in unrealized gain on investments was due primarily to movement in the company’s equity portfolio. Unrealized gain on investments was $3,582,854 at December 31, 2001. Declines in the market value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses 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, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired and, a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
The composition of the investment portfolio at December 31, 2003 and 2002 is as follows:
Our Company’s fixed income, equity and hedge fund portfolios are invested in accordance with a written Investment Policy Statement adopted by our Board of Directors. Our Company engages professional advisors to manage day to day investment matters under the oversight of the Investment Committee.
Our fixed income portfolio is managed with the target objectives of achieving an annualized rate of return for the trailing 5-year period of 250 basis points over the Consumer Price Index, and total returns commensurate with Merrill Lynch’s U.S. Domestic Index. Our overall portfolio is required to have at least an “A” S&P rating, an “A2” Moody’s rating or an equivalent rating from comparable rating agencies.
Our losses and loss adjustment expenses decreased by 54.2% to $2,502,884 in 2003 from $5,468,410 in 2002, and for 2002 decreased by 9.8% from $6,065,656 in 2001. These amounts included favorable development of prior years’ estimates of losses and loss adjustment expenses of approximately $5,016,302 in 2003, $577,001 in 2002 and $22,742 in 2001. Our loss ratio, calculated as the ratio of losses and loss adjustment expenses to net premiums earned, was 29.8% in 2003, 80.7% in 2002 and 94.8% in 2001. Our losses and loss adjustment expenses in 2003, before the favorable development of prior years’ estimates of losses and loss adjustment expenses was $7,519,188. Our loss ratio absent this factor would have been 89.6%. The reason for the favorable development of prior years’ estimates is discussed in more detail below under the caption “Losses and Loss Adjustment Expenses.” As noted above, the decrease in losses and loss adjustment expenses as a result of favorable development of prior years’ estimates of losses and loss adjustment expenses was the primary reason for our substantial increase in net income in 2003.
Policy acquisition costs of $2,446,978 were expensed in 2003 compared to $1,983,400 in 2002, an increase of 23.4%. Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. Policy acquisition costs expensed in 2002 reflected an increase of 4.9% from $1,891,474 in 2001. Such costs as a percentage of premiums earned (excluding the effects of increases to retrocession premiums) were 29.2% in 2003, 29.5% in 2002 and 29.6% in 2001.
Assumed reinsurance premiums receivable represent current assumed premiums receivable less commissions payable to the fronting carriers. This balance was $570,309 at December 31, 2003 and $514,992 at December 31, 2002. This balance fluctuates due to the timing of renewal premiums written.
Prepaid expenses and other assets were $158,863 at December 31, 2003, an increase of 16.7% from 2002. These expenses relate to the directors and officers’ liability insurance policy, director fees and management fees.
Based in part upon the analysis that resulted in the $5.0 million reduction in our loss reserves discussed above, our Board of Directors determined that we had capital in excess of that currently required. Therefore, on December 22, 2003, they declared a special dividend of $10.50 per share, ($3.5 million in the aggregate) to return a portion of our capital to our shareholders. The special dividend was paid January 15, 2004.
On September 8, 2000, the Bermuda Monetary Authority authorized the purchase of up to 15,000 of our shares by AmerInst Investment Company. Such purchases are made through privately negotiated transactions and are in addition to our practice of purchasing the shares of individuals who have died or retired from the practice of public accounting. Subsequently, on July 19, 2002, the Bermuda Monetary Authority authorized blanket permission for AmerInst Investment Company to purchase common shares from individuals who have died or retired from the practice of public accounting and on a negotiated case-by-case basis without limit. Through March 5, 2004, we had purchased in negotiated transactions 17,228 common shares for a purchase price of $550,761. In addition, through that date, we had purchased 14,000 common shares from individuals who had died or retired for a purchase price of $617,265.
As is customary in the business, an actuarial review and projection is performed for us by our independent actuary as of June 30 and December 31 of each year. We review the actuarial estimates throughout the year and the possible impact on our financial position. Unless a significant trend is evident during the year, our policy has been to make adjustments in the fourth quarter. As noted in our discussion of our results of operations, based on the analysis by the Company’s actuaries, a reduction of $5.0 million from unpaid losses and loss adjustment reserves occurred in the fourth quarter of 2003.
In 2003, for the first time, our actuary was able to analyze the loss and allocated loss adjustment expenses separately for CNA’s value plan and non-value plan policies. The analysis of this additional data, not previously available from the ceding company resulted in a decrease in the actuary’s estimate of ultimate loss and loss adjustment expenses. In addition, the actuary was able to obtain more detailed information concerning the distribution of policy limits purchased by insureds under the value plan. Using more detailed limits information also resulted in a decrease in ultimate loss and loss adjustment expenses. Detailed information for value plan policies was only available for treaty periods December 1, 1999 and after. Consequently, value plan experience for periods earlier than December 1, 1999 was included in the non-value plan analysis.
The traditional loss development method separately forecasts ultimate loss and allocated loss adjustment expense for each year on the basis of historical emergence patterns found in incurred and paid loss and allocated loss adjustment expense data. The claim count based Cape Cod method treats ultimate claim counts as the exposure base, and uses a claim severity index to reflect changes in expected losses per claim over time. In effect, the Cape Cod method combines a loss development approach (which forecasts future emergence of loss and allocated loss adjustment expense based on past emergence patterns) with an expected pure premium approach (which assumes that future expected emergence can be projected based on historical pure premiums). The claim severity index assumed a 5.0% claim severity trend, based on recent professional liability severity trend indications and judgment.
For all reported years, the selected ultimate loss and allocated loss adjustment expense was the average of the paid and incurred Cape Cod results.
instead of selecting an expected amount. This change in methodology resulted in a decrease in the ultimate loss and allocated loss adjustment expense estimate. Based on the actuarial analysis, we believed it was reasonable to release loss reserves by $5.0 million. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our loss reserving philosophy.
The BF method essentially blends together an expected loss result and a loss development result. The expected losses used in the BF calculation were selected by multiplying expected claim counts by average excess of $1 million frequency and severity amounts. The actuary selected a 2.01% frequency provision and a $408,349 severity provision for allocated loss adjustment expense in addition to limits, based on historical allocated loss adjustment expense data from Coregis and CNA.
The attorneys’ professional liability coverage was a new program. There are no current incurred or paid losses. The relationship with the carrier of that insurance was terminated December 31, 2003. Therefore, policies written during 2003 are the only ones we have reinsured. An estimated ultimate loss and allocated loss adjustment expense ratio of 75% was selected for this business.
The above table of losses reestimated has been prepared on a net basis - i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up, as required under FAS 113. The schedule has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the costs of providing such information relative to any benefits of providing it.
The reinsurance activity of AMIC Ltd. depends upon agreements entered into with outside parties. From the inception of AmerInst Insurance Group, Inc. (“AIIG”), AMIG Ltd.’s predecessor entity, through mid-1993, Crum and Forster Managers Corporation, through a group of affiliated insurance companies (collectively, “CGI”), was the primary insurer for the AICPA Plan. In 1988, AIIG’s wholly-owned subsidiary, AIIC Inc. provided reinsurance to CGI, assuming 10% of the risks related to the first $1,000,000 of coverage for each policy issued under the program. For the period 1989 through mid-1993, an unaffiliated company, Virginia Surety Company, Inc., (“VSC”) provided reinsurance to CGI and retroceded a portion to AIIC Inc. such that AIIC Inc. assumed 10% to 12.5% of the risk related to the first $1,000,000 of coverage limits for each policy issued under the program. In August 1993, the AICPA Plan endorsed the CNA insurance group as its insurance carrier, replacing CGI as the primary insurer. AIIC Inc. then began a reinsurance relationship with CNA, taking a 10% participation of the first $1,000,000 of liability of each policy written under the plan. Effective in December 1999, the Company began taking a 10% share of the “value plan” business from CNA, the “value plan” provides for separate $1,000,000 limits for losses and separate $1,000,000 limits for expenses per occurrence and $2,000,000 in the aggregate. Our maximum limits under the “value plan” are $2,000,000 per occurrence and $4,000,000 in the aggregate.
AMIC, Ltd. entered into an excess loss arrangement with PDIC for a 15% quota share participation of the lawyer professional liability coverage provided by PDIC. The participation terminated December 31, 2003.
Pursuant to the reinsurance agreements described in Note 1, AMIC Ltd. is required to provide the ceding companies with collateral for AMIC Ltd.’s liabilities to them. At December 31, 2003 $137,328 was held in deposit pursuant to the 2003 excess reinsurance agreement with PDIC. At December 31, 2002, $108,000 was held in deposit pursuant to the 1988 reinsurance agreement with CGI. Also at December 31, 2003 and 2002, the carrying value of investments in a trust account held by Bank of New York pursuant to reinsurance agreements with VSC in effect from 1989 to mid-1993 was $240,090 and $358,538, respectively. Additionally, at December 31, 2003 and 2002, AMIC Ltd. had provided CNA with a Section 114 Trust, held by JPMorgan Chase Bank, with investments with a carrying value of $17,518,895 and $17,919,996 respectively.
The cost or amortized cost, gross unrealized holding gains and losses, and estimated fair value of investments in fixed maturity investments by major security type, and equity securities at December 31, 2003 and 2002 are as follows:
Details of the liability for unpaid losses and loss adjustment expenses and related reinsurance recoveries receivable at December 31, 2003 and 2002 are as follows:
As a result of the change in estimates of insured events in prior years, the provision for losses and loss expenses decreased by $5,016,302 in 2003, $577,001 and $22,742 in 2002 and 2001, respectively. The 2003 decrease related mainly to positive loss development in the policy years 1988 to 2000. The 2002 decrease related mainly to positive loss development in the fiscal years 1988 to 1999.
AMIG Ltd., AMIC Ltd., Mezco and Investco have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. USA Risk Group of Bermuda Ltd. provides AMIG Ltd. and AMIC Ltd. certain management, administrative and operations services under the direction of the AMIG Ltd.’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party within a period not exceeding ninety days and no less than 60 days prior written notice. Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $228,367 in 2003, $212,192 in 2002 and $167,558 in 2001.