Fireside Bank leases 16 facilities, of which 11 are occupied, with an aggregate square footage of approximately 152,000 in 5 states. The latest expiration date of the existing leases is in August of 2016.
Unitrin Specialty leases facilities with an aggregate square footage of approximately 148,000 at 3 locations in 3 states. The latest expiration date of the existing leases is in June of 2018.
Unitrin’s Life and Health Insurance segment leases facilities with aggregate square footage of approximately 506,000 at 149 locations in 27 states. The latest expiration date of the existing leases is in October of 2017.
Kemper, Unitrin Specialty and Unitrin Direct share leased facilities with an aggregate square footage of approximately 58,000 at 4 locations in 3 states. The latest expiration date of the existing leases is in March of 2018.
(a) Adjusted for the retrospective application of a change in accounting principle for the elimination of a reporting lag for certain investments accounted for under the equity method of accounting. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements.
(c) Shareholders’ Equity decreased by $ 7.3 million at December 31, 2006, as a result of the Company’s initial application of the recognition provisions of SFAS No. 158 for the Company’s postretirement benefit plans.
Net Loss was $29.6 million ($0.47 per common share) for the year ended December 31, 2008, compared to Net Income of $205.4 million ($3.13 per common share) for the year ended December 31, 2007. Net Loss from Continuing Operations was $38.0 million ($0.60 per common share) in 2008, compared to Net Income from Continuing Operations of $178.1 million ($2.71 per common share) for same period in 2007. As discussed throughout this MD&A results from continuing operations decreased for the year ended December 31, 2008 due primarily to lower operating results in the aggregate, including higher catastrophe losses, lower Net Investment Income and higher losses arising from other than temporary declines in fair value of investments and realized investment losses from sales of stocks of financial institutions. Catastrophe losses from continuing operations were $144.9 million before tax for the year ended December 31, 2008, compared to $39.4 million for the same period in 2007. The Company reported Income from Discontinued Operations of $8.4 million and $27.3 million for the years ended December 31, 2008 and 2007, respectively.
Net Investment Income decreased by $77.0 million in 2008 due primarily to lower net investment income from certain investments in limited liability investment companies and limited partnerships, lower short-term investment income and lower dividend income from the Company’s investment in Northrop, partially offset by higher net investment income from acquired businesses.
Net Realized Investment Gains (Losses), which are reported in the Statement of Operations, was a loss of $93.7 million in 2008, compared to a gain of $62.5 million in 2007. Net Realized Gains (Losses) for the years ended December 31, 2008 and 2007, include pretax losses of $152.9 million and $33.0 million, respectively, from other than temporary declines in the fair values of investments.
Except for investments accounted for under the equity method of accounting or under the fair value option of SFAS No. 159, under the provisions of GAAP a company is generally required to classify its investments in fixed maturities, preferred stocks and common stocks into one of the following three investment categories based on the its intent with respect to a particular investment at the time of acquisition:
The classification of the investment may affect a company’s reported results. For investments classified as trading or for which a company elects the fair value option, a company is required to recognize changes in the fair values into income for the period reported. For investments in fixed maturities classified as held to maturity, a company is required to carry the investment at amortized cost, with only the amortization occurring during the period recognized into income. Changes in the fair value of investments classified as available for sale are not recognized to income during the period, but rather are recognized as a separate component of equity until realized. Investments accounted for under the equity method of accounting are valued at cost plus cumulative undistributed earnings and not at fair value. Had the Company reported all the changes in the fair values of its investments in fixed maturities, preferred stock and common stock, including its investment in Intermec, and other equity securities into income, the Company’s reported net income for the year ended December 31, 2008, would have decreased by $448.2 million.
a) The Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value;
b) The duration and extent to which the fair value has been less than cost; and
A change in any one or more of the foregoing factors is likely to result in a projected ultimate net claim loss and LAE that is different from the previously estimated reserve and/or previous frequency and severity trends. Such changes in estimates may be material.
For example, the Company’s actuaries review frequency (number of claims per policy or exposure), severity (dollars of loss per claim) and average premium (dollars of premium per exposure). Actual frequency and severity experienced will vary depending on changes in mix by class of insured risk. Similarly, the actual frequency and rate of recovery from reinsurance will vary depending on changes in the attachment point for reinsurance. In particular, in periods of high growth or expansion into new markets, there may be additional uncertainty in estimating the ultimate losses and LAE. The contributing factors of this potential risk are changes in the Company’s mix by policy limit and mix of business by state or jurisdiction.
on the actuarial indications in determining the appropriate estimated level of reserves, due in part to the continued improvement in the actuarial indications in some product lines.
In addition, the Company has experienced favorable development in some particularly long-tail lines such as asbestos, environmental and construction defect. The Company’s reserves for asbestos, environmental and construction defects were $13 million, $5 million and $53 million, respectively, at December 31, 2008. Development in these lines emerge over a longer period of time and thus are more difficult to ascertain. In 2008, the Company updated certain analyses for these long-tail lines using industry analyses as well as its own experience. See Note 8, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements.
The estimated variability shown above does not constitute a statistical range of actuarially determined probable outcomes, nor does it constitute a range of all possible outcomes. Rather, it is based solely on the Company’s historical experience over the last five full years, which may not necessarily be indicative of future variability due to a number of factors including, but not limited to, changes in claims handling procedures, underwriting, mix of business by class and policy limit, growth in new lines of business or geographical areas, and the legal environment. The impact of changes in these factors is difficult to quantify and predict. Accordingly, the Company’s actuaries must exercise considerable professional judgment in making their actuarial indications in light of these factors. Reserves in the Company’s Kemper segment account for 38% of the Company’s reserves for property and casualty insurance losses and LAE. Accordingly, the indicated estimated variability is more likely to result from changes in the reserves for the Kemper segment.
Although development will emerge in all of Unitrin’s personal lines’ product lines, development in Kemper’s personal automobile insurance product line could have the most significant impact. To further illustrate the sensitivity of Kemper’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries estimated the impact of decreases in the cumulative development factors used in the incurred loss development methodology. For the most recent quarterly evaluation period, the Company assumed an average decrease of 11.1% in the cumulative development factor, gradually declining to an average decrease of 3.2% over the next 8 older evaluation quarters, gradually declining to average decrease of 0.4% over the next 15 older evaluation quarters and then gradually declining to 0% thereafter. Assuming that Kemper’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed decreases in the cumulative development factors, the Company estimates that Kemper’s automobile insurance loss and LAE reserves would have decreased by $72 million at December 31, 2008 for all accident years combined.
To further illustrate the sensitivity of Kemper’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries also estimated the impact of increases in the cumulative development factors used in the incurred loss development methodology. For the most recent quarterly evaluation period, the Company assumed an average increase of 11.1% in the cumulative development factor, gradually declining to an average increase of 3.2% over the next 8 older evaluation quarters, gradually declining to an average increase of 0.4% over the next 15 older evaluation quarters and then gradually declining to 0% thereafter. Assuming that Kemper’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed increases in the cumulative development factors, the Company estimates that Kemper’s automobile insurance loss and LAE reserves would have increased by $72 million at December 31, 2008 for all accident years combined.
In addition to the factors described above, other factors may also impact loss reserve development in future periods. These factors include governmental actions, including court decisions interpreting existing laws, regulations or policy provisions, developments related to insurance policy claims and coverage issues, adverse or favorable outcomes in pending claims litigation, the number and severity of insurance claims, the impact of inflation on insurance claims and the impact of residual market assessments. Although the Company’s actuaries do not make specific numerical assumptions about these factors, changes in these factors from past patterns will impact historical loss development factors and in turn future loss reserve development. Significant positive changes in one or more factors will lead to positive future loss reserve development, which could result in the actual loss developing closer to, or even below, the lower end of the Company’s estimated reserve variability. Significant negative changes in one or more factors will lead to negative loss reserve development, which could result in the actual loss developing closer to, or even above, the higher end of the Company’s estimated reserve variability. Accordingly, due to these factors and the other factors enumerated throughout the MD&A and the inherent limitations of the loss reserving estimation methodologies, the estimated and illustrated reserve variability may not necessarily be indicative of the Company’s future reserve variability, which could ultimately be greater than the estimated and illustrated variability. In addition, as previously noted, development will emerge in all of Unitrin’s product lines over time. Accordingly, the Company’s future reserve variability could ultimately be greater than the illustrated variability.
The process of determining whether or not an asset, such as Goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Such projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. In evaluating the recoverability of Goodwill, the Company performs a discounted cash flow analysis of the Company’s reporting units. The discounted cash value may be different from the fair value that would result from an actual transaction between a willing buyer and a willing seller. Such analyses are particularly sensitive to
changes in discount rates and investment rates. Changes to these rates might result in material changes in the valuation and determination of the recoverability of Goodwill. For example, an increase in the interest rate used to discount cash flows will decrease the discounted cash value. There is likely to be a similar, but not necessarily as large as, increase in the investment rate used to project the cash flows resulting from investment income earned on the Company’s investments. Accordingly, an increase in the investment rate would increase the discounted cash value.
e) Estimated rate used to discount the ultimate estimated liability to a present value.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a one-percentage point decrease in the Company’s estimated discount rate would increase the pension benefit obligation at December 31, 2008 by $52.9 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2008 by $44.8 million. A one-percentage point decrease in the Company’s estimated long-term rate of return on plan assets would increase the pension expense for the year ended December 31, 2008 by $3.6 million, while a one-percentage point increase in the rate would decrease pension expense by $3.6 million for the same period.
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. To limit its exposures to catastrophic events, the Company maintains various primary catastrophe reinsurance programs for its property and casualty insurance businesses. Coverage for each primary catastrophe reinsurance program is provided in various layers (see Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for further discussion of these programs). In addition to these programs, the Company purchases reinsurance from the FHCF for hurricane losses in Florida at retentions lower than those described below for the Company’s primary catastrophe reinsurance programs.
Catastrophe reinsurance premiums for the Company’s primary reinsurance programs and the FHCF reduced earned premiums for the years ended December 31, 2008, 2007 and 2006, by the following:
Total catastrophe losses and LAE (including development), net of reinsurance recoveries, reported in continuing operations were $144.9 million, $39.4 million and $56.9 million for the years ended December 31, 2008, 2007 and 2006, respectively. The Company reported the following catastrophe reserve development: adverse $4.8 million, favorable $4.6 million and adverse $4.0 million in 2008, 2007 and 2006, respectively. Catastrophe losses and LAE (including development), net of reinsurance recoveries, for the years ended December 31, 2008, 2007 and 2006 are presented below.
In the third quarter of 2008, three major hurricanes that significantly impacted the Company (Dolly, Gustav and Ike) made landfall in the United States. A summary of the Company’s estimated losses and LAE, net of reinsurance recoveries of $65.4 million, from Hurricanes Dolly, Gustav and Ike reported in the Company’s Consolidated Statements of Operations for the year ended December 31, 2008 by business segment were:
the reserve setting process. A change in any one or more of these factors is likely to result in an ultimate net claim cost different from the estimated reserve. The Company’s estimates of indirect losses from residual market assessments are based on a variety of factors including, but not limited to, actual or estimated assessments provided by or received from the assessing entity, insurance industry estimates of losses, and estimates of the Company’s market share in the assessable states. Actual assessments may differ materially from these estimated amounts.
Homeowners insurance incurred losses and LAE increased due primarily to higher catastrophe losses and LAE and to a lesser extent the impact of lower favorable loss and LAE reserve development, due largely to lower favorable catastrophe loss and LAE reserve development. Catastrophe losses and LAE (excluding development) on homeowners insurance were $90.4 million for the year ended December 31, 2008, compared to $35.5 million for the same period in 2007. Catastrophe losses and LAE increased for the year ended December 31, 2008 due primarily to the aforementioned hurricanes and increased frequency and severity of wind and hail storms.
Loss and LAE reserve development on homeowners insurance had a favorable effect of $13.5 million (including favorable development of $5.2 million for catastrophes) for the year ended December 31, 2008, compared to a favorable effect of $22.5 million (including favorable development of $10.6 million for catastrophes) in 2007.
Other personal insurance incurred losses and LAE increased due primarily to higher catastrophe losses and LAE and unfavorable loss and LAE development, compared to favorable loss and LAE development in 2007. Catastrophe losses and LAE (including development) on other personal insurance were $3.8 million for the year ended December 31, 2008, compared to $0.6 million in 2007. Unfavorable loss and LAE reserve development on other insurance was $0.7 million for the year ended December 31, 2008, compared to $2.8 million of favorable loss and LAE development for the same period in 2007.
limited liability investment companies and limited partnerships, and lower levels of investments. The Kemper segment reported a decrease in net investment income of $3.2 million from its investments in limited liability investment companies and limited partnerships for the year ended December 31, 2007, compared to the same period in 2006.
Incurred losses and LAE increased for the year ended December 31, 2007 due primarily to higher non-catastrophe incurred losses and LAE, including the impact of lower favorable loss and LAE reserve development, partially offset by lower catastrophe losses and LAE, due largely to higher favorable catastrophe loss and LAE reserve development. Automobile insurance incurred losses and LAE increased due primarily to the impact of lower favorable loss and LAE reserve development and higher non-catastrophe losses and LAE as a percentage of earned premiums. Loss and LAE reserve development on automobile insurance had a favorable effect of $28.9 million for the year ended December 31, 2007, compared to a favorable effect of $49.1 million in 2006. Catastrophe losses and LAE (including development) on automobile insurance were $2.3 million for the year ended December 31, 2007, compared to $4.4 million in 2006. Homeowners insurance incurred losses and LAE increased due primarily to higher non-catastrophe losses and LAE, partially offset by the impact of higher favorable loss and LAE reserve development due largely to higher favorable catastrophe loss and LAE reserve development. Loss and LAE reserve development on homeowners insurance had a favorable effect of $22.5 million (including favorable development of $10.6 million for catastrophes) for the year ended December 31, 2007, compared to a favorable effect of $14.7 million (including favorable development of $0.9 million for catastrophes) in 2006. Favorable catastrophe loss and LAE reserve development for the year ended December 31, 2007 is due primarily to favorable development from catastrophes which occurred in the second half of 2006 and Hurricane Rita which occurred in 2005. Catastrophe losses and LAE (excluding development) on homeowners insurance were $35.5 million for the year ended December 31, 2007, compared to $38.4 million for the same period in 2006. Favorable loss and LAE reserve development on other insurance was $2.8 million for the year ended December 31, 2007, compared to $4.4 million for the same period in 2006.
Net Income in the Kemper segment decreased by $28.9 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to the changes in Operating Profit. The Kemper segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $26.0 million in 2007, compared to $25.6 million in 2006.
Operating Profit in the Unitrin Specialty segment decreased by $25.1 million for the year ended December 31, 2008, compared to 2007, due primarily to higher incurred losses and LAE as a percentage of earned premiums in both personal automobile insurance and commercial automobile insurance and the lower Net Investment Income. Unitrin Specialty’s incurred losses related to Hurricanes Dolly, Gustav and Ike were $1.5 million. See MD&A, “Catastrophes,” for additional information on Hurricanes Dolly, Gustav and Ike and the Company’s catastrophe reinsurance programs.
Earned Premiums in the Unitrin Specialty segment increased by $4.9 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to higher earned premiums on personal automobile insurance, partially offset by lower earned premiums on commercial automobile insurance. Personal automobile insurance earned premiums increased by $17.2 million in 2007 due primarily to higher volume, partially offset, to a lesser extent, by lower average premium rates. Commercial automobile insurance earned premiums decreased by $12.3 million in 2007, due to lower volume and lower average premium rates. Average premium rates for commercial automobile insurance decreased primarily due to a change in the mix of business from heavier weight class vehicles with higher limits of liability insurance to lighter weight vehicles with lower limits of liability insurance.
Personal automobile insurance loss and LAE as a percentage of earned premiums increased for the year ended December 31, 2007, compared to the same period in 2006, due primarily to a higher frequency of claims and lower favorable loss reserve development. Personal automobile insurance loss and LAE reserve development had a favorable effect of $4.2 million in 2007, compared to a favorable effect of $6.7 million in 2006. Commercial automobile insurance incurred losses and LAE as a percentage of earned premiums decreased in 2007 due primarily to higher favorable loss and LAE reserve development and, to a lesser extent, the change in the mix of lighter weight and heavier weight commercial vehicles insured by the Unitrin Specialty segment. Commercial automobile insurance loss and LAE reserve development had a favorable effect of $10.1 million in 2007, compared to a favorable effect of $2.2 million in 2006. Loss and LAE reserve development on certain reinsurance pools in run-off, included in other insurance, had a favorable effect of $1.0 million in 2007, compared to no reserve development in 2006.
The Unitrin Direct segment reported Operating Losses of $52.5 million and $41.2 million for the years ended December 31, 2008 and 2007, respectively. The Operating Loss increased due primarily to higher volume of insurance in the underperforming Unitrin Direct stand-alone book of business, which excludes business from the Merastar acquisition, and lower Net Investment Income.
On August 29, 2008, Unitrin’s subsidiary, Trinity, entered into a definitive agreement to acquire Direct Response in a cash transaction initially valued at approximately $220 million, subject to certain purchase price adjustments. Such purchase price adjustments are currently estimated to reduce the purchase price to approximately $200 million. Except for one approval yet to be received from a state insurance regulator, the Company has received all federal and state regulatory approvals necessary to close the transaction. The Company anticipates closing the transaction in the first quarter of 2009, subject to timely approval by such insurance regulator and the satisfaction of other customary closing conditions. Direct Response specializes in the sale of personal automobile insurance through direct mail and the Internet through web insurance portals and its own websites, response.com and teachers.com. The results for Direct Response will be included in the Unitrin Direct business segment from the date of acquisition. Direct Response had earned premiums of approximately $153 million for the year ended December 31, 2008. The Company intends to consolidate its back office operations with those of Direct Response to further improve Unitrin Direct’s operating scale over time.
Earned Premiums in the Unitrin Direct segment increased by $32.9 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to the June 29, 2007 acquisition of Merastar and higher volume from direct marketing initiatives. Earned Premiums in the Unitrin Direct segment for the year ended December 31, 2008 included earned premiums of $45.6 million from Merastar, compared to $22.5 million for the year ended December 31, 2007. See Note 3, “Acquisitions of Businesses,” to the Consolidated Financial Statements for additional information pertaining to the acquisition of Merastar.
Net Investment Income decreased by $4.3 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to lower net investment income from certain investments in limited liability investment companies and limited partnerships which the Company accounts for under the equity method of accounting, partially offset by higher levels of investments allocated to the Unitrin Direct segment, due in part to the acquisition of Merastar. The Unitrin Direct segment reported a net investment loss of $4.4 million from these investments for the year ended December 31, 2008, compared to net investment income of $0.5 million for the same period in 2007.
Losses and LAE as a percentage of earned premiums for Unitrin Direct’s stand-alone book of business increased from 85.5% for the year ended December 31, 2007 to 86.7% for the year ended December 31, 2008 due primarily to increased severity of automobile liability insurance losses, inadequate rates and higher catastrophe losses and LAE, partially offset by the impact of lower adverse loss and LAE reserve development (which recognizes changes in estimates of prior year reserves in the current period). Losses and LAE as a percentage of earned premiums for the Merastar book of business decreased from 80.6% for the year ended December 31, 2007 to 75.4% for the year ended December 31, 2008 due primarily to higher favorable loss and LAE development, partially offset by higher catastrophe losses and LAE. Adverse loss and LAE reserve development for the Unitrin Direct stand-alone book of business was $5.8 million for the year ended December 31, 2008, compared to adverse development of $6.9 million for the same period in 2007. Favorable development for the Merastar book of business was $2.6 million for the year ended December 31, 2008, compared to favorable development of $1.4 million in the same period in 2007. See MD&A, “Critical Accounting Estimates,” for additional information pertaining to the Company’s process of estimating property and casualty insurance reserves for losses and LAE, development of property and casualty insurance losses and LAE and estimated variability of property and casualty insurance reserves for losses and LAE. Catastrophe losses and LAE for the Unitrin Direct stand-alone business were $1.3 million for the year ended December 31, 2008, compared to $0.4 million for the same period in 2007. Catastrophe losses and LAE for the Merastar book of business were $1.8 million for the year ended December 31, 2008, compared to $0.2 million in the same period in 2007. The Unitrin Direct segment’s total catastrophe losses and LAE related to Hurricanes Dolly, Gustav and Ike were $0.5 million for the year ended December 31, 2008. See MD&A, “Catastrophes,” for additional information on Hurricanes Dolly, Gustav and Ike and the Company’s catastrophe reinsurance programs.
Insurance Expenses increased by $12.5 million in 2008 due primarily to the inclusion of a full year of expenses from the Merastar acquisition, costs associated with closing redundant back office operations and higher bad debt expense related to premium receivables.
non-renewed dwelling coverage in certain coastal areas of the Gulf and southeastern United States. In the fourth quarter of 2008, the Life and Health Insurance segment halted new sales of dwelling coverage in all markets. The Life and Health Insurance segment believes that these actions have reduced its exposure to catastrophe risks and will continue to reduce its exposure to catastrophe risks over time. The Life and Health Insurance segment is also considering other actions to significantly reduce its exposure to catastrophe risks.
Catastrophe losses and LAE (including development), net of reinsurance, on property insurance were $41.5 million for the year ended December 31, 2008, compared to $10.5 million for the same period in 2007. Catastrophe losses and LAE for the year ended December 31, 2008 included $22.8 million, net of reinsurance, from Hurricanes Dolly, Gustav and Ike. Catastrophe losses for the year ended December 31, 2008 also included unfavorable development of $11.0 million due primarily to additional losses related to certain re-opened claims from Hurricane Rita. Catastrophe losses and LAE for the year ended December 31, 2007 included unfavorable development of $6.9 million, due primarily to development on Hurricanes Katrina and Rita. The Life and Health Insurance segment has a number of pending legal matters related to Hurricane Rita and could continue to report either favorable or unfavorable development in future periods depending on the resolution of these matters.
Future Policyholder Benefit reserves increased by $441.0 million due primarily to the addition of insurance reserves related to the Primesco acquisition. Property Insurance reserves increased by $11.6 million due primarily to reserves related to Hurricanes Dolly, Gustav and Ike.
Net Investment Income decreased by $0.3 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to lower yields on investments in limited liability investment companies and limited partnerships, partially offset by higher yields on investments in fixed maturities and equity securities and higher levels of investments. The Life and Health Insurance segment reported net investment income of $1.5 million from its investments in limited liability investment companies and limited partnerships for the year ended December 31, 2007, compared to net investment income of $12.5 million for the same period in 2006. Yields on equity securities in 2007 included a special $5.2 million dividend on the Company’s investment in IRI. Net Investment Income in 2006 did not include a corresponding dividend from the Company’s investment in IRI.
Operating Profit in the Life and Health Insurance segment decreased by $4.8 million for the year ended December 31, 2007, compared to the same period in 2006, due to the lower Other Income, partially offset by lower Insurance Expenses and lower Policyholders’ Benefits and Incurred Losses and LAE.
Catastrophe losses and LAE (including development), net of reinsurance recoveries, on property insurance sold by the Life and Health Insurance segment’s career agents were $10.5 million and $10.8 million in 2007 and 2006, respectively (see MD&A, “Catastrophes”). Catastrophe losses and LAE for the year ended December 31, 2007 included adverse development of $4.2 million on Hurricane Rita related to the Company’s estimate of the cost to settle certain legal matters that are not recoverable from reinsurance. Catastrophe losses and LAE for the years ended December 31, 2007 and 2006 included adverse development of $1.8 million and $4.4 million, net of reinsurance, respectively, on Hurricane Katrina.
Net Income in the Life and Health Insurance segment decreased by $4.5 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to the lower Operating Profit.
The Fireside Bank segment reported an Operating Loss of $25.3 million in 2008, compared to an Operating Loss of $66.0 million in 2007. Automobile Finance Revenues decreased by $17.9 million for the year ended December 31, 2008 compared the same period in 2007. The Provision for Loan Losses was $110.0 million in 2008, compared to $166.8 million in 2007. General and Administrative Expenses decreased by $11.4 million in 2008, compared to 2007. Operating Loss in 2008 included a charge of $9.2 million to write off goodwill (see Note 7, “Goodwill,” to the Consolidated Financial Statements).
Interest, Loan Fees and Earned Discounts in the Fireside Bank segment decreased by $13.8 million for the year ended December 31, 2008, compared to the same period in 2007, due to both lower average loans outstanding and lower average yield on the loans outstanding. The yield on loans outstanding was 18.11% at December 31, 2008, compared to 18.66% at December 31, 2007. Fireside Bank only makes loans that are
secured by automobiles. Fireside Bank has no loans outstanding that are secured by real estate. Fireside Bank does not sell or securitize any portion of its loan portfolio.
The Provision of Loan Losses for the year ended December 31, 2008 included $77.7 million for loans originated in 2008 and a $32.3 million increase in the Bank’s estimated loss expectations for loans originated in previous years. The additions to the estimated loss expectations were primarily for loans originated in 2007 and 2006 and were caused primarily by a higher level of gross charge-off and lower recovery rates due to higher levels of unemployment, lower auction prices on repossessed vehicles and negative general economic conditions. Approximately 65% of Net Automobile Loan Receivables are concentrated in the state of California. Fireside Bank’s estimated loss expectations for automobile loans originated in 2008 are lower than its current estimated loss expectations for loans originated in 2007 due in large part to the implementation of an improved risk-based-pricing and credit-scoring model in early 2008 to aid in the underwriting process. The implementation of this model resulted in the prospective elimination of certain unprofitable segments of business written in prior years. The segments of business eliminated represent in excess of 25% of the loans originated by Fireside Bank in 2007.
Effective July 1, 2008, Fireside Bank ceased the loan payment deferral program that it had begun in the fourth quarter of 2007. Under the former program, qualifying customers were allowed to move delinquent payments to the end of the loan. Loan deferrals were only available once in a twelve-month period and twice during the life of a loan and only to customers that had demonstrated a renewed ability to make their loan payments by either making three consecutive loan payments or the equivalent of three payments. Customer accounts with loan deferrals represented less than 1% of Net Automobile Loan Receivables Due at December 31, 2008.
Interest, Loan Fees and Earned Discounts in the Fireside Bank segment increased by $13.9 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to higher levels of loans outstanding, partially offset by lower yield.
General and Administrative Expenses, as a percentage of Interest, Loan Fees and Earned Discounts, increased from 38.7% for the year ended December 31, 2006, to 42.0% for the year ended December 31, 2007, due primarily to an increase in the number of collectors and higher related collection costs in 2007.
Fireside Bank reported a Net Loss of $38.8 million for the year ended December 31, 2007, compared to Net Income of $26.1 million in 2006 due to the lower operating results. Fireside Bank’s effective tax rate differs from the Federal statutory tax rate due primarily to state income taxes. State income taxes were a benefit of $6.7 million in 2007, compared to expense of $4.6 million in 2006.
compared to 2006, due primarily to the Company’s pro rata share of unrealized losses from investments recognized in operations by certain of the limited liability investment companies and limited partnerships. Dividend income from the Company’s investments in Northrop preferred and common stock decreased by $14.2 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to the conversion of the higher yielding Northrop preferred stock into Northrop common stock during 2008 and to a lesser extent the sales of the Northrop common stock throughout the year and the timing of the Northrop preferred stock ex-dividend dates in 2007. Dividend income from the Company’s investment in Northrop preferred stock increased by $6.2 million for year ended December 31, 2007, compared to the same period in 2006, due to the timing of ex-dividend dates. Dividend income from other equity securities increased by $6.8 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to a special dividend of $5.2 million from the Company’s equity investment in IRI. The Company cannot anticipate when or if similar dividends from its equity investments in IRI may occur in the future. Short-term investment income increased by $6.8 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to higher levels of short-term investments. The Company invested the proceeds from the issuance of its 6.00% senior notes in short-term investments until the principal on its 5.75% senior notes was repaid in the third quarter of 2007 (see Note 9, “Notes Payable,” to the Consolidated Financial Statements.
Net Comprehensive Investment Gains (Losses) are comprised of realized investment gains and losses reported in the Statement of Operations and unrealized investment gains and losses that are not reported in the Statement of Operations, but rather are reported in the Statement of Comprehensive Income (Loss). The components of Net Comprehensive Investment Gains (Losses) for the years ended December 31, 2008, 2007 and 2006 were:
Total Comprehensive Investment Gains (Losses) for the year ended December 31, 2008 included unrealized losses of $593.6 million before tax and foreign currency translation adjustments on investments of $2.0 million before tax. The unrealized losses on Northrop Preferred and Common Stock and Other Equity Securities were due primarily to the overall decline in the stock market in the fourth quarter of 2008. Total Comprehensive Investment Gains (Losses) for the year ended December 31, 2008 include realized gains on dispositions of $127.4 million and realized losses on dispositions of $66.2 million.
Poor’s; a rating of Aaa, Aa, A or Baa from Moody’s; or a rating from the NAIC of 1 or 2. The Company has not made significant investments in securities that are directly or indirectly related to sub-prime mortgage loans including, but not limited to, collateralized debt obligations and structured investment vehicles.
The following table summarizes the fair value of the Company’s investments in Fixed Maturities by industry at December 31, 2008 and 2007:
The following table summarizes the fair value of the Company’s ten largest investment exposures at December 31, 2008:
The Company had $286.4 million invested in various limited liability investment companies and limited partnerships at December 31, 2008, of which $44.1 million was included in the Company’s Investments in Other Equity Securities and $242.3 million was included in Other Investments. As limited liability investment companies and limited partnerships, these entities are required to follow certain specialized industry accounting which requires that unrealized gains and losses be reported in their statements of operations. The Company is required to account for some of its investments in these entities, namely those entities in which the Company’s interest is not deemed minor, under the equity method of accounting. This specialized accounting requiring income or loss recognition, as the case may be, of unrealized gains and losses, along with the requirement to account for some of these investments under the equity method of accounting, adds a degree of volatility to the Company’s net investment income. The Company had ownership interests totaling $132.3 million in such entities sponsored by Tennenbaum Capital Partners, LLC (“TCP”) included in Other Investments at December 31, 2008. The Company also had a $10.0 million unfunded, future capital commitment to these TCP-sponsored entities to fund future investments at December 31, 2008. Such capital commitment was funded in January of 2009. The Company’s Investments in Fixed Maturities included an investment of $64.7 million in two redeemable, auction rate preferred stocks, rated AA by S&P and issued by one of the TCP-sponsored entities at December 31, 2008. The Company owns no other auction rate preferred stocks. TCP is a private investment firm that specializes in investing in companies undergoing change due to industry trends, economic cycles or specific company circumstances. As such, the TCP-sponsored entities in which the Company invests employ a long-term investment strategy focused on opportunities investments that may include holdings in illiquid securities such as distressed debt or leveraged loans. From time to time, the Company may also invest directly in some of the companies in which the TCP sponsored entities invest. Such direct investments had a fair value of $36.1 million at December 31, 2008. Goldman Sachs Group, Inc. (“Goldman Sachs”), a bank holding company and a leading global investment banking, securities and investment management firm, sponsors certain limited partnerships in
The Company’s Investments in Fixed Maturities included investments in the obligations of 46 states, and municipalities and political subdivisions thereof, with a fair value of $1,308.5 million at December 31, 2008, of which $1,264.2 million are callable prior to their maturity at or above par. Certain states provide premium tax incentives to insurance companies that invest in their states. The Company has large investment concentrations in Louisiana and Georgia, in particular, as a result of premium tax incentives.
The Company does not directly participate, as either a lender or borrower of securities, in any securities lending program. The Company does not participate directly in credit default swaps. The Company does not engage directly in hedging activities including, but not limited to, activities involving interest rate swaps, forward foreign currency contracts, commodities contracts, exchange traded and over-the-counter options or warrants. The Company has limited exposure to such programs and activities by virtue of its investments in Highbridge Capital LP (“Highbridge”).
November 21, 2008, the general partner notified the Company that the general partner was imposing a restriction on the redemption of certain assets representing 70% of the Company’s investment in Highbridge and that such assets would not be redeemed currently, but rather would be redeemed over several periods.
In addition, at December 31, 2008 the Company has unfunded commitments of $67.1 million for investments in limited liability investment companies and limited partnerships that are not accounted for under the equity method of accounting.
Interest and Other Expenses was $58.5 million, $66.9 million and $62.5 million in 2008, 2007 and 2006, respectively. Interest expense, excluding interest on a mortgage note payable included in real estate investment expense, was $32.2 million, $33.2 million and $28.5 million in 2008, 2007 and 2006, respectively. Interest expense increased in 2007 due primarily to higher levels of debt outstanding resulting from the issuance of the Company’s 6.00% senior notes due May 15, 2017 (the “6.00% Senior Notes”), partially offset by repayment of the Company’s 5.75% senior notes due July 1, 2007 (the “5.75% Senior Notes”). Other Corporate Expenses were $26.3 million, $33.7 million and $34.0 million in 2008, 2007 and 2006, respectively. Other Corporate Expenses decreased by $7.4 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to lower compensation and employee benefit costs.
At December 31, 2008, there were approximately 1.4 million shares of the Company’s outstanding common stock that could be repurchased under the Company’s outstanding repurchase authorization. Common stock may be repurchased in the open market or in privately negotiated transactions from time to time subject to market conditions and other factors. The Company repurchased and retired 2,045,100 shares of its common stock in 2008 at a cost of $69.0 million. The Company repurchased and retired 3,042,100 shares of its common stock in 2007 at a cost of $139.5 million. The Company has repurchased and retired approximately 62.8 million shares of its common stock in open market transactions at an aggregate cost of approximately $1.8 billion since 1990.
On May 11, 2007, the Company issued $360 million of its 6.00% Senior Notes due May 15, 2017 for an effective yield of 6.19%. The 6.00% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Company’s option at specified redemption prices. The Company used the proceeds from the sale of the notes to repay the $300 million principal aggregate amount of its 5.75% Senior Notes which were due on July 1, 2007 and for general corporate purposes. Interest expense under the 6.00% Senior Notes was $22.0 million and $14.1 million for the years ended December 31, 2008 and 2007, respectively.
In 2002, the Company issued $300 million of its 5.75% Senior Notes for an effective yield of 5.99%. The 5.75% Senior Notes were retired in 2007. Interest expense under the 5.75% Senior Notes was $9.0 million and $18.0 million for the years ended December 31, 2007 and 2006, respectively.
Unitrin does not anticipate making significant changes to its capital structure in 2009. Sources available for future shareholder dividend payments, capital contributions to subsidiaries, income tax payments and the payment of interest on Unitrin’s senior notes include the receipt of dividends from Unitrin’s subsidiaries and borrowings under Unitrin’s revolving credit agreement. Various state insurance laws restrict the ability of Unitrin’s insurance subsidiaries to pay dividends without regulatory approval. Such insurance laws generally
restrict the amount of dividends paid in an annual period to the greater of statutory net income from the previous year or 10% of statutory capital and surplus. Unitrin’s direct insurance subsidiaries paid dividends consisting of $84.2 million in cash and 819,159 shares of Northrop common stock with a fair value of $51.0 million to Unitrin during 2008. In 2009, Unitrin estimates that its direct insurance subsidiaries would be able to pay $120 million in dividends to Unitrin without prior regulatory approval. Fireside Bank has agreed not to pay dividends without the prior approval of the FDIC and CDFI. The Company does not expect Fireside Bank to pay a dividend in 2009.
On April 1, 2008, the Company completed its acquisition of Primesco in a cash merger transaction valued at $95.5 million, including transaction costs of $0.2 million. The Company funded the acquisition primarily through borrowings under its revolving credit agreement which were repaid during the third quarter of 2008.
On August 29, 2008 Unitrin’s subsidiary, Trinity, entered into a definitive agreement to acquire Direct Response in a cash transaction initially valued at approximately $220 million, subject to certain purchase price adjustments. Such purchase price adjustments are currently estimated to reduce the purchase price to approximately $200 million. At December 31, 2008 Trinity maintained cash and short-term investments sufficient to fund the acquisition price. Except for one approval yet to be received from a state insurance regulator, the Company has received all federal and state regulatory approvals necessary to close the transaction. The Company anticipates closing the transaction in the first quarter of 2009, subject to timely approval by such insurance regulator and the satisfaction of other customary closing conditions. Unitrin made a capital contribution of $65.0 million to Trinity during the fourth quarter of 2008. Unitrin may make an additional capital contribution to Trinity in 2009 to maintain Trinity’s risk-based capital at appropriate levels considering the addition of the Direct Response business. Unitrin would likely fund such a contribution through borrowings under its revolving credit agreement or the receipt of dividends from its other insurance subsidiaries. The amount of such contribution, if any, is dependent on Trinity’s operating and investment results in 2009.
The primary sources of funds for Fireside Bank are customer deposits, repayments of automobile loans, interest on automobile loans and investment income. The primary uses of funds by Fireside Bank are automobile loans made to consumers, repayment of customer deposits, interest paid to depositors and general expenses.
Net Cash Provided by Operating Activities decreased by $182.9 million for the year ended December 31, 2008, compared to the same period in 2007, due primarily to the lower operating results. Net Cash Provided by Operating Activities decreased by $54.3 million for the year ended December 31, 2007, compared to the same period in 2006, due primarily to higher property and casualty claims paid.
Net Cash Used by Financing Activities increased by $263.1 million for the year ended December 31, 2008, compared to the same period in 2007. During 2008, the Company borrowed and repaid $232.0 million under its revolving credit agreement. During the second quarter of 2007, the Company issued its $360 million senior secured notes for net proceeds of $354.8 million. The Company repaid its $300 million senior secured notes in the third quarter of 2007. The Company funds its Automobile Loan Receivables through the issuance of Certificates of Deposit. Automobile Loan Receivables declined by $134.9 million in 2008. Net cash used by Certificates of Deposits withdrawals, net of Certificates of Deposits issued, was $163.5 million for the year ended December 31, 2008, compared to net cash provided of $111.6 million for the same period in 2007. The Company used $69.0 million of cash during 2008 to repurchase shares of its common stock, compared to $139.5 million of cash used to repurchase shares of its common stock for the same period in 2007.
exceeded Sales of Fixed maturities by $237.6 million in 2008, while Sales and Maturities of Fixed Maturities exceeded purchases of fixed maturities by $179.0 million in 2007. Net cash provided by dispositions of short-term investments was $132.3 million for the year ended December 31, 2008, compared to net cash used to acquire short-term investments of $184.0 million for the same period in 2007. Cash used to acquire investments in limited liability investment companies and limited partnerships decreased by $17.9 million in 2008, compared to 2007. Automobile Loan Originations decreased by $247.2 million in 2008, compared to 2007. The repayment of automobile loan receivables decreased by $72.8 million in 2008, compared to 2007. Cash provided by sales of Northrop common stock increased by $292.3 million in 2008, compared to 2007, as the Company reduced its risk to further declines in the stock market in 2008. Cash received from dispositions of other equity securities, net of cash paid to acquire other equity securities was $169.5 million in 2008, compared to net cash paid to acquire other equity securities, net of cash received from dispositions, of $29.0 million in 2007, as the Company reduced its risk to further declines in the stock market in 2008. The Company received proceeds of $68.8 million related to the disposition of its Unitrin Business Insurance operations in 2008. The Company used $95.4 million of cash to acquire businesses in 2008, compared to $46.9 million in 2007.
Net Cash Used by Investing Activities increased by $136.8 million for the year ended December 31, 2007, compared to the same period in 2006. Net cash used to acquire short-term investments was $184.0 million in 2007, compared to net cash provided by sales of short-term investments of $63.3 million in 2006. The Company used $46.9 million of cash to fund the acquisition of Merastar in 2007. Purchases of other equity securities, net of cash received from dispositions of other equity securities was $29.0 million in 2007, compared to $85.6 million in 2006. Cash used to acquire investments in limited liability investment companies and limited partnerships increased by $32.2 million in 2007. The acquisition of automobile loan receivables, net of automobile loans repaid, used $30.2 million less cash in 2007, compared to 2006. Cash provided by the sales and maturities of fixed maturities, net of purchases, decreased by $25.4 million. Sales of Northrop Common Stock provided $114.5 million more cash in 2007 than in 2006.
Cash increased by $79.7 million from December 31, 2007 to December 31, 2008, due primarily to cash provided by operating activities. Cash decreased by $53.4 million from December 31, 2006 to December 31, 2007. At the end of 2006, the Company temporarily did not fully invest its available funds due primarily to the implementation of certain premium tax strategies. The Company implemented similar premium tax strategies at the end of 2007, while maintaining a lower level of cash.
Amounts included in Life and Health Insurance Policy Benefits within the contractual obligations table above represent the estimated cash payments to be made to policyholders and beneficiaries. Such cash outflows are based on the Company’s current assumptions for mortality, morbidity and policy lapse, but are undiscounted with respect to interest. Policies must remain in force for the policyholder or beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. The Company estimates that future cash inflows would total $4.6 billion using the same assumptions used to estimate the cash outflows.
The contractual obligations reported above also exclude the Company’s liability of $17.0 million for unrecognized tax benefits. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability.
FIN 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109;
FSP SFAS 142-3, Determination of the Useful Life of Intangible Assets.
Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006
The Consolidated Financial Statements included herein have been prepared on the basis of GAAP and include the accounts of Unitrin, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
The process of estimating and establishing reserves for losses and LAE for property and casualty insurance is inherently uncertain and the actual ultimate net cost of a claim may vary materially from the estimated amount reserved. The reserving process is particularly imprecise for claims involving asbestos, environmental matters, mold, construction defect and other emerging and/or long-tailed exposures, which may not be discovered or reported until years after the insurance policy period has ended. Management considers a variety of factors including, but not limited to, past claims experience, current claim trends and relevant legal, economic and social conditions, in estimating reserves. A change in any one or more factors is likely to result in the ultimate net claim cost to differ from the estimated reserve. Such changes in estimates may be material.
Investments in Fixed Maturities include bonds, notes and redeemable preferred stocks at fair value and are classified as available for sale. Investments in Other Equity Securities include common and non-redeemable preferred stocks and other equity interests at fair value and are classified as available for sale. Other equity interests consist of limited partnership interests in partnerships which the Company’s interest is deemed minor under applicable accounting standards. Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities and equity securities is reported in Accumulated Other Comprehensive Income (Loss) included in Shareholders’ Equity. Short-term Investments include fixed maturities that mature within one year from the date of purchase, money market mutual funds, Federal funds sold and repurchase agreements at cost, which approximates fair value. Other Investments primarily include loans to policyholders, real estate, investments in certain limited liability investment companies and limited partnerships and mortgage loans. Loans to policyholders and mortgage loans are carried at unpaid principal balance. Real estate is carried at cost, net of accumulated depreciation. Investments in limited liability investment companies and limited partnerships in which the Company’s interest is not deemed minor under applicable accounting standards are accounted for under the equity method of accounting. Gains and losses on sales of investments are computed on the specific identification method and are reported in the Consolidated Statements of Operations in the period in which the sales occur. The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Losses arising from other than temporary declines in fair value are computed on the specific identification method and reported in the Consolidated Statements of Operations in the period that the decline is determined to be other than temporary.
Automobile Loan Receivables consists primarily of sub-prime loans to residents of California and other western and midwestern states. Automobile Loan Receivables is stated net of unearned discount, deferred loan fees and costs and reserve for loan losses. Unearned discount arises when the loan amount includes unearned pre-computed interest. The Reserve for Loan Losses is maintained at a level that considers such factors as actual and expected loan loss experience and economic conditions to provide for estimated loan losses. Additions to the Reserve for Loan Losses are charged to expense. Actual loan losses or recoveries are charged or added, respectively as the case may be, to the Reserve for Loan Losses when incurred or received.
products are primarily amortized over the anticipated premium-paying period of the related policies in proportion to the ratio of the annual premiums to the total premiums anticipated, which is estimated using the same assumptions used in calculating policy reserves.
The Company accounts for Goodwill pursuant to the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Accordingly, Goodwill is not amortized, but rather is tested annually for recoverability or when certain triggering events require testing. The Company tests Goodwill in the first quarter of its fiscal year. In 2008, the Company determined that the Goodwill related to its investment in Fireside Bank was impaired and wrote off $9.2 million of Goodwill. See Note 7, “Goodwill” to the Consolidated Financial Statements.
Reserves for losses and LAE on property and casualty coverage represent the estimated claim cost and loss adjustment expense necessary to cover the ultimate net cost of investigating and settling all losses incurred and unpaid. Such estimates are based on individual case estimates for reported claims and estimates for incurred but not reported losses. These estimates are adjusted in the aggregate for ultimate loss expectations based on historical experience patterns and current economic trends, with any change in the probable ultimate liabilities being reported in the Consolidated Statements of Operations in the period of change. Such changes in estimates may be material.
Premium revenues for universal life-type products consist of charges for the cost of insurance, policy administration and policy surrenders that have been assessed against policy account balances during the period.
In the normal course of business, Unitrin’s insurance subsidiaries reinsure certain risks above certain retention levels with other insurance enterprises. Amounts recoverable from reinsurers for benefits and losses for which Unitrin’s insurance subsidiaries have not been relieved of their legal obligations to the policyholder are included in Other Receivables.
The Company accounts for uncertain tax positions in accordance with FIN 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109. Accordingly, the Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
Awards under the Company’s stock-based compensation plans are accounted for under the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment.
The following individual line items in the Consolidated Statement of Operations for the year ended December 31, 2008 were affected by the change in accounting principle:
The following individual line items in the Consolidated Statements of Cash Flows for years the years ended December 31, 2008, 2007 and 2006 were affected by the change in accounting principle:
During 2008, 2007 and 2006, the following accounting guidance relevant to the Company has been issued by the FASB, and/or became effective.
Accordingly, the Company recognized its pro rata share of the effect of Intermec’s adoption of FIN 48 in the Company’s consolidated financial statements in the second quarter of 2007. Based on Intermec’s disclosure in its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007, the impact of Intermec’s initial application of FIN 48 resulted in the Company recognizing a reduction in the Company’s Shareholders’ Equity of $0.9 million, which was net of a tax benefit of $0.5 million.
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 GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements. On January 1, 2008, the Company adopted SFAS No. 157. The initial application of SFAS No. 157 did not have a material effect on the fair values reported by the Company. The additional disclosures required by SFAS No. 157 are presented in Note 22, “Fair Value Measurements.” On October 10, 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP SFAS No. 157-3 does not change the fair value measurement principles in SFAS No. 157, but rather provides guidance of the application of those measurement principles in the extreme inactive markets that currently exist.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 amends SFAS No. 87, Employers’ Accounting for Pensions, SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and Termination Benefits, SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions, and SFAS No. 132(R), Employers’ Disclosure about Pensions and Other Postretirement Benefits. SFAS No. 158 requires the recognition of the funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in the statement of financial position and the recognition of changes in the funded status through comprehensive income in the year in which such changes occur. The Company adopted the recognition provisions of SFAS No. 158 and initially applied them to the funded status of the Company’s defined benefit postretirement plans and provided the required disclosures as of December 31, 2006. The initial recognition of the funded status of the Company’s defined benefit postretirement plans resulted in a decrease in Shareholders’ Equity of $7.3 million, which was net of a tax benefit of $5.5 million. The Company’s investee, Intermec, recognized the financial impact of SFAS No. 158 in its financial statements at December 31, 2006. The Company accounts for its investment in Intermec under the equity method of accounting on a three-month-delay basis. Accordingly, the Company recognized a decrease of $2.3 million, which was net of a tax benefit of $1.3 million, to its Shareholders’ Equity in the first quarter of 2007 for its pro rata share of the impact of Intermec’s adoption of SFAS No. 158.
nature and financial effects of the business combination. The Company is required to apply SFAS No. 141(R) prospectively to business combinations occurring on or after January 1, 2009.
In April 2008, the FASB issued FSP SFAS 142-3, Determination of the Useful Life of Intangible Assets. FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. Previously, under the provisions of SFAS No. 142, an entity was precluded from using its own assumptions about renewal or extension of an arrangement where there was likely to be substantial cost or material modifications. FSP SFAS 142-3 removes the requirement of SFAS No. 142 for an entity to consider whether an intangible asset can be renewed without substantial cost or material modification to the existing terms and conditions and requires an entity to consider its own experience in renewing similar arrangements. FSP SFAS 142-3 also increases the disclosure requirements for a recognized intangible asset to enable a user of financial statements to assess the extent to which the expected future cash flows associated with the asset are affected by the entity’s intent or ability to renew or extend the arrangement. FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. Early adoption is prohibited. The guidance for determining the useful life of a recognized intangible asset is applied prospectively to intangible assets acquired after the effective date. Accordingly, the Company does not anticipate that the initial application of FSP SFAS No. 142-3 will have an impact on the Company. The disclosure requirements must be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date.
In May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60. SFAS No. 163 clarifies how SFAS No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts (“GIC’s”), including the recognition and measurement of premium revenue and claim liabilities and requires expanded disclosures about GIC’s. SFAS No. 163 does not apply to a GIC that is accounted for as a derivative instrument within the scope of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Except for certain disclosure requirements regarding insurance enterprise risk-management activities, SFAS No. 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and all interim periods within those fiscal years. Early adoption is generally not permitted. The Company estimates that the initial application of SFAS No. 163 will not be material.
In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-6-1 concluded that all outstanding share-based payment awards that contain a right to receive nonforfeitable dividends participate in the undistributed earnings with common shareholders, and therefore, the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share, pursuant to SFAS No. 128, Earnings per Share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. Early adoption is prohibited. Upon adoption, all prior-period earnings per share data presented must be adjusted retrospectively to conform to FSP EITF 03-6-1. The Company estimates that its Basic Net Income per Share from Continuing Operations will decrease by no more than $0.01 per common share on an annual basis on the initial and retrospective application of FSP EITF 03-6-1.
The Company has not yet completed the process of estimating the fair value of the value of Insurance In Force acquired and Insurance Reserves assumed. The Company expects to complete this process and finalize the allocation of the purchase price by March 31, 2009. Based on the Company’s preliminary allocation of the purchase price, assets acquired and liabilities assumed at the date of acquisition of Primesco were:
On June 29, 2007, Trinity, a subsidiary of Unitrin, acquired Merastar in a cash transaction for a total purchase price of $47.9 million, including transaction costs of $0.7 million. Beginning with the Company’s third quarter of
2007, the results of the acquisition have been included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Unitrin Direct segment. Merastar provides automobile and homeowners insurance and is licensed in 48 states.
The Company accounts for its Unitrin Business Insurance operations as discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets. On June 3, 2008, the Company completed its previously disclosed sale of its Unitrin Business Insurance operations to AmTrust for total consideration of $101.8 million. Total consideration consisted of cash, other receivables of $10.9 million, with an outstanding balance of $0.7 million at December 31, 2008, and a note receivable from AmTrust valued at $25.1 million. The note receivable is payable in four equal annual installments of $7.5 million and is non-interest bearing. Net proceeds were $94.5 million, including $7.3 million of early contract termination fees and other transaction related costs. AmTrust acquired the renewal rights to the Unitrin Business Insurance book of business, certain legal entities, selected other assets, and the workforce that the Company employed to underwrite and process its Unitrin Business Insurance products. The Company retained Property and Casualty Insurance Reserves for unpaid insured losses that occurred prior to June 1, 2008, the effective date of the sale. In accordance with SFAS No. 144, the Company is not permitted to report these liabilities as Liabilities of Discontinued Operations. Accordingly, Property and Casualty Insurance Reserves as reported in the Company’s Consolidated Balance Sheets at December 31, 2008 and December 31, 2007 include $261.1 million and $342.2 million, respectively, for unpaid insured losses and LAE incurred by Unitrin Business Insurance. However, pursuant to the provisions of SFAS No. 144, changes in the Company’s estimate of such retained liabilities after the sale are reported as a separate component of the results of discontinued operations.
Summary financial information included in Income from Discontinued Operations before Income Taxes for the years ended December 31, 2008, 2007 and 2006, are presented below:
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2008 by contractual maturity were:
f) Debt-like characteristics of perpetual preferred stocks and issuer ratings; and
g) The Company’s intentions to sell or ability to hold the investments.
The vast majority of the Company’s equity securities at December 31, 2008 are perpetual preferred stocks of financial institutions. The Company considers the debt-like characteristics of these perpetual preferred stocks when evaluating impairment. The Company concluded that the declines in the fair values of the perpetual preferred stocks of these financial institutions were temporary in nature, largely driven by current market conditions, and since the Company intends to hold the securities until recovery, no impairments are necessary. Based on evaluations of factors above at December 31, 2008 and 2007, the Company concluded that the declines in the fair values of the Company’s investments in equity securities presented on the preceding page were temporary at the respective evaluation dates.
The carrying value, fair value and approximate voting percentage for the Company’s investment in the common stock of Intermec, which is accounted for under the equity method of accounting and reported as Investment in Investee in the Company’s Consolidated Balance Sheets at December 31, 2008 and 2007 were:
The carrying values of the Company’s Other Investments at December 31, 2008 and 2007 were:
The components of Automobile Loan Receivables at December 31, 2008 and 2007 were:
An aging of Net Automobile Loan Receivables Outstanding at December 31, 2008 and 2007 is presented below:
The Company tests goodwill for recoverability on an annual basis in the first quarter and between annual tests if circumstances or events indicate that the fair value of a reporting unit may have declined below its carrying value. The quoted value of Unitrin’s common stock was significantly below the per share carrying value of the Company at December 31, 2008. Accordingly, the Company tested goodwill for each of its reporting units for recoverability at December 31, 2008. The Company used discounted projections of future cash flows to estimate fair value of all reporting units except for Fireside Bank. In November 2008, the Company disclosed that it was pursuing strategic alternatives for Fireside Bank. In connection with its assessments of such strategic alternatives, the estimated fair value for Fireside Bank was based on discussions with and inquiries from third parties as well as the Company’s own projections. For each reporting unit tested, except for Fireside Bank, the estimated fair value exceeded the carrying value of the reporting unit, and the Company concluded that the goodwill was recoverable. In the case of Fireside Bank, the carrying value exceeded the estimated fair value. Accordingly, pursuant to the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, the Company was required to compute the implied fair value of Fireside Bank’s goodwill and compare it with carried goodwill to determine if goodwill was impaired at December 31, 2008. Pursuant
to SFAS No. 142, the implied fair value of goodwill is computed by allocating the estimated fair value of reporting unit to its assets and liabilities as if the reporting unit had been acquired in a business combination on the goodwill measurement date. Based on such allocation, the Company concluded that the Company’s carrying value of goodwill for Fireside Bank exceeded the implied fair value of goodwill and that goodwill associated with Fireside Bank was impaired. Accordingly, the Company wrote off the entire carrying value of Goodwill for Fireside Bank.
Goodwill for the Life and Health Insurance segment increased in 2008 by $29.1 million due to the acquisition of Primesco. See Note 3, “Acquisitions of Businesses,” for additional information pertaining to the acquisition of Primesco.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2008, 2007 and 2006 was:
Property and Casualty Insurance Reserves are estimated based on historical experience patterns and current economic trends. Actual loss experience and loss trends are likely to differ from these historical experience patterns and economic conditions. Loss experience and loss trends emerge over several years from the dates of loss inception. The Company monitors such emerging loss trends. Upon concluding, based on the data available, that an emerging loss trend will continue, the Company adjusts its property and casualty insurance reserves to recognize such trend. Changes in such estimates are included in the Consolidated Statements of Operations in the period of change.
In 2008, the Company reduced its property and casualty insurance reserves by $79.3 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance losses and LAE reserves developed favorably by $45.8 million and commercial lines insurance losses and LAE reserves developed favorably by $33.5 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2006 and 2005 accident years due to the improvements in the Company’s claims handling procedures, partially offset by adverse development of $8.9 million related to certain re-opened claims from Hurricane Rita in the 2005 accident year. The commercial lines insurance losses and LAE reserves developed favorably primarily in the Company’s discontinued operations. During the fourth quarter of 2008, the Company’s actuaries conducted their regular reserve review of retained insurance reserves of discontinued operations for all traditional reserving groups. In addition, the Company’s actuaries updated certain commercial property and liability analyses using A.M Best’s latest industry study to re-estimate asbestos and environmental liabilities and a more detail review by peril of other general liabilities, including construction defect liabilities. These additional procedures, along with the actuaries’ regular reserve reviews during 2008, resulted in favorable reserve development of $29.7 million.
In 2007, the Company reduced its property and casualty insurance reserves by $101.1 million to record favorable development of losses and LAE from prior accident years. Personal lines insurance losses and LAE and commercial lines insurance losses and LAE developed favorably by $44.4 million and $56.7 million, respectively, in 2007. The reserve reductions were primarily due to the emergence of more favorable loss trends than expected for the 2006, 2005 and 2004 accident years, partially due to the improvements in the Company’s claims handling procedures.
Interest Paid, including facility fees, for the years ended December 31, 2008, 2007 and 2006 was:
purposes. The Company had no outstanding advances under its unsecured revolving credit agreements at December 31, 2008 and 2007. Undrawn letters of credit issued pursuant to the unsecured, revolving credit agreement were $13.1 million at both December 31, 2008 and 2007. Accordingly, the amounts available for future borrowing were $311.9 million at both December 31, 2008 and 2007.
On May 11, 2007, the Company issued $360 million of its 6.00% Senior Notes due May 15, 2017. The 6.00% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Company’s option at specified redemption prices. The Company issued the 6.00% Senior Notes for proceeds of $354.8 million, net of transaction costs, for an effective yield of 6.19%. The Company used a portion of the proceeds from the sale of the 6.00% Senior Notes to repay the $300 million aggregate principal amount of its 5.75% Senior Notes which matured on July 1, 2007.
In 2003, the Company issued $200 million of its 4.875% Senior Notes due November 1, 2010 for an effective yield of 5.04%. The 4.875% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Company’s option at specified redemption prices.
Net rental expense for operating leases for the years ended December 31, 2008, 2007 and 2006 was:
Future minimum lease payments under operating leases at December 31, 2008 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $1.0 million at December 31, 2008. Capital leases are not material.
At December 31, 2008, there are approximately 1.4 million shares of the Company’s outstanding common stock that can be repurchased under the outstanding repurchase authorization of the Company’s Board of Directors. Common stock can be repurchased in the open market or in privately negotiated transactions from time to time subject to market conditions and other factors. The Company repurchased and retired 2.0 million shares of its common stock in open market transactions at an aggregate cost of $69.0 million in 2008. The Company repurchased and retired approximately 3.0 million shares of its common stock in open market transactions at an aggregate cost of $139.5 million in 2007. The Company repurchased and retired approximately 2.0 million shares of its common stock in open market transactions at an aggregate cost of $89.9 million in 2006. Common Stock, Paid-in Capital and Retained Earnings were reduced on a pro rata basis for the cost of the repurchased shares.
Unitrin has adopted a number of long-term equity-based compensation plans to attract, motivate and retain key employees and/or directors of the Company. The Company’s stock option plans provide for the grant of stock options and stock settled stock appreciation rights (“SARs”). In addition, restricted stock and restricted stock units may be granted under the Company’s 2005 Restricted Stock and Restricted Stock Unit Plan. Options outstanding and available for future grants under all of the Company’s stock option plans at December 31, 2008, are:
The Company has four stock option plans, all of which have been approved by the Company’s shareholders. Stock options to purchase the Unitrin’s common stock are granted to employees and directors at prices equal to the fair market value of Unitrin’s common stock on the date of grant. Employee options generally vest over a period of three and one-half years and expire ten years from the date of grant. The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom options are granted, the number of shares covered by such options and the exercise price, vesting and expiration dates of such options. Options are non-transferable and are exercisable in installments. Prior to 2003, only non-qualified stock options had been granted. However, beginning in 2003, non-qualified stock options granted to employees were coupled with tandem stock appreciation rights (“Tandem SARs”), settled in Unitrin common stock.
The Company’s four stock option plans include provisions, subject to certain limitations beginning in 2006 and 2009 as described below, to automatically grant restorative, or reload stock options (“Restorative Options”), to replace shares of previously owned Unitrin common stock that an exercising option holder surrenders, either actually or constructively, to satisfy the exercise price and/or tax withholding obligations relating to the exercise. Restorative Options are subject to the same terms and conditions as the original options, including the expiration date, except that the exercise price is equal to the fair market value of Unitrin common stock on the date of grant and cannot be exercised until six months after the date of grant. The grant of a Restorative Option does not result in an increase in the total number of shares and options held by an employee but changes the mix of the two.
For original awards granted beginning in 2006 and Restorative Options granted thereunder, Restorative Options will be granted only if, on the date of exercise of the option giving rise to the Restorative Option, the market price of Unitrin common stock exceeds such option’s exercise price by 15%. Further, Restorative Options will not be granted if the option giving rise to the Restorative Option is set to expire within twelve months. For original awards granted beginning in 2009, Restorative Options will not be granted upon the exercise of the original award.
Option and SAR activity for the year ended December 31, 2008 is presented below:
The weighted-average grant-date fair values of options granted during 2008, 2007 and 2006 were $4.81, $6.39 and $5.79, respectively. Total intrinsic value of stock options exercised was $0.4 million, $7.4 million and $14.3 million for the years ended December 31, 2008, 2007 and 2006, respectively. Cash received from option exercises was $1.6 million, $5.1 million and $6.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. Total tax benefits realized for tax deductions from option exercises were $0.2 million, $2.6 million and $5.2 million for the years ended December 31, 2008, 2007 and 2006, respectively.
Activity related to nonvested restricted stock for the year ended December 31, 2008 is presented below:
For awards with a graded vesting schedule, the Company recognizes compensation expense on a straight-line basis over the requisite service period for each separately vesting portion of the awards as if each award were, in-substance, multiple awards. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. Share-based compensation expense for all of the Company’s long-term equity based compensation plans was $7.4 million, $15.7 million and $11.9 million for the years ended December 31, 2008, 2007 and 2006, respectively. Total unamortized compensation expense related to nonvested awards of such plans at December 31, 2008 was $5.7 million, which is expected to be recognized over a weighted-average period of approximately 1.5 years.
Net Income (Loss) Per Share and Net Income (Loss) Per Share Assuming Dilution for the years ended December 31, 2008, 2007 and 2006 were:
Other Comprehensive Income for the years ended December 31, 2008, 2007 and 2006 was:
Net Investment Income for the years ended December 31, 2008, 2007 and 2006 was:
The components of Net Realized Investment Gains (Losses) for the years ended December 31, 2008, 2007 and 2006 were:
The components of Liabilities for Income Taxes as presented in the Consolidated Balance Sheets at December 31, 2008 and 2007 were:
Income taxes paid were $98.8 million and $116.9 million in 2008 and 2007, respectively.
Included in the balance of unrecognized tax benefits at December 31, 2008 and December 31, 2007 are tax positions of $10.6 million and $12.7 million, respectively, for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred income tax accounting, other than for interest and penalties, the disallowance of the shorter deductibility period would not affect the effective income tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. The liability for unrecognized tax benefits included accrued interest of $6.0 million and $6.8 million at December 31, 2008 and December 31, 2007, respectively. Tax benefit for the year ended December 31, 2008 includes an interest benefit of $0.8 million, which is comprised of an interest benefit of $2.5 million resulting from the expiration of the statutes of limitations referred to above, and interest expense of $1.7 million on unrecognized tax benefits for prior years. Tax expense for the year ended December 31, 2007 includes an interest benefit of $0.3 million, which is comprised of an interest benefit of $4.0 million resulting from the expiration of the statutes of limitations referred to above, and interest expense of $3.7 million on unrecognized tax benefits for prior years.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2008, 2007 and 2006 were:
The Company sponsored two qualified defined benefit pension plans in 2008 and one plan in 2007 (the “Pension Plans”) covering most of its employees. The Pension Plans are generally non-contributory, but participation in one of the Pension Plans requires or required some employees to contribute of 3% of pay, as defined, per year. Benefits for participants who are or were required to contribute to the Pension Plans are based on compensation during plan participation and the number of years of participation. Benefits for the vast majority of participants who are not required to contribute to the Pension Plans are based on years of service and final average pay, as defined. The Company funds the Pension Plans in accordance with the requirements of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).
NOTE 18. PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (Continued)
The Company estimates that Pension Expense for the year ended December 31, 2009 will include expense of $1.0 million resulting from the amortization of the related accumulated actuarial loss included in Accumulated Other Comprehensive Income (Loss) at December 31, 2008.
The measurement dates of the assets and liabilities of all plans presented above for 2008 and 2007 were December 31, 2008 and December 31, 2007, respectively.
The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation for the OPEB Plan at December 31, 2008 was 7% for 2009, gradually declining to 5% in the year 2011 and remaining at that level thereafter for medical benefits and 9% for 2009, gradually declining to 5% in the year 2013 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation for the OPEB Plan at December 31, 2007 was 8% for 2008, gradually declining to 5% in the year 2011 and remaining at that level thereafter for medical benefits and 10% for 2008, gradually declining to 5% in the year 2013 and remaining at that level thereafter for prescription drug benefits.
A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation for the OPEB Plan at December 31, 2008 by $2.3 million and 2008 OPEB expense by $0.1 million. A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation for the OPEB Plan at December 31, 2007 by $2.7 million and 2007 OPEB expense by $0.2 million.
The investment objective of the Pension Plans is to produce current income and long-term capital growth through a combination of equity and fixed income investments which, together with appropriate employer contributions and any required employee contributions, is adequate to provide for the payment of the benefit obligations of the Pension Plans. The assets of the Pension Plans may be invested in both fixed income and equity investments.
Fixed income investments may include cash and short-term instruments, U.S. Government securities, corporate bonds, mortgages and other fixed income investments. Equity investments may include various types of stock, such as large-cap, mid-cap and small-cap stocks, and may also include investments in investment companies and Unitrin common stock (subject to Section 407 and other requirements of ERISA). The Pension Plans have not invested in Unitrin common stock.
The trust investment committee for the Pension Plans periodically reviews the performance of the Pension Plans’ investments and asset allocation. Several external investment managers, one of which is Fayez Sarofim & Co. (“FS&C”), manage the equity investments of the trust for the Pension Plans. One of Unitrin’s directors, Mr. Fayez Sarofim, is Chairman of the Board, President and the majority shareholder of FS&C, a registered investment advisory firm (see Note 24, “Related Parties,” to the Consolidated Financial Statements). Each manager is allowed to exercise investment discretion, subject to limitations, if any, established by the trust investment committee for the Pension Plans. All other investment decisions are made by the Company, subject to general guidelines as set by the trust investment committee for the Pension Plans.
The components of Pension Expense for the years ended December 31, 2008, 2007 and 2006 were:
Total Pension Expense Recognized presented above includes service cost benefits earned and reported in discontinued operations of $0.7 million, $1.2 million and $1.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.
The actuarial assumptions used to develop the components of the OPEB Expense for the years ended December 31, 2008, 2007 and 2006, were:
The actuarial assumptions used to develop the components of the OPEB Accumulated Benefit Obligation at December 31, 2008 and 2007 were:
The Company also does not allocate insurance reserves from its 2002 acquisition of certain insurance companies from SCOR (see Note 8, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). It is also the Company’s management practice to allocate certain corporate expenses to its insurance operations. In accordance with SFAS No. 144, the Company is not permitted to allocate certain corporate expenses to discontinued operations. Accordingly, such amounts that the Company is not permitted to allocate to discontinued operations are reported in Other Expense, Net. The Company considers the management of certain investments, including Northrop preferred and common stock, Baker Hughes common stock and Intermec common stock, to be a corporate responsibility. Accordingly, the Company does not allocate dividend income from these investments to its operating segments. The Company does not allocate Net Realized Investment Gains (Losses) to its operating segments.
Segment Net Income for the years ended December 31, 2008, 2007 and 2006 was:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2008, 2007 and 2006 was:
Catastrophes and storms are inherent risks of the property and casualty insurance business. These catastrophic events and natural disasters include hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds and winter storms. Such events result in insured losses that are, and will continue to be, a material factor in the results of operations and financial position of the Company’s property and casualty insurance companies. Further, because the level of these insured losses occurring in any one year cannot be accurately predicted, these losses may contribute to material year-to-year fluctuations in the results of the operations and financial position of these companies. Specific types of catastrophic events are more likely to occur at certain times within the year than others. This factor adds an element of seasonality to property and casualty insurance claims. The Company has adopted the industry-wide catastrophe classifications of storms and other events promulgated by ISO to track and report losses related to catastrophes. ISO classifies a disaster as a catastrophe when the event causes $25.0 million or more in direct losses to property and affects a significant number of policyholders and insurers. ISO-classified catastrophes are assigned a unique serial number recognized throughout the insurance industry. The discussions that follow utilize ISO’s definition of catastrophes.
In the event that the Company’s incurred catastrophe losses and LAE covered by any of its catastrophe reinsurance programs presented above exceed the retention for that particular layer, each of the programs above requires one reinstatement of such coverage. In such an instance, the Company is required to pay a reinstatement premium to the reinsurers to reinstate the full amount of reinsurance available under such layer. The reinstatement premium is a percentage of the original premium based on the ratio of the losses exceeding the Company’s retention to the reinsurers’ coverage limit. In 2008, the Kemper segment and the Life and Health Insurance segment also participated in a catastrophe reinsurance program providing coverage of 40% of the sum of first $50 million of catastrophe losses of the Kemper segment in excess of $250 million and catastrophe losses of the Life and Health Insurance segment in excess of $80 million resulting from a single occurrence. Reinstatements are not permitted under this combined reinsurance program.
The annual reinsurance program covering the Kemper segment became effective on April 1, 2007 (the “2007 Kemper Program”). The first layer of the 2007 Kemper Program provided coverage of approximately 62% of reinsured catastrophe losses of $30 million above retention of $40 million. The second layer of the 2007 Kemper Program provided coverage of approximately 90% of reinsured catastrophe losses of $80 million above retention of $70 million. The third layer of the 2007 Kemper Program provided coverage of approximately 90% of reinsured catastrophe losses of $100 million above retention of $150 million. Prior to the effective date of the 2007 Kemper program, reinsurance coverage was provided by an annual program that became effective July 1, 2006 (the “2006 Kemper Program”), which was terminated effective with the Kemper 2007 Program. The
The annual program covering the Company’s Unitrin Direct and Unitrin Specialty segments and Unitrin Business Insurance provided, effective January 1, 2007, reinsurance coverage of 100% of reinsured catastrophe losses of $36 million above retention of $4 million. In 2006, the annual program covering these segments also provided reinsurance coverage of 100% of reinsured catastrophe losses of $36 million above retention of $4 million. The 2007 and 2006 annual programs covering these segments did not include Merastar. The annual program covering Merastar was effective on March 31, 2007 and provided reinsurance coverage of 97.5% of reinsured catastrophe losses of $7.25 million above retention of $0.75 million.
The Life and Health Insurance segment presented above includes reinsurance reinstatement premiums of $4.4 million for the year ended December 31, 2008 to reinstate coverage following Hurricanes Dolly, Gustav and Ike.
recoveries of $65.4 million, from Hurricanes Dolly, Gustav and Ike reported in the Company’s Consolidated Statements of Operations for the year ended December 31, 2008 by business segment were:
In addition to the reinsurance programs described in Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements, Unitrin’s insurance subsidiaries utilize other reinsurance arrangements to limit their maximum loss, provide greater diversification of risk and to minimize exposures on larger risks. The ceding of insurance does not discharge the primary liability of the original insurer. Accordingly, insurance reserve liabilities are reported gross of any estimated recovery from reinsurers in the Consolidated Balance Sheets. Amounts recoverable from reinsurers are estimated in a manner consistent with the insurance reserve liability and are included in Other Receivables in the Consolidated Balance Sheets.
insurance companies and involuntary pools. Earned Premiums assumed on short-duration policies for the years ended December 31, 2008, 2007 and 2006 were:
Effective January 1, 2007, Trinity, a subsidiary of Unitrin, and Milwaukee Insurance Company (“MIC”) entered into a new quota share reinsurance agreement whereby Trinity assumes 100% of policy liabilities occurring on MIC’s direct book of business on or after January 1, 2007, which business was administered by the Unitrin Business Insurance unit and the Kemper segment. Prior to January 1, 2007, Trinity and MIC were parties to a quota share reinsurance agreement whereby Trinity assumed 95% of the business written by MIC (administered by the Unitrin Business Insurance unit and the Kemper segment) and 95% of the business that MIC assumed from First NonProfit Insurance Company (“FNP”). The new quota share reinsurance agreement amended the 95% quota share reinsurance agreement so that policy liabilities occurring on MIC’s in-force direct book of business prior to January 1, 2007 remain ceded under the 95% agreement, as do FNP policy liabilities incurred prior to January 1, 2007. In connection with the new quota share reinsurance agreement, Trinity transferred to MIC the unearned premium reserves maintained by Trinity related to the FNP business, net of a ceding commission. MIC was owned by Mutual Insurers Holding Company (“MIHC”), which in turn was owned by MIC’s policyholders. Similarly, FNP was owned by First NonProfit Mutual Holding Company (“FNMHC”), which was owned by FNP’s policyholders. In November 2007, MIHC and FNMHC merged, and, accordingly, MIC and FNP became subsidiaries of the merged company. In the past, certain employees of the Company and its subsidiaries have been members of the boards of directors of one or more of MIC, MIHC, FNP and FHMHC. Effective in November 2007 and prior to the merger, the last remaining representatives of the Company resigned such board memberships. Accordingly, the only relationship that currently exists among the Company and/or its employees and these companies is the relationship of Trinity as a reinsurer of certain business pursuant to the above mentioned quota reinsurance agreement between Trinity and MIC.
The Company classifies certain investments in mutual funds included in Other Investments as trading securities and reports these investments at fair value. The Company has no material liabilities that are measured and reported at fair value.
SFAS No. 157 defines fair value and establishes a hierarchal framework which prioritizes and ranks the market price observability used in fair value measurements. Market price observability is affected by a number of factors, including the type of asset or liability and the characteristics specific to the asset or liability being measured. Assets and liabilities with readily available, active, quoted market prices or for which fair value can be measured from actively quoted prices generally are deemed to have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Under SFAS No. 157, the inputs used to measure fair value must be classified into one of three levels as follows:
Observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and
The Company’s investments in available for sale securities reported as Fixed Maturities and classified as Level 1 in the above table primarily consist of U.S. Treasury Bonds and Notes. The Company’s investments in available for sale securities reported as Other Equity Securities and classified as Level 1 in the above table primarily
consist of investments in publicly-traded common stocks. The Company’s investments in available for sale securities reported as Fixed Maturities and classified as Level 2 in the above table primarily consist of investments in corporate bonds and redeemable preferred stocks, state and municipal bonds, and bonds and mortgage-backed securities of U.S. government agencies. The Company’s investments in available for sale securities reported as Other Equity Securities and classified as Level 2 in the above table primarily consist of investments in preferred stocks. The Company uses a leading, nationally recognized provider of market data and analytics to price the vast majority of the Company’s Level 2 measurements. The provider utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information. Because many fixed maturity securities do not trade on a daily basis, the provider’s evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to prepare evaluations. In addition, the provider uses model processes to develop prepayment and interest rate scenarios. The pricing provider’s models and processes also take into account market convention. For each asset class, teams of its evaluators gather information from market sources and integrate relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The Company generally validates the measurements obtained from its primary pricing provider by comparing them with measurements obtained from one additional pricing provider that provides either prices from recent market transactions or quotes in inactive markets or evaluations based on its own proprietary models. The Company investigates significant differences related to the values provided. On completion of its investigation, management exercises judgment to determine the price selected and whether adjustments, if any, to the price obtained from the Company’s primary pricing provider would warrant classification of the price as Level 3. In instances where a measurement cannot be obtained from either pricing provider, the Company generally will evaluate bid prices from one or more binding quotes obtained from market makers to value investments in inactive markets and classified by the Company as Level 2. The Company generally classifies securities when it receives non-binding quotes or indications as Level 3 securities unless the Company can validate the quote or indication against recent transactions in the market. For securities classified as Level 3, the Company either uses valuations provided by third party fund managers, third party appraisers or the Company’s own internal valuations. These valuations typically employ valuation techniques including earning multiples based on comparable public securities, industry specific non-earnings based multiples, and discounted cash flow models. Valuations classified as Level 3 by the Company generally consist of investments in various private placement securities of non-rated entities. In rare cases, if the private placement security has only been outstanding for a short amount of time, the Company, after considering the initial assumptions used in acquiring an investment, will rely on the original purchase price as representative of the fair value.
Additional information pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2008 is presented below:
Included in the Statement of Operations for the year ended December 31, 2008 for investments classified as Level 3 is a net realized loss of $31.3 million related to the write down of subordinated fixed maturity obligations of a single issuer subsequent to a capital restructuring, net of a gain realized $2.2 million from the partial disposition of a subordinated fixed maturity obligation from the capital restructuring of the same issuer which the Company had previously written down due to an other than temporary decline in fair value. Losses Included in Statement of Operations for the year ended December 31, 2008 include a realized loss of $18.8 million to write down a subordinated fixed maturity obligation of a single issuer due to a capital restructuring. Other Comprehensive Income (Loss) for investments classified as Level 3 include an unrealized loss of $13.6 million for the year ended December 31, 2008 related to an overall decline in the fair value of the Company’s investments in fifteen limited liability investment companies and limited partnerships in which the Company’s ownership is considered minor and are therefore not accounted for under the equity method of accounting. Other Comprehensive Income (Loss) for investments classified as Level 3 includes an unrealized loss of $4.5 million for the year ended December 31, 2008 related to a decline in the fair value of two redeemable, auction rate preferred stocks of a single issuer. The Company attributes the unrealized loss related to these preferred stocks to liquidity issues in the market for auction rate preferred stocks, rather than credit issues related to the issuer of the securities. Accordingly, the Company expects to fully recover its investment on or before the date that the securities mature.
During the course of 2008, Unitrin and certain of its subsidiaries, like many property and casualty insurers, were forced to defend numerous individual lawsuits, mass actions and statewide putative class actions in Louisiana and Texas arising out of Hurricanes Katrina and Rita. In these matters, the plaintiffs seek compensatory and
Fireside Bank is defending two class action lawsuits in California state courts alleging that its post-repossession notices to defaulting borrowers failed to comply with certain aspects of California law. The plaintiffs seek: (i) compensatory damages, including a refund of deficiency balances collected from customers who received the allegedly defective notices; (ii) punitive damages; and (iii) equitable relief. Statewide classes have been certified in these matters and Fireside Bank successfully moved to have the two cases treated on a coordinated basis. Fireside Bank is contesting the allegations that its post-repossession notices were deficient and believes it has meritorious defenses to these lawsuits.
One of Unitrin’s directors, Mr. Fayez Sarofim, is the Chairman of the Board, President and the majority shareholder of Fayez Sarofim & Co. (“FS&C”), a registered investment advisory firm. Certain of Unitrin’s insurance company subsidiaries and FS&C were parties to agreements under which FS&C provided investment management services to these subsidiaries. Under these investment advisory arrangements, FS&C was entitled to a fee calculated and payable quarterly based upon the fair market value of the assets under management. During 2008, FS&C sold all of the investments it managed for Unitrin’s insurance company subsidiaries. Accordingly, Unitrin’s insurance company subsidiaries had no investments managed by FS&C at December 31, 2008. Unitrin’s insurance company subsidiaries had $226.2 million and $208.2 million in assets invested with FS&C for investment management at December 31, 2007 and 2006, respectively. Unitrin’s insurance company subsidiaries paid, in the aggregate, $0.5 million per year to FS&C for the years ended 2008, 2007 and 2006.
With respect to the Company’s 401(k) Savings Plan, one of the alternative investment choices afforded to participating employees is the Dreyfus Appreciation Fund, an open-end, diversified managed investment fund. FS&C provides investment management services to the Dreyfus Appreciation Fund as a sub-investment advisor. According to published reports filed by FS&C with the SEC, the Dreyfus Appreciation Fund pays monthly fees to FS&C according to a graduated schedule computed at an annual rate based on the value of the Dreyfus Appreciation Fund’s average daily net assets. The Company does not compensate FS&C for services rendered to the Dreyfus Appreciation Fund. Participants in the Company’s 401(k) Savings Plan had allocated $14.7 million, $25.3 million and $27.0 million for investment in the Dreyfus Appreciation Fund at December 31, 2008, 2007
We have audited the accompanying consolidated balance sheets of Unitrin, Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedules listed in Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unitrin, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for certain investments reported under the equity method of accounting in 2008.