The unaffiliated third party had until July 2007 to pay the principal balance. We have negotiated an extension through May 1, 2009. The unaffiliated third party continues to pay interest during the extension period and has the option to pay the principal balance, or $750,000 less in exchange for granting us an ownership interest in the building.
Both the GAAP loss and loss adjustment expense ratio and the GAAP expense ratio are calculated based upon unconsolidated insurance company operations. The following table sets forth the intercompany fees, which are eliminated upon onsolidation.
We are a publicly traded specialty risk management organization offering a full range of insurance products and services, focused on niche and specialty program business, which we believe is under served by the standard insurance market. Program business refers to an aggregation of individually underwritten risks that have some unique characteristic and are distributed through a select group of focused general agencies, retail agencies and program administrators. We perform the majority of underwriting and claims services associated with these programs. We also provide property and casualty insurance coverage and services through programs and specialty risk management solutions for agents, professional and trade associations, public entities and small to medium-sized insureds. In addition, we also operate as an insurance agency representing unaffiliated insurance companies in placing insurance coverages for policyholders. We define our business segments as specialty risk management operations and agency operations.
In June 2002, we sold 21,275,000 shares of newly issued common stock at $3.10 per share in a public offering. After deducting underwriting discounts, commissions, and expenses, we received net proceeds from the offering of $60.5 million. We utilized $57.5 million of the $60.5 million raised in the public offering to pay down our line of credit by $20.0 million and contributed $37.5 million to the surplus of our Insurance Company Subsidiaries. The remaining proceeds were used for general corporate purposes.
from the date of issuance. Since the junior subordinated debentures issued in 2003 are callable in 2008, we will be reviewing the capital strategy associated with refinancing at lower costs through debentures or equity.
With a fee-for-service program, or managed program, we earn fee-for-service revenue by providing management and other services to a client’s risk-bearing entity, but generally do not share in the operating results of the program. The fees we receive from these programs are generally either a fixed amount or based on a percentage of premium serviced or claim count.
We provide three broad types of insurance company programs, including fully insured, captives and client risk-sharing programs. With a client risk-sharing program, our Insurance Company Subsidiaries underwrite individual primary insurance policies for members of a group or association, or a specific industry and then share the operating results with the client or client group through a reinsurance agreement with a captive or rent-a-captive. In some instances, a captive owned by a client or client group reinsures a portion of the risk on a quota-share basis. A captive is an insurance company or reinsurance company, which is formed for the purpose of insuring or reinsuring risks related to the businesses of its shareholders or members. A rent-a-captive allows organizations to obtain the benefits of a captive insurance company, without the initial costs and capital investment required to form their own captive. This is often an interim step utilized by groups and associations prior to forming their own captive. As part of its participation in a rent-a-captive, the client group purchases redeemable preferred stock of our unconsolidated subsidiary. These shares entitle the client group to participate in profits and losses of the program through a dividend or additional capital contribution. Dividends or additional capital contributions are determined and accrued on the basis of underwriting profits or losses plus investment income on trust accounts less costs. The captive and rent-a-captive structures are licensed reinsurance companies, which have a self-sustaining integrated set of activities and assets, and are in the reinsurance business for the purpose of providing a return to their investors, who are the shareholders (“primary beneficiaries”) of the captive company. The primary beneficiaries have their own equity at risk, decision making authority, and the ability to absorb losses. Therefore, the transactions associated with the captive and rent-a-captive structures are accounted for under the provisions of SFAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.”
In addition to premium revenue and investment income from our net retained portion of the operating results, we may also be compensated through the receipt of fees for policy issuance services and acquisition costs, captive administration, reinsurance placement, loss prevention services, and claims administrative and handling services. In addition, we may benefit from the fees our risk management subsidiary earns for services we perform on behalf of our Insurance Company Subsidiaries. These fees are eliminated upon consolidation. However, the fees associated with the captive’s portion of the program are reimbursed through a ceding commission. For financial reporting purposes, ceding commissions are treated as a reduction in underwriting expenses.
We establish a liability for losses and LAE, which represent case based estimates of reported unpaid losses and LAE and actuarial estimates of incurred but not reported losses (“IBNR”) and LAE. Such liabilities, by necessity, are based upon estimates and, while we believe the amount of our reserves is adequate, the
The reserve categories where the above methods are not applicable are few. The largest of these is our workers’ compensation residual market reserve category, where we utilize detailed reserve analyses performed by the industry statistical agency NCCI in making our estimates. We adjust these estimates for timing differences in the reporting of the data. The other reserve categories that deviate from the above methods are smaller; as a group constituting less than three percent of the total reserves.
To analyze the development patterns, we compile, to the extent available, long-term and short-term historical data for our insurance subsidiaries, organized in a manner which provides an indication of the historical development patterns. To the extent that the historical data may provide insufficient information about future patterns - whether due to environmental changes such as legislation or due to the small volume or short history of data for some segments of our business - benchmarks based on industry data, and forecasts
made by industry rating bureaus regarding the effect of legislative benefit changes on such patterns, may be used to supplement, adjust, or replace patterns based on our insurance companies’ historical data.
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. In particular, the development factor based methods all have as a key assumption that the development of losses in the future will follow a pattern similar to those measured by past experience and as adjusted either explicitly or by actuarial judgment. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple and varied factors. With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the years ended December 31, 2007 and 2006.
One implicit assumption underlying development patterns is that the claims inflation trends will continue into the future similar to their past patterns. To estimate the sensitivity of the estimated ultimate loss and settlement expense payments to an unexpected change in inflationary trends, the actuarial department derived expected payment patterns separately for each major line of business. These patterns were applied to the December 31, 2007 loss and settlement expense reserves to generate estimated annual incremental loss and settlement expense payments for each subsequent calendar year. Then, for the purpose of sensitivity testing, an explicit annual inflationary variance of one percent was added to the inflationary trend that is implicitly embedded in the estimated payment pattern, and revised incremental loss and settlement expense payments were calculated. General inflation trends have been fairly stable over the past several years but there have been fluctuations of one to two percent over the past ten years and therefore we used a one percent annual inflation variance factor. The effect differed by line of business but overall was a three percent change in reserve adequacy or approximately $6.8 million effect on after tax net income. A variance of this type would
An explicit assumption used in the analysis is the set of initial expected loss ratios (“IELRs”) used in the current accident year reserve projections and in some of the prior accident year ultimate loss indications. To estimate the sensitivity of the estimated ultimate loss to a change in IELRs, the actuarial department recasted the loss reserve indications using a set of IELRs all one percent higher than the final IELRs. The effect differed by line of business but overall was less than a one percent change in reserve adequacy or a $2.2 million effect on after tax net income. Often the loss ratios by line of business will vary from the IELR in different directions causing them to partially offset each other. A variance of this type would typically be recognized in loss and settlement expense reserves and, accordingly, would not have a material effect on liquidity because the claims have not been paid.
The other factors having influence upon the loss and LAE reserve levels are too numerous and interdependent to efficiently model and test for sensitivity. Likewise, the development factors by reserve category and age are too numerous to model and test for sensitivity. Instead, ranges are estimated by reserve category considering past history, fluctuations in the development patterns, emerging issues, trends and other factors. The ranges are compiled and the total range is estimated considering the sensitivity to all of the underlying factors together. The resulting range is our best estimate of the expected ongoing variability in the loss reserves.
The sensitivity around the other lines of business primarily reflects the size of the underlying book of business. Our other reserves represent 5% of total reserves at December 31, 2007. The majority of these reserves represent professional liability programs which tend to be claims-made and reinsured at lower limits, therefore reducing the volatility that is inherent in a smaller book of business.
Reinsurance recoverables represent (1) amounts currently due from reinsurers on paid losses and LAE, (2) amounts recoverable from reinsurers on case basis estimates of reported losses and LAE, and (3) amounts recoverable from reinsurers on actuarial estimates of IBNR losses and LAE. Such recoverables, by necessity, are based upon estimates. Reinsurance does not legally discharge us from our legal liability to our insureds, but it does make the assuming reinsurer liable to us to the extent of the reinsurance ceded. Instead of being netted against the appropriate liabilities, ceded unearned premiums and reinsurance recoverables on paid and unpaid losses and LAE are reported separately as assets in our consolidated balance sheets. Reinsurance recoverable balances are also subject to credit risk associated with the particular reinsurer. In our selection of reinsurers, we continually evaluate their financial stability. While we believe our reinsurance recoverables are collectible, the ultimate recoverable may be greater or less than the amount accrued. At December 31, 2007 and 2006, reinsurance recoverables on paid and unpaid losses were $199.5 million and $202.7 million, respectively.
In our risk-sharing programs, we are subject to credit risk with respect to the payment of claims by our clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, or on the portion of risk either ceded to the captives, or retained by the clients. The capitalization and credit worthiness of prospective risk-sharing partners is one of the factors we consider upon entering into and renewing risk-sharing programs. We collateralize balances due from our risk-sharing partners through funds withheld trusts or stand-by letters of credit issued by highly rated banks. We have historically maintained an allowance for the potential uncollectibility of certain reinsurance balances due from some risk-sharing partners, some of which may be in dispute. At the end of each quarter, an analysis of these exposures is conducted to determine the potential exposure to uncollectibility. At December 31, 2007, we believe this allowance is adequate. To date, we have not, in the aggregate, experienced material difficulties in collecting balances from our risk-sharing partners. No assurance can be given, however, regarding the future ability of any of our risk-sharing partners to meet their obligations.
Our investment portfolio is primarily invested in debt securities classified as available for sale, with a concentration in fixed income securities of a high quality. Our investment philosophy is to maximize after-tax earnings and maintain significant investments in tax-exempt bonds. Our policy for the valuation of temporarily
For the year ending December 31, 2007, total assumed written premiums were $39.2 million, of which $31.0 million, relates to assumed business we manage directly, and therefore, no estimation is involved. The remaining $8.2 million of assumed written premiums includes $6.9 million related to residual markets.
Fee income, which includes risk management consulting, loss control, and claims administration services, is recognized in the period the services are provided. Claims processing fees are recognized as revenue over
We review, on an ongoing basis, the collectibility of our receivables and establish an allowance for estimated uncollectible accounts. As of December 31, 2007 and 2006, the allowance for uncollectibles on receivables was $2.7 million and $2.9 million, respectively.
We continue to follow pricing guidelines mandated by our corporate underwriting guidelines. Overall, our year-to-date rate change was down 1.7%, compared to industry average price decreases of approximately 15%. We anticipate that rates will continue to remain slightly down into 2008. We continue to be selective on new program implementation by focusing only on those programs that meet our underwriting guidelines and have a proven history of profitability. Our statutory surplus increased by $23.3 million in 2007 to $188.4 million, from $165.1 million in 2006. Currently, our earned surplus is $33.7 million, which represents our ability to dividend from the Insurance Company Subsidiaries to our holding company for capital strategies, such as acquisitions, dividends, debt repayments, and share repurchases.
months. On January 31, 2008, we exercised our option to purchase the remainder of the economics related to the acquisition of the USSU business, by eliminating the Management Agreement for a payment of $21.5 million, which now completes the transaction.
On February 8, 2008, our Board of Directors declared a quarterly dividend of $0.02 per common share. This is the first quarterly dividend since the third quarter of 2001. Our Board of Directors determined that reinstating the dividend best serves shareholder interests by creating long-term value and is part of our capital management strategy.
The merger is expected to expand and complement our specialty lines capabilities with ProCentury’s insurance professionals and product expertise in the excess and surplus lines market. We believe there are significant profitable revenue growth opportunities, as well as cost savings opportunities.
Revenues increased $14.2 million, or 4.7%, to $318.2 million for the year ended December 31, 2006, from $304.0 million for the comparable period in 2005. This increase reflects a $4.9 million, or 2.0%, increase in net earned premiums. The increase in net earned premiums was the result of our selective growth consistent with our corporate underwriting guidelines and our controls over price adequacy, as well as the favorable impact from an increase in our retention levels on certain reinsurance treaties effective in 2005. Offsetting the overall increase in net earned premiums for the year ended December 31, 2006, was a reduction in audit related premiums in comparison to 2005. The increase in revenue was also the result of an overall increase in fee-for-service revenue, primarily as a result of new managed programs. In addition, the increase in revenue reflects a $4.1 million increase in investment income, primarily due to an increase in average invested assets as a result of improved cashflow from favorable underwriting results, an increase in the duration of our reserves, and proceeds from the junior subordinated debentures issued in the third quarter of 2005. The increase in investment income was also the result of a slight increase in yield.
Revenues from specialty risk management operations increased $23.4 million, or 7.6%, to $329.9 million for the year ended December 31, 2007, from $306.5 million for the comparable period in 2006.
Net earned premiums increased $13.3 million, or 5.2%, to $268.2 million for the year ended December 31, 2007, from $254.9 million in the comparable period in 2006. As previously indicated, this increase was the result of selective growth consistent with our corporate underwriting guidelines and our controls over price adequacy, partially offset by the reduction in residual market premiums and mandatory rate decreases in the Nevada, Florida and Massachusetts workers’ compensation lines of business.
Management fees increased $5.3 million, or 28.0%, to $24.0 million, for the year ended December 31, 2007, from $18.7 million for the comparable period in 2006. This increase was related to fees received as a result of our acquisition of the USSU business. Total fees received in 2007 as a result of the USSU acquisition were $5.5 million. Slightly offsetting these fees was a slight decrease in fees in our Northeast operations. This decrease in fees primarily related to a decrease in premium volume due to reduced rates in the self-insured markets on which the fees are based, because of mandatory rate reductions and an increase in competition.
Net investment income increased $4.4 million, or 20.7%, to $25.5 million in 2007, from $21.1 million in 2006. Average invested assets increased $79.2 million, or 16.0%, to $573.1 million in 2007, from $493.9 million in 2006. The increase in average invested assets primarily relates to the cash flows from operations, resulting from continued favorable underwriting results, increased fee revenue, and the lengthening of the duration of our reserves. The increase in the duration of our reserves reflects the impact of growth in our excess liability business, which was implemented at the end of 2003. This type of business has a longer duration than the average reserves on our other programs and is now a larger proportion of reserves. In addition, the increase in average invested assets reflects cash flows from our equity offering in July. The invested proceeds from the equity offering added approximately $600,000 to the overall net investment income for the year. The average investment yield for 2007 was 4.61%, compared to 4.47% in 2006. The current pre-tax book yield was 4.5%. The current after-tax book yield was 3.41%, compared to 3.28% in 2006. This increase is primarily the result of the increase in market interest rates, and the purchase of assets of longer duration to take advantage of higher yields. The duration of the investment portfolio is 4.3 years at December 31, 2007, compared to 3.9 years at December 31, 2006.
Revenues from specialty risk management operations increased $12.0 million, or 4.1%, to $306.5 million for the year ended December 31, 2006, from $294.5 million for the comparable period in 2005.
growth consistent with our corporate underwriting guidelines and our controls over price adequacy, as well as the favorable impact from an increase in our retention levels on certain reinsurance treaties. Offsetting these increases was an overall decrease in audit related premiums in comparison to 2005, reflecting improvements in the estimation of exposures during the underwriting cycle.
Management fees increased $2.0 million, or 11.8%, to $18.7 million, for the year ended December 31, 2006, from $16.7 million for the comparable period in 2005. This increase was primarily the result of a Florida-based program implemented in the second quarter of 2005. In addition, this increase was the result of growth in a specific New England-based program. Also contributing to the overall increase in management fees was the recognition of $250,000 from a profit-based revenue sharing payment related to a specific managed program.
Net investment income increased $4.1 million, or 22.8%, to $22.1 million in 2006, from $18.0 million in 2005. Average invested assets increased $69.6 million, or 16.4%, to $493.9 million in 2006, from $424.3 million in 2005. The increase in average invested assets reflects cash flows from underwriting activities primarily from favorable underwriting results and an increase in the duration of our reserves. The increase in the duration of our reserves reflects the impact of our public entity excess program, which was implemented at the end of 2003. This program has a longer duration than the average reserves on our remaining programs and is a larger proportion of reserves. In addition, the $19.4 million in net proceeds received from capital raised in 2005 through the issuances of debentures increased average invested assets. The average investment yield for 2006 was 4.47%, compared to 4.24% in 2005. The current pre-tax book yield was 4.35%. The current after-tax book yield was 3.28%, compared to 3.06% in 2005. This increase is primarily the result of the shift in our investment portfolio to tax-exempt investments. The duration of the investment portfolio is 3.9 years.
Net losses and loss adjustment expenses (“LAE”) decreased $5.2 million, or 3.5%, to $146.3 million for the year ended December 31, 2006, from $151.5 million for the same period in 2005. Our loss and LAE ratio improved 2.9 percentage points to 62.3% for the year ended December 31, 2006, from 65.2% for the same period in 2005. This ratio is the unconsolidated net loss and LAE in relation to net earned premiums. The accident year loss ratio remained flat at 63.4% for 2006, compared to 63.3% in 2005. The favorable development in our loss ratio was primarily the result of improvement in frequency and claim settlements within the professional liability line of business. In addition, workers’ compensation residual market experience improved as a result of lower market share assessments and lower loss reserves on the industry pooled experience. Both 2006 and 2005, were adversely impacted by a single large workers’ compensation claim. The increase was $1.5 million and $900,000 in 2006 and 2005, respectively. Excluding the adverse impact of this claim, overall workers’ compensation reflected improvement in claim settlements relative to their collective case reserves. The experience within the general liability line of business also improved due to favorable case reserve settlements in 2006, in comparison to 2005. These improvements were partially offset by a single property claim of $1.9 million within a California-based agricultural program. Allowances within other reserve categories, collectively, did not contribute to the development in 2006, compared to 2005 where
Our agency operations include an allocation of corporate overhead, which includes expenses associated with accounting, information services, legal, and other corporate services. The corporate overhead allocation excludes those expenses specific to the holding company. For the years ended December 31, 2007, 2006, and 2005, the allocation of corporate overhead to the agency operations segment was $2.8 million, $3.3 million, and $3.2 million, respectively. These balances include an allocation to our Insurance & Benefit Consultants agency business that was previously allocated to specialty risk management operations. For the years ended December 31, 2006 and 2005, pre-tax income for agency operations was overstated and specialty risk management was understated by $342,000 and $102,000, respectively.
Revenue from agency operations, which consists primarily of agency commission revenue, decreased $969,000, or 7.9%, to $11.3 million for the year ended December 31, 2007, from $12.3 million for the comparable period in 2006. This decrease was primarily the result of a reduction in premium on client renewals due to a more competitive pricing environment primarily on larger Michigan accounts.
Revenue from agency operations, which consists primarily of agency commission revenue, increased $1.0 million, or 8.7%, to $12.3 million for the year ended December 31, 2006, from $11.3 million for the comparable period in 2005. This increase was primarily the result of the November 2005 acquisition of a Florida-based retail agency and an increase in profit sharing commissions in comparison to 2005. Offsetting these increases was a decrease in commission revenue as a result of a reduction in premium on client renewals due to a more competitive pricing environment.
Agency operations generated pre-tax income, after the allocation of corporate overhead, of $2.6 million for the year ended December 31, 2006, compared to $3.2 million for the comparable period in 2005. This decrease in pre-tax income in comparison to 2005 was primarily the result of a slight increase in operating expenses coupled with the decrease in commission revenue, as noted above, offset by the favorable impact from the Florida-based retail agency acquisition.
Reserves are reviewed by our internal actuaries for adequacy on a quarterly basis. When reviewing reserves, we analyze historical data and estimate the impact of numerous factors such as (1) per claim information; (2) industry and our historical loss experience; (3) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (4) trends in general economic conditions, including the effects of inflation. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple factors.
The key assumptions used in our selection of ultimate reserves included the underlying actuarial methodologies, a review of current pricing and underwriting initiatives, an evaluation of reinsurance costs and retention levels, and a detailed claims analysis with an emphasis on how aggressive claims handling may be impacting the paid and incurred loss data trends embedded in the traditional actuarial methods. With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the years ended December 31, 2007, 2006, and 2005.
changes in the key assumptions utilized in the analysis and calculations of our reserves during 2007 and 2006. The major components of this change in ultimate loss estimates are as follows (in thousands):
The commercial multiple peril and general liability line of business had an increase in net ultimate loss estimates of $12.5 million, or 19.8% of net commercial multiple peril and general liability reserves. The net increase reflects increases of $2.8 million, $1.6 million, $5.6 million, and $811,000 in the ultimate loss estimates for accident years 2006, 2005, 2004 and 2003, respectively, which were primarily due to larger than
expected claim emergence in a Florida-based program. The larger than expected claim emergence within this Florida-based program was the result of accelerated claim activity on a handful of incurred losses and greater claims frequency from a claim reserving process change. This may be attributable to more aggressive investigation on possible losses and more dedicated resources on claim handling, resulting in case reserving changes, rather than worsening results. While this program had unfavorable development in prior accident year reserves, the current and inception to date profits remain positive and within our corporate guidelines for return on surplus. The change in ultimate loss estimates for all other accident years was insignificant.
The workers’ compensation residual market line of business had a decrease in net ultimate loss estimates of $3.1 million, or 11.7% of net reserves. This decrease reflects reductions of $1.8 million, $958,000, and $490,000 in accident years 2005, 2004 and 2003, respectively. We record loss reserves as reported by the NCCI, plus a provision for the reserves incurred but not yet analyzed and reported to us due to a two quarter lag in reporting. These changes reflect a difference between our estimate of the lag incurred but not reported and the amounts reported by the NCCI in the quarter. The change in ultimate loss estimates for all other accident years was insignificant.
Salaries and employee benefits increased $1.8 million, or 3.4%, to $56.4 million in 2007, from $54.6 million for the comparable period in 2006. This increase was primarily due to merit increases, our acquisition of the USSU business, and variable compensation attributable to our performance. Overall, our headcount remained flat for 2007.
Other administrative expenses increased $2.0 million, or 7.5%, to $28.8 million in 2006, from $26.8 million in 2005. A portion of this increase was the result of the expenses associated with the additions of our Florida-based agency and our entry into the self-insured workers’ compensation market in Nevada. In addition, the increase in other administrative expenses was the result of information technology enhancements and various increases in other general operating expenses in comparison to 2005.
Amortization expense for 2007, 2006, and 2005 was $1.9 million, $590,000, and $373,000, respectively. Amortization expense per dilutive share for 2007, 2006, and 2005 was $0.06, $0.02, and $0.01, respectively. Amortization expense primarily relates to the customer relationships acquired with the Florida-based agency operation in 2005 and the acquisition of the USSU business in 2007. The increase in amortization expense in 2007 was related to our acquisition of the USSU business.
Cash flow provided by operations was $88.6 million in 2007, compared to $74.3 million in 2006. Cash flow provided by operations in 2005 was $81.9 million.
We continue to anticipate a temporary increase in cash outflows related to our investments in technology as we enhance our operating systems and controls. We believe these temporary increases will not affect our liquidity, debt covenants, or other key financial measures.
Regulated subsidiaries’ cash flow provided by operations for the year ended December 31, 2006, was $69.7 million, compared to $76.3 million for the comparable period in 2005. This decrease was primarily the result of timing in relation to reinsurance payments. This decrease was slightly offset as a result of improved underwriting results, lower paid losses in proportion to incurred losses, and an increase in investment income.
The following table summarizes the principal amounts and variables associated with our long-term debt (in thousands):
We received a total of $53.3 million in net proceeds from the issuances of the above long-term debt, of which $26.2 was contributed to the surplus of our Insurance Company Subsidiaries and the remaining balance was used for general corporate purposes. Associated with the issuance of the above long-term debt we incurred approximately $1.7 million in issuance costs for commissions paid to the placement agents in the transactions.
quarterly floating rate payments to us, referencing the same notional amount, based on the three-month LIBOR, plus 4.20%.
In relation to the above interest rate swaps, the net interest income received for the years ended December 31 2007 and 2006, was approximately $172,000 and $67,000, respectively. For the year ended December 31, 2005, the net interest expense incurred was approximately $4,000. The total fair value of the interest rate swaps as of December 31, 2007 and 2006, was approximately ($545,000) and $200,000, respectively. Accumulated other comprehensive income at December 31, 2007 and 2006, included accumulated (loss) income on the cash flow hedge, net of taxes, of approximately ($484,000) and $121,000, respectively.
Debt covenants consist of: (1) maintenance of the ratio of Adjusted EBITDA to interest expense of 2.0 to 1.0, (2) minimum net worth of $130.0 million and increasing annually, commencing June 30, 2005, by fifty percent of the prior year’s positive net income, (3) minimum A.M. Best rating of “B”, and (4) on an annual basis, a minimum Risk Based Capital Ratio for Star of 1.75 to 1.00. As of December 31, 2007, we were in compliance with these covenants.
As of December 31, 2007 and 2006, the recorded values of our investment portfolio, including cash and cash equivalents, were $651.6 million and $527.6 million, respectively. The debt securities in the investment
In April 2007, we purchased the business of USSU for a purchase price of $23.0 million. This purchased price was comprised of $13.0 million in cash and $10.0 million in our common stock. Total additional shares issued for the $10.0 million portion of the purchase price were 907,935 shares.
Goodwill associated with this acquisition was approximately $12.0 million. In addition, we recorded an increase to other intangible assets of approximately $9.5 million. These other intangible assets related to customer relationships acquired with the acquisition. We determined that the estimated useful life of the other intangible assets to be approximately five years. As such, we will amortize the $9.5 million in other intangible assets over a five year period.
In addition, we entered into a Management Agreement with the former owners of USSU. Under the terms the Management Agreement, the former owners were responsible for certain aspects of the daily administration and management of the USSU business. Their consideration for the performance of these duties was in the form of a management fee payable by us based on a share of net income before interest, taxes, depreciation, and amortization. We retained the option to terminate the Management Agreement, at our discretion, based on a multiple of the management fee calculated for the trailing twelve months. On January 31, 2008, we exercised this option to purchase the remainder of the economics related to the acquisition of the USSU business, by eliminating the Management Agreement for a payment of $21.5 million, which now completes the transaction. As a result of this purchase, we recorded an increase to other intangible assets of approximately $11.4 million and an increase to goodwill of approximately $10.1 million.
Five year call feature associated with debentures, estimated seven year repayment.
For interest rate terms and actual rates on long-term debt in effect as of December 31, 2007, refer to the Long-term Debt section within Other Items of the Liquidity and Capital Resources section of Management’s Discussion and Analysis. Estimates of interest expense for future periods are based on the most current interest rates in effect: on $13.0 million senior debentures at 8.87%; on $12.0 million senior debentures at 9.23%; on $20.6 million junior subordinated debentures at 8.57%; and on $10.3 million junior subordinated debentures at 8.88%. The assumption that the loans will be repaid at the end of seven years is based on management’s best estimate of the life of the debentures.
In addition, there are two interest rate swaps associated with our long-term debt. The first interest rate swap relates to $5.0 million of our $12.0 million of senior debentures, which has a fixed interest rate of 8.925% with an ending date of May 24, 2009. The second interest rate swap relates to $20.0 million of our $20.6 million junior subordinated debentures, which has a fixed interest rate of 8.34% with an ending date of September 16, 2010.
Insurance operations are subject to various leverage tests (e.g. premium to statutory surplus ratios), which are evaluated by regulators and rating agencies. Our targets for gross and net written premium to statutory surplus are 2.8 to 1.0 and 2.25 to 1.0, respectively. As of December 31, 2007, on a statutory consolidated basis, gross and net premium leverage ratios were 1.8 to 1.0 and 1.5 to 1.0, respectively.
In April 2007, we received an upgrade of our financial strength rating by A.M. Best Company to “A−” (Excellent), from “B++” (Very Good) for our Insurance Company Subsidiaries.
We have historically maintained an allowance for the potential exposure to uncollectibility of certain reinsurance balances. At the end of each quarter, an analysis of these exposures is conducted to determine the potential exposure to uncollectibility. The following table sets forth our exposure to uncollectible reinsurance and related allowances for years ending December 31, 2007 and 2006 (in thousands):
Balances related to risk-sharing partners, which have either captive or rent-a-captive quota-share reinsurance contracts with us.
As of December 31, 2007, we have no off-balance sheet arrangements as defined in Item 303(a) (4) of Regulation S-K.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value and establishes a framework for measuring fair value in accordance with generally accepted accounting principles. SFAS No. 157 also requires expanded disclosures about (1) the extent to which companies measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair value and (3) the effect of fair value measures on earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We will adopt SFAS No. 157 on January 1, 2008. We do not believe the adoption of SFAS No. 157 will have a material impact on our consolidated financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” SFAS No. 141(R) provides revised guidance on how an acquirer recognizes and measures in its financial statements, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. In addition, it provides revised guidance on the recognition and measurement of goodwill acquired in the business combination. SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) is effective for business combinations completed on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, or January 1, 2009. We do not expect the provisions of SFAS No. 141(R) to have a material effect on our consolidated financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51.” SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. We will evaluate the impact of SFAS No. 160, but believe the adoption of SFAS No. 160 will not impact our consolidated financial statements.
Each ProCentury shareholder will have the option to elect to receive cash or Meadowbrook stock, subject to proration so that the maximum total cash consideration will not exceed 45% of the total consideration paid in order to preserve the tax-free exchange of the stock consideration. As long as Meadowbrook’s 30-day volume-weighted average price preceding the election date, which will be at least five days before the closing of the transaction, is between $8.00 and $10.50, the exchange ratio will vary such that the stock consideration equals $20.00 per share based on such 30-day average price. Above or below this range for Meadowbrook’s stock price, the exchange ratio will be fixed as if the 30-day volume-weighted average price preceding the election date equaled $10.50 or $8.00, as applicable. Outstanding options to purchase ProCentury common shares will become fully vested and option holders can either exercise such options and, in connection with the closing, elect to receive the form of merger consideration described above for the ProCentury shares acquired on exercise or agree to have their options cancelled in exchange for a per share cash payment equal to the difference between $20.00 and the exercise price of their options.
Refer to list of Financial Statement Schedules and Note 19 - Quarterly Financial Data (Unaudited) of the Notes to the Consolidated Financial Statements.