In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Global Indemnity plc and its subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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 “Management’s Report on Internal Control over Financial Reporting” appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Share amounts have been retrospectively restated to reflect the 1-for-2 stock exchange effective July 2, 2010 when the Company completed its re-domestication to Ireland.
Shares outstanding and per share amounts have been retrospectively restated to reflect the 1-for-2 stock exchange effective July 2, 2010 when the Company completed its re-domestication to Ireland.
The Company offers property and casualty insurance products in the excess and surplus lines marketplace through its Insurance Operations and provides third party treaty reinsurance for writers of excess and surplus and specialty lines of property and casualty insurance through its Reinsurance Operations. The Company manages its Insurance Operations by differentiating them into three product classifications: Penn-America, which markets to small commercial businesses through a select network of wholesale general agents with specific binding authority; United National, which markets insurance products for targeted insured segments, including specialty products, such as property, general liability, and professional lines through program administrators with specific binding authority; and Diamond State, which markets property, casualty, and professional lines products, which are developed by the Company’s underwriting department by individuals with expertise in those lines of business, through wholesale brokers and also markets through program administrators having specific binding authority. These product classifications comprise our Insurance Operations business segment and are not considered individual business segments because each product has similar economic characteristics, distribution, and coverages. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Company’s Reinsurance Operations consist solely of the operations of its Bermuda-based wholly-owned subsidiary, Wind River Reinsurance. Wind River Reinsurance provides reinsurance solutions through brokers, primary writers, including regional insurance companies, and program managers. Wind River Reinsurance also participates as a retrocessionaire on business assumed by other reinsurers.
The Company’s wholly-owned business trust subsidiaries, United National Group Capital Trust I (“UNG Trust I”), United National Group Capital Statutory Trust II (“UNG Trust II”), are not consolidated pursuant to the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification”). The Company’s business trust subsidiaries have issued $30.0 million in floating rate capital securities (“Trust Preferred Securities”) and $0.9 million of floating rate common securities. The sole assets of the Company’s business trust subsidiaries are $30.9 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments, and distributions as the Trust Preferred Securities and the floating rate common securities. The registration of the Company’s wholly owned business trust subsidiary, Penn-America Statutory Trust II (“Penn Trust II”), was cancelled effective February 2, 2009 as a result of the redemption of its $15.0 million issued and outstanding notes on May 15, 2008.
In February 2010, the Company’s Board of Directors approved a plan for the Company to re-domesticate from the Cayman Islands to Ireland. At a special shareholders meeting held on May 27, 2010, the Company’s shareholders voted in favor of completing the re-domestication proposal pursuant to which all United America Indemnity, Ltd. ordinary shares would be cancelled and all holders of such shares would receive ordinary shares of Global Indemnity plc, a newly formed Irish company that was incorporated on March 9, 2010, on a one-for-two basis (two United America Indemnity, Ltd. shares exchanged for one Global Indemnity plc share). The re-domestication transaction was completed on July 2, 2010, following approval from the Grand Court of the Cayman Islands, at which time Global Indemnity plc replaced United America Indemnity, Ltd. as the ultimate parent company, and United America Indemnity, Ltd. became a wholly-owned subsidiary of Global Indemnity plc. Shares of United America Indemnity, Ltd. previously traded on the NASDAQ Global Select Market under the symbol “INDM.” Shares of the Irish company, Global Indemnity plc, began trading on the NASDAQ Global Select Market on July 6, 2010 under the symbol “GBLI.”
On November 2, 2010, we committed to a Profit Enhancement Initiative with respect to our U.S. Insurance Operations. The plan was initiated on November 4, 2010, and is part of our efforts to streamline our operations in response to the continuing impact of the domestic recession as well as the competitive landscape within the excess and surplus lines market. This initiative is intended to enhance profitability and earnings by aligning corporate overhead costs with recent changes in our business. In the fourth quarter of 2010, the Company reduced its U.S. based census by approximately 25%, closed underperforming U.S. facilities, and supplemented staffing in Bermuda and in Ireland. All action items relating to this initiative were implemented by December 31, 2010.
The total cost of implementing this initiative was recorded in our consolidated statements of operations within our Insurance Operations segment in the fourth quarter of 2010. Components of the initiative included: (1) employee termination and severance charges of $1.71 million; (2) expenses of $1.53 million relating to discontinuing use of leased office space, net of sublease income; (3) restructuring expenses of $0.63 million for related asset and leasehold improvement impairments; and (4) expenses of $2.91 million relating to the curtailment of our workers’ compensation product initiative, consisting of a minimum ceded premium charge of $1.48 on our workers’ compensation reinsurance treaty and $1.43 million in asset impairments.
The following table summarizes charges incurred by expense type and the remaining liability as of December 31, 2010:
The following table summarizes the charges incurred within our consolidated statement of operations by major account line:
As of December 31, 2010 and 2009, the Company held $204.0 million and $138.9 million in corporate loans. Corporate loans are primarily investments in senior secured floating rate loans that banks have made to corporations. The loans are generally priced at an interest rate spread over LIBOR which resets every 60 to 90 days. The Company’s investments in corporate loans are purchased in secondary markets for the purpose of being held as investments. They are carried at fair value with any change in the difference between amortized cost and fair value, net of the effect of deferred income taxes, reflected in accumulated other comprehensive income in shareholders’ equity. These investments are typically below investment grade.
their fair value. The change in the difference between amortized cost and the fair value of partnership interests of less than 3% ownership, net of the effect of deferred income taxes, is reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income other than for impairments deemed to be other than temporary.
(6) the investment has an unrealized loss and was identified by the Company’s Investment Manager as an investment to be sold before recovery or maturity; and
(7) the investment failed cash flow projection testing to determine if anticipated principal and interest payments will be realized.
other than temporary, the Company must separate the other than temporary impairment into two components: the amount representing the credit loss and the amount related to all other factors, such as changes in interest rates. The credit loss represents the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of the other than temporary impairment is recorded through earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes.
For equity securities, management carefully reviews all securities with unrealized losses and further focuses on securities that have either:
(2) the value of the investment has been 20% or more below cost for six continuous months or more to determine if the security should be impaired.
At December 31, 2010, the Company had approximately $86.4 million of cash and cash equivalents that was invested in a diversified portfolio of high quality short-term debt securities.
The Company tests for impairment of goodwill at least annually and more frequently as circumstances warrant in accordance with applicable accounting guidance. Impairment of goodwill is recognized only if the carrying amount of the business unit, including goodwill, exceeds the fair value of the reporting unit. The amount of the impairment loss would be equal to the excess carrying value of the goodwill over the implied fair value of the reporting unit goodwill. Based on the analysis performed in 2010, there were no impairments of goodwill as of December 31, 2010.
said assets. Based on the analysis performed in 2010, there were no impairments of indefinite lived intangible assets as of December 31, 2010.
Intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. The carrying amounts of definite lived intangible assets are regularly reviewed for indicators of impairment in accordance with applicable accounting guidance. Impairment is recognized only if the carrying amount of the intangible asset is in excess of its undiscounted projected cash flows. The impairment is measured as the difference between the carrying amount and the estimated fair value of the asset. Based on the analysis performed in 2010, there were no impairments of definite lived intangible assets as of December 31, 2010.
During 2010, the Company decreased its uncollectible reinsurance reserve by $0.2 million due to a decrease in the amount of carried reinsurance receivables. During 2009, the Company decreased its uncollectible reinsurance reserve by $0.7 million due to a decrease in the amount of carried reinsurance receivables.
Certain professional general agencies of the Insurance Operations are paid special incentives, referred to as commissions, when loss results of business produced by these agencies are more favorable than predetermined thresholds. Similarly, in some circumstances, insurance companies that cede business to the Company’s Reinsurance Operations are paid ceding or profit commissions based on the profitability of the ceded portfolio. These commissions are charged to other underwriting expenses when incurred. The liability for the unpaid portion of these commissions, which is stated separately on the face of the consolidated balance sheet as contingent commissions, was $9.3 million and $11.2 million as of December 31, 2010 and 2009, respectively.
Basic earnings per share have been calculated by dividing net income available to common shareholders by the weighted-average ordinary shares outstanding. Diluted earnings per share has been calculated by dividing net income available to common shareholders by the sum of the weighted-average ordinary shares outstanding and the weighted-average common share equivalents outstanding, which include options, warrants, and other equity awards. Basic and diluted per common share and related weighted average number of common share amounts are the same for 2008 since potential ordinary shares were anti-dilutive and excluded from the computation due to the Company’s net loss for the year ended December 31, 2008. See Note 17 for details.
Represents the amount of other than temporary impairment losses recognized in accumulated other comprehensive income (“AOCI”) since the date of adoption of the recent guidance on other than temporary impairments. Per the accounting guidance, these items were not included in earnings as of December 31, 2009.
During 2010, the Company purchased a mortgage-backed security (“MBS”) issued by Government National Mortgage Association (“GNMA”) which represented approximately 8% of shareholders’ equity as of December 31, 2010. Excluding U.S. treasury, agency bonds, and the MBS issued by GNMA, the Company did not hold any debt or equity investments in a single issuer that was in excess of 2.0% of shareholders’ equity at December 31, 2010 or 2009, respectively.
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2010:
Fixed maturities in a gross unrealized loss position for twelve months or longer is primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not impaired.
The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2009:
U.S. treasury and agency obligations - As of December 31, 2010, gross unrealized losses related to U.S. treasury and agency obligations were $0.004 million. All unrealized losses have been in an unrealized loss position for less than twelve months. All of these securities are rated AAA. The Company’s investment manager’s analysis for this sector includes on-site visits and meetings with officials in addition to the standard rigorous analysis that determines the financial condition of the issuer.
Corporate bonds and loans - As of December 31, 2010, gross unrealized losses related to corporate bonds and loans were $0.6 million. Of this amount, $0.005 million has been in an unrealized loss position for twelve months or greater. All of these securities are rated below investment grade. The Company’s investment manager’s analysis for this sector includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, issuer’s current competitive position, vulnerability to changes in the competitive environment, regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.
Foreign bonds - As of December 31, 2010, gross unrealized losses related to foreign bonds were $0.005 million. All unrealized losses have been in an unrealized loss position for less than twelve months. These securities are rated A. The Company’s investment manager maintains financial models for the Company’s bond issuers. These models include a projection of each issuer’s future financial performance including prospective debt servicing capabilities and capital structure composition. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, issuer’s current competitive position, vulnerability to changes in the competitive environment, regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection.
The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the years ended December 31, 2010, 2009, and 2008:
The proceeds from sales of available for sale securities resulting in net realized investment gains (losses) for the years ended December 31, 2010, 2009, and 2008 were as follows:
Average of total cash and invested assets, net of payable for securities purchased, as of the beginning and ending of the period.
As of December 31, 2010, the Company held insurance enhanced municipal bonds of approximately $118.0 million, which represented approximately 6.9% of the Company’s total cash and invested assets. These securities had an average rating of “AA.” Approximately $47.9 million of these bonds are pre-refunded with U.S. treasury securities, of which $37.5 million are backed by financial guarantors, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond. Of the remaining $70.1 million of insurance enhanced municipal bonds, $35.0 million would have carried a lower credit rating had they not been insured. The following table provides a breakdown of the ratings for these municipal bonds with and without insurance.
In addition to the $118.0 million of insurance enhanced municipal bonds, the Company also held insurance enhanced asset-backed and credit securities with a market value of approximately $31.7 million, which represented approximately 1.8% of the Company’s total invested assets. The financial guarantors of the Company’s $31.7 million of insurance enhanced asset-backed and credit securities include Financial Guaranty Insurance Company ($0.9 million), Municipal Bond Insurance Association ($12.2 million), Ambac ($2.6 million), Assured Guaranty Corporation ($10.8 million), and Other ($5.2 million).
The Company elected to apply the fair value option within its limited partnership investment portfolio to an investment where the Company previously owned more than a 3% interest. The fair value of this investment was $1.1 million as of December 31, 2010 and 2009. Effective December 31, 2009, the Company redeemed the majority of its ownership interest in this limited partnership, resulting in its ownership interest falling below 3%. As of December 31, 2010, the Company’s remaining interest in this limited partnership was comprised of convertible preferred securities of a privately held company. Accordingly, this investment is classified as Level 3 within the fair value hierarchy.
During the years ended December 31, 2010, 2009, and 2008, the Company recognized the following gains (losses), net of taxes, due to changes in the value of these investments.
Level 1 - inputs utilize quoted prices (unadjusted) in active markets for identical assets that the Company has the ability to access at the measurement date.
Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for invested assets
within the Level 3 category presented in the tables below may include changes in fair value that are attributed to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.
The securities classified as Level 2 in the above table consist primarily of fixed maturity securities. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, security prices are derived
through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recent reported trades, matrix or model processes are used to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed securities, collateralized mortgage obligations, and mortgage-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. For corporate loans, price quotes from multiple dealers along with recent reported trades for identical or similar securities are used to develop prices.
The following table presents changes in Level 3 investments measured at fair value on a recurring basis for 2009:
The securities classified as Level 3 in the above table consist of $8.0 million related to the Company’s limited partnerships investments. This entire amount was comprised of securities for which there is no readily available independent market price. The estimated fair value of these limited partnerships is measured utilizing the Company’s net asset value as a practical expedient for each limited partnership. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates, and any market clearing activity that may have occurred since the prior month-end pricing period. Of the investments in limited partnerships, $1.1 million was related to a limited partnership which holds convertible preferred securities of a privately held company. These securities were subject to an appraisal action in Delaware State Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
Included in “Other invested assets” in the fair value hierarchy at December 31, 2010 and 2009 are limited liability partnerships measured at fair value. The following table provides the fair value and future funding commitments related to these investments at December 31, 2010 and 2009.
This limited partnership is a registered mutual fund which invests in a portfolio of high yield convertible securities issued by companies with small to medium market capitalizations and lower credit ratings (generally below investment grade). In accordance with the partnership agreement, the Company has exercised its right to submit a capital withdrawal request effective December 31, 2009. As of December 31, 2009, the Company was unable to redeem a portion of its ownership interest in this limited partnership with a fair market value of $1.1 million. This is related to convertible preferred securities of one company which were subject to an Appraisal Action in Delaware Court. In February, 2011, the Company’s remaining interest of $1.1 million was liquidated.
Corporate bonds are individually evaluated on a nominal spread or an option adjusted spread basis depending on how the market trades a security or sector. Spreads are updated each day and compared with those from the broker/dealer community and contributing firms. Issues are generally benchmarked off of the U.S. treasuries or LIBOR.
accounting guidance, and to ensure that its assets are properly classified in the fair value hierarchy. The Company’s procedures include, but are not limited to:
In 2008, goodwill was tested for impairment using a two-step process. The first step was to determine if there was impairment by comparing the estimated fair value of the reporting unit to the carrying value of the business unit including goodwill. The second step, which is only required if step one yields a business unit carrying value that is greater than the fair value of the business unit, was to determine the amount of the impairment loss, which was equal to the excess carrying value over the implied fair value of the goodwill of the reporting unit giving rise to the goodwill.
In performing step one of the goodwill impairment test during the fourth quarter of 2008, the Company used two approaches to estimate the fair value of the Penn-America reporting unit: 1) a market capitalization approach that allocated a portion of the Company’s total market capitalization to each of its business units; and 2) a discounted cash flow approach that estimated fair value as the present value of estimated future cash flows. Under each approach, the carrying value of the Penn-America reporting unit exceeded the estimated fair value, indicating that step two of the goodwill impairment test was required.
In the discounted cash flow approach, the Company projected the financial results of the Penn-America reporting unit and discounted the projection using a discount factor of 16.0%. The discount factor was based on the weighted average cost of capital for the insurance industry of 15.9% as calculated from empirical data for market participants and other relevant sources as prepared by an independent valuation firm. The discounted cash flow approach also assumed a 5.0% annual increase in net premiums written, a loss ratio declining from 62.2 to 57.7 over the next six years, an equity to net premium written ratio of 1:1, and that an investment income return of 5.25% would be attainable in future periods.
- Goodwill of $84,246 related to the merger with Penn-America Group, Inc.
The following table presents details of the Company’s intangible assets as of December 31, 2009:
were comprised of trade names and state insurance licenses, were $9.2 million. Impairment testing performed in 2010 and 2009 indicated that there was no impairment.
In 2008, the Company worked with an independent valuation firm to determine the fair value of its indefinite lived intangible assets. The fair value of the state insurance licenses was valued higher than the carrying value of $5.0 million, which demonstrated there was no impairment. The method used to determine the fair value of the Penn-America trade name was the relief from royalty method. The relief from royalty method calculates the present value of savings resulting from the right to manufacture or sell products that incorporate the intangible asset(s) without having to pay a license fee for its use. This method is commonly used to value trademarks, patents, developed technology, and base (core) technology. The assumed royalty rate under this approach was 0.5%, which yielded an estimated value of the trade name in the amount of $4.2 million, indicating that there was an impairment of $0.8 million pre-tax and $0.5 million after tax.
As of December 31, 2010, definite lived intangible assets were $5.1 million, net of accumulated amortization, and were comprised of customer relationships and non-compete agreements related to the 2010 acquisition. The Company worked with an independent valuation firm to corroborate the fair value of the definite lived intangible assets related to the 2010 acquisition. The impairment test performed in 2010 did not result in impairment of these assets.
In 2008, the Company’s definite lived intangible assets pertained to the Penn-America Group, Inc. agency relationships that were in force at the time of the merger and internally developed software. The Company determined that the forecasted undiscounted cash flows related to the agency relationships, net of a capital charge equal to 16.0% of required capital, were negative, and therefore there was no value to the agency relationships. As a result, the Company recorded an impairment charge of $11.4 million pre-tax and $7.4 million after-tax, which reduced the balance of the agency relationships at December 31, 2008 to $0. The internally developed software related to Penn-America does not directly generate cash flows; therefore, the Company worked with an independent valuation firm to determine the fair value of the software. The cost approach was used to value the software, which estimates the cost to replicate the software to determine the fair value of the internally developed software. The software was valued at $0.3 million, which was greater than the carrying value of $0.1 million, indicating there was no impairment.
The Company cedes risk to unrelated reinsurers on a pro rata (“quota share”) and excess of loss basis in the ordinary course of business to limit its net loss exposure on insurance contracts. Reinsurance ceded arrangements do not discharge the Company of primary liability. Moreover, reinsurers may fail to pay the Company due to a lack of reinsurer liquidity, perceived improper underwriting, losses for risks that are excluded from reinsurance coverage, and other similar factors, all of which could adversely affect the Company’s financial results.
At December 31, 2010 and 2009, the Company carried reinsurance receivables of $422.8 million and $543.4 million, respectively. These amounts are net of a purchase accounting adjustment and an allowance for uncollectible reinsurance receivables. The purchase accounting adjustment is related to discounting the loss reserves to their present value and applying a risk margin to the discounted reserves. This adjustment was $12.0 million and $17.5 million at December 31, 2010 and 2009, respectively. The allowance for uncollectible reinsurance receivables was $12.7 million and $12.9 million at December 31, 2010 and 2009, respectively. The change is primarily due to the decrease in the amount of carried reinsurance receivables.
Casualty Excess of Loss - Effective May 1, 2010, the Company renewed its casualty excess of loss treaty which provides coverage for $2.0 million per occurrence in excess of $1.0 million per occurrence for general liability and auto liability. Allocated loss adjustment expenses are included within limits. This replaces the treaty that expired April 30, 2010, which provided coverage for $2.25 million per occurrence in excess of $0.75 million per occurrence, with allocated loss adjustment expenses shared in proportion to losses retained and ceded.
Casualty Clash Excess of Loss - Effective January 1, 2011, the Company renewed its casualty clash excess of loss treaty which provides coverage of $10.0 million per occurrence in excess of $3.0 million per occurrence, subject to a $20.0 million limit for all loss occurrences. This replaces the treaty that expired December 31, 2010, which provided identical coverage.
Property Quota Share - Effective January 1, 2010, the Company renewed its 40% quota share treaty related to the Penn-America property line of business. This treaty covers premiums earned in 2010 on policies written in 2009 and 2010. During 2010, the Company ceded $14.1 million of earned premium. This treaty expired on December 31, 2010 and was not renewed.
Marine Excess of Loss - Effective May 24, 2010, the Company entered into a new marine excess of loss treaty which provides coverage in three layers for $13.0 million per occurrence in excess of $2.0 million per occurrence. The first layer of $3.0 million in excess of $2.0 million, and the second layer of $5.0 million in excess of $5.0 million, provides for two full reinstatements of coverage at 100% additional premium. The third layer of $5.0 million in excess of $10.0 million provides for one full reinstatement of coverage at 100% additional premium.
The Company’s income before income taxes from the Non-U.S. Subsidiaries and U.S. Subsidiaries, including the results of the quota share agreement between Wind River Reinsurance and the Insurance Operations, for the years ended December 31, 2010, 2009, and 2008 were as follows:
The effective income tax rate for 2010 was 9.5%, compared with an effective income tax rate of 5.8% for 2009 and an effective income tax benefit of (17.5%) for 2008. The effective rate differed from the weighted average expected income tax expense rate of 12.8% for 2010 primarily due to investments in tax-exempt securities and the decrease in prior years’ tax contingencies due to lapses on the statute of limitations. The effective rate differed from the weighted average expected income tax expense rate of 12.2% for 2009 primarily due to investments in tax-exempt securities and the decrease in prior years’ tax contingencies due to lapses on the statute of limitations. The
effective rate differed from the weighted average expected income tax benefit of (32.4%) for 2008 primarily due to investments in tax-exempt securities and the impairments of goodwill and intangible assets.
The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 2010 and 2009 are presented below:
Management believes it is more likely than not that the deferred tax assets will be completely utilized in future years. As a result, there is no valuation allowance at December 31, 2010 and 2009.
The Company and some of its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2007.
If recognized, the gross unrecognized tax benefits could lower the effective income tax rate in any future period. The provision for gross unrecognized tax benefits decreased $0.4 million during 2010 due to the expiration of the IRS statute of limitations on the Company’s 2006 federal income tax return. As a result, the effective income tax rate was reduced by 0.4% during 2010.
The Company classifies all interest and penalties related to uncertain tax positions as income tax expense. As of December 31, 2010, the Company has recorded $0.1 million in liabilities for tax-related interest and penalties on its consolidated balance sheet.
During 2010 the Company reduced its prior accident year loss reserves by $53.9 million and reduced its allowance for uncollectible reinsurance by $0.2 million, which primarily consisted of a $43.7 million reduction in general liability lines, a $5.4 million reduction in umbrella lines, a $4.8 million reduction in professional liability lines, and a $2.5 million reduction in property lines, partially offset by a $2.0 million increase in auto liability lines and a $0.7 million increase in workers’ compensation lines:
General Liability: The $43.7 million reduction primarily consisted of net reductions of $45.5 million related to accident years 2002 through 2009 due to lower than anticipated frequency and severity. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. This reduction was partially offset by net increases of $3.8 million related to accident years 1998 through 2001 where the Company increased the loss and loss adjustment expense estimates related to construction defect claims.
Professional Liability: The $4.8 million reduction primarily consisted of net reductions of $9.6 million related to accident years 2001 through 2008 driven by lower than expected paid and incurred activity. This reduction was partially offset by increases of $4.7 million related to accident year 2009 where the Company experienced higher than expected claim frequency and severity.
Property: The reduction in the property lines primarily consisted of reductions of $2.7 million related to accident years 2002 and 2004 through 2008 driven by lower than anticipated severity, partially offset by increases of $0.2 million primarily related to accident year 2009 where the Company experienced higher than expected claim frequency and severity.
Workers’ Compensation: The increase in our workers’ compensation lines is related to an accident year 2009 structured excess of loss treaty at our Reinsurance Operations where we increased our loss estimates based on industry workers’ compensation results.
The increase in the allowance for uncollectible reinsurance is due to the increase in the amount of the Company’s carried reinsurance receivables.
Establishing reserves for A&E and other mass tort claims involves more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies. In 2009, one of the Company’s insurance companies was dismissed from a lawsuit seeking coverage from it and other unrelated insurance companies. The suit involved issues related to approximately 3,900 existing asbestos-related bodily injury claims and future claims. The dismissal was the result of a settlement of a disputed claim related to accident year 1984. The settlement is conditioned upon certain legal events occurring which will trigger financial obligations by the insurance company. Management will continue to monitor the developments of the litigation to determine if any additional financial exposure is present.
As of December 31, 2010, 2009, and 2008, the survival ratio on a gross basis for the Company’s open A&E claims was 5.5 years, 5.1 years, and 9.2 years, respectively. As of December 31, 2010, 2009, and 2008, the survival ratio on a net basis for the Company’s open A&E claims was 6.0 years, 5.7 years, and 13.8 years, respectively. The survival ratio, which is the ratio of gross or net reserves to the 3-year average of annual paid claims, is a financial measure that indicates how long the current amount of gross or net reserves are expected to last based on the current rate of paid claims.
On July 20, 2005, we sold $90.0 million of guaranteed senior notes, due July 20, 2015. These senior notes have an interest rate of 6.22%, payable semi-annually. On July 20, 2011 and on each anniversary thereafter to and including July 20, 2014, we are required to prepay $18.0 million of the principal amount. On July 20, 2015, we are required to pay any remaining outstanding principal amount on the notes. The notes are guaranteed by Global Indemnity (Cayman), Ltd.
On May 15, 2008, the Company redeemed all of the $15.0 million issued and outstanding notes of Penn Trust II. In conjunction with this redemption, the $15.5 million of junior subordinated debentures of PAGI, which are the sole assets of Penn Trust II, were also redeemed. The registration of Penn Trust II was cancelled effective February 2, 2009.
On February 17, 2009, the Company filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission (“SEC”) covering up to $300.0 million of Class A ordinary shares, preferred shares, depositary shares, debt securities, warrants to purchase Class A ordinary shares, preferred shares or debt securities, stock purchase contracts, and stock purchase units. The filing was made in order to provide the Company with future financial flexibility.
On March 10, 2009, the Company filed Amendment No. 1 to the Form S-3 filing with the SEC, which included a preliminary prospectus defining the terms of our intended non-transferable rights offering (the “Rights Offering”). On March 17, 2009, the Company filed a final Prospectus under SEC Rule 424(b)(2), denoting the amended terms of the prospectus.
As part of the Rights Offering, the Company purchased 5,000 Class A ordinary shares for $0.04 million that had been purchased by a former employee with the non-transferable Class A Rights that were distributed to that former employee for Class A ordinary shares held of non-vested restricted stock. Since the restricted stock was not vested, the former employee, upon leaving the Company, had to forfeit those Class A ordinary shares that had been purchased with the non-transferable Class A Rights that were distributed on that unvested restricted stock. See above for more details concerning the Rights Offering.
As mentioned in Note 12 above, as a result of the Rights Offering, the Company agreed to pay Fox Paine & Company an arrangement fee of $2.0 million and a backstop fee equal to 5% of the aggregate gross proceeds raised in the Rights Offering, or $5.0 million, for total payments of $7.0 million. Since Fox Paine & Company is a related party, and all other shareholders were not offered these fees in the Rights Offering, the payment of the fees was subject to the prior approval of the Company’s shareholders, which was obtained at the Annual General Shareholders’ meeting that was held on October 27, 2009. The fees were paid on October 27, 2009. See Note 12 above for more details concerning the Rights Offering.
Validus Reinsurance, Ltd. (“Validus”) was a participant on the Company’s following catastrophe reinsurance treaty:
$100.0 million in excess of $10.0 million, which expired on May 31, 2008;
During the years ended December 31, 2010 and 2009 the Company paid $0.2 million and $0.2 million in brokerage fees to Frank Crystal & Company, an insurance broker. James W. Crystal, the chairman and chief executive officer of Frank Crystal & Company, became a member of the Company’s Board of Directors effective July 6, 2010.
As mentioned in Note 13 above, the Company has a remaining commitment of $2.6 million to the Fox Paine Capital Fund, II.
issuance pursuant to awards granted under the Plan. Award activity for stock options granted under the Plan and the weighted average exercise price per share are summarized as follows:
During 2008, the Company granted 124,709 Time-Based Options and 124,709 Performance-Based Options under the Plan. The Company also cancelled 98,736 Time-Based Options and 98,736 Performance-Based Options under the plan as a result of the amendment and restatement of Larry A. Frakes’ employment agreement. The Time-Based Options vest in 25% increments over a four-year period, with any unvested options being forfeited upon termination of employment for any reason, and expire 10 years after the grant date. The Performance-Based Options vest in 25% increments and are conditional upon the Company achieving various operating targets and expire 10 years after the grant date.
Performance-Based Options vest in 25% increments and are conditional upon the Company achieving various operating targets and expire 10 years after the grant date.
Option intrinsic values, which are the differences between the fair market value of $20.45 at December 31, 2010 and the strike price of the option, are as follows:
The weighted average fair value of options granted under the Plan was $4.56 and $15.14 in 2009 and 2008, respectively, using a Black-Scholes option-pricing model and the following weighted average assumptions:
The following tables summarize the range of exercise prices of options outstanding at December 31, 2010, 2009, and 2008:
Includes 122,603 shares that were purchased by key employees in 2003.
The following table summarizes the non-vested Restricted Shares activity for the years ended December 31, 2010, 2009, and 2008:
During 2008, the Company granted an aggregate of 111,327 Restricted Shares to key employees of the Company and an aggregate of 23,698 fully vested Director Restricted Shares, at a weighted average fair value of $33.40 per share, to non-employee directors of the Company under the Plan. In 2008, the company granted 35,837 Restricted Shares to key employees and 18,770 fully vested Director Restricted Shares to non-employee directors of the Company out of shares held in treasury. Included in the 111,327 are 71,000 Restricted Shares granted by the Company to key executives of the Company in exchange for signed employment agreements. Included in the 71,000 are 6,000 shares that vest 331/3% on each subsequent anniversary date of the award for a period of three years, and 15,000 shares that vest 25% on each subsequent anniversary date of the award for a period of four years. Of the remaining 50,000 shares, 10% of the shares vested upon being granted and 22.5% vest on each subsequent anniversary date of the award for a period of four years. The Company also granted 8,080 shares to a key executive in 2008. The 8,080 Restricted Shares vest 25% on each subsequent anniversary date of the award for a period of four years.
During 2010, the Company granted an aggregate of 47,610 Restricted Shares to key employees of the Company and an aggregate of 76,648 fully vested Director Restricted Shares, at a weighted average fair value of $16.34 per share, to non-employee directors of the Company under the Plan. In 2010, the Company granted 8,149 Restricted Shares to key employees and 18,529 fully vested Director Restricted Shares to non-employee directors of the Company out of shares held in treasury. Included in the 47,610 are 10,000 Restricted Shares granted by the
Company to key executives of the Company in exchange for signed employment agreements. Included in the 10,000 are 5,000 shares that were forfeited in 2010 and 5,000 shares that vest 331/3% on each subsequent anniversary date of the award for a period of three years.
Effective May 10, 2007, Larry A. Frakes was hired as the Company’s President and Chief Operating Officer, as well as Chief Executive Officer of all of the Company Affiliates. Mr. Frakes’ four-year employment agreement includes several equity components including (a) the granting of $10.0 million of stock options, or 197,473 shares split evenly between time-based and performance-based options at the grant date market value of $50.64 per share; (b) an annual bonus program under which the first $0.5 million is paid in restricted stock based on the market value at December 31 of the subject Bonus Year; (c) the purchase of $1.0 million of the Company’s Class A ordinary shares by Mr. Frakes; and (d) the requirement that, effective January 1, 2009, Mr. Frakes hold Class A ordinary shares of the Company with a value of the lesser of two times his Annual Compensation or the sum of owned, granted, and vested Class A ordinary shares. The time-based options vest at 25% on each December 31 of years 2008 through 2011. The performance-based options generally vest at the same rate based on the achievement of various Company financial performance goals. The restricted stock portion of the 2008, 2009, and 2010 bonuses vest at 25% per year each year after the bonus year, and awards for the 2011 bonus year and thereafter will vest at 33.3% per year each year after the bonus year.
On September 14, 2009, the Company entered into an amended and restated employment agreement with Mr. Frakes, which amended and restated Mr. Frakes’ amended employment agreement that was entered into on February 5, 2008. The amended and restated employment agreement changes and clarifies the terms of options granted under the original employment agreement. The Time Based Options vest at 25% on December 31, 2008, 2010, 2011, and 2012. The Performance Based Options have three vesting opportunities. Each tranche, which represents 25% of the total award, can initially vest on December 31, 2008, 2009, 2010, and 2011. Subsequent vesting opportunities occur on April 30, 2011 and 2012 for each tranche.
Earnings (loss) per share have been computed using the weighted average number of ordinary shares and ordinary share equivalents outstanding during the period. With the exception of the Rights Offering discussion below, all share counts and corresponding per share market prices have been adjusted to reflect the one-for-two stock exchange of Global Indemnity plc shares for United America Indemnity, Ltd. shares as part of the re-domestication to Ireland. See Note 2 above for more information regarding the re-domestication. As detailed below, share counts for prior years have also been restated as a result of the Rights Offering that took place in 2009.
The market price of the Company’s Class A ordinary shares was $4.89 per share on March 12, 2009, which was the ex-rights date related to the Rights Offering. Since the $3.50 per share subscription price of the shares issued under the Rights Offering was lower than the $4.89 per share market price on March 12, 2009, the Rights Offering contained a bonus element. In computing the basic and diluted weighted share counts, the number of shares outstanding prior to May 5, 2009 (the date that the ordinary shares were issued in conjunction with the Rights Offering) was adjusted by a factor of 1.114 to reflect the impact of a bonus element associated with the Rights Offering. See Note 12 above for more details concerning the Rights Offering.
The Company’s U.S. insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis, and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2010, the maximum amount of distributions that could be paid for 2011 by the United National Insurance Companies and the Penn-America Insurance Companies as dividends under applicable laws and regulations without regulatory approval is approximately $42.4 million and $21.4 million, respectively. The Penn-America Insurance Companies limitation includes $7.0 million that would be distributed to United National Insurance Company or its subsidiary Penn Independent Corporation based on the December 31, 2010 ownership percentages. For 2010, the United National Insurance Companies and Penn-America Insurance Companies declared and paid dividends of $50.3 million and $19.1 million, respectively.
The NAIC’s RBC model provides a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks, as well as its reinsurance exposures, to assess the potential need for regulatory attention. The model provides four levels of regulatory
(b) less than or equal to 150%, but greater than 100% of its ACLRBC (the “Regulatory Action Level”), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed;
Based on the standards currently adopted, the Company reported in its 2010 statutory filings that the capital and surplus of the U.S. Insurance Companies are above the prescribed Company Action Level RBC requirements.
The Insurance Operations segment and the Reinsurance Operations segment follow the same accounting policies used for the Company’s consolidated financial statements. For further disclosure regarding the Company’s accounting policies, please see Note 4.
Includes excise tax of $1,021 related to cessions from U.S. Insurance Companies to Wind River Reinsurance.
Includes excise tax of $1,342 related to cessions from U.S. Insurance Companies to Wind River Reinsurance.
In January 2010, the FASB issued authoritative guidance that requires new disclosures related to fair value measurements and clarifies existing disclosure requirements about the level of disaggregation, inputs, and valuation techniques. Specifically, reporting entities now must disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition, in the reconciliation for Level 3 fair value measurements, a reporting entity should separately present information about purchases, sales, issuances, and settlements. The guidance clarifies that a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities for disclosure of fair value measurement, considering the level of disaggregated information required by other applicable GAAP guidance and should also provide disclosures about the valuation techniques and inputs used to measure fair value for each class of assets and liabilities. This guidance was effective on January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the reconciliation for Level 3 fair value measurements, which will be effective on January 1, 2011. The Company adopted this new guidance in the first quarter of 2010 and it did not have a material impact on the Company’s consolidated financial position or results of operations.
In December, 2010, the FASB issued new accounting guidance surrounding goodwill impairment testing for reporting units with zero or negative carrying values. Under previous guidance, these reporting units would have been exempt from goodwill impairment testing, even though qualitative indicators of goodwill impairment may have existed. This guidance modifies the requirements for these reporting units to evaluate whether it is more likely than not goodwill impairment exists using qualitative factors. This guidance is effective for fiscal years beginning after December 15, 2010. This guidance is not expected to have a material impact on our consolidated financial position or results of operations.
On March 11, 2011, an earthquake and resultant tsunami struck off the northeast coast of Japan. Given the magnitude and recent occurrence of this event, there is a lack of data available from industry participants resulting in significant uncertainty with respect to potential insured losses, and as a result, the Company’s potential losses from this event. We are evaluating our exposure to loss from this event and have not determined an initial estimate.
An unaudited summary of the Company’s 2010 and 2009 quarterly performance is as follows: