We lease office space in Duluth, Georgia; Honolulu, Hawaii; Mechanicsburg, Pennsylvania; St. Thomas in the United States Virgin Islands; and Bluffton, South Carolina. These leases account for approximately 16,500 square feet of office space. These leases expire within sixty-seven months. The monthly rents, exclusive of operating expenses, to lease these facilities currently total approximately $24,000. We believe that these leases could be renewed or replaced at commercially reasonable rates without material disruption to our business.
We invest funds in the participant loss layer for several of the alternative risk transfer programs. We receive investment income and incur an equal expense on the amounts owed to alternative risk transfer participants. “Expense on amounts withheld” represents investment income that we remit back to alternative risk transfer participants. The related investment income is included in our “Net investment income” line on our Consolidated Statements of Income. Beginning in 2007, we began presenting this expense as a separate income statement line item and no longer included as part of “Other operating and general expenses” or the calculation of the “Underwriting expense ratio.” All prior periods have been reclassified to conform to the current period’s presentation.
The ratio of net income to the average of the shareholders’ equity at the beginning and end of the period.
Adjusted to reflect a 200-for-1 share split effective December 6, 2004.
Book value per common share is computed using only vested common shares. All unvested restricted shares have been excluded for purposes of this calculation. As of December 31, 2007 total vested common shares were 19,205,000. There were no unvested restricted shares prior to 2007.
Statutory combined ratio of NIIC represents the sum of the following ratios: (1) losses and LAE incurred as a percentage of net earned premium and (2) underwriting expenses incurred as a percentage of net written premiums.
Our specialty property and casualty insurance companies are licensed in all 50 states, the District of Columbia and the Cayman Islands. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. While many companies write property and casualty insurance for transportation companies, we believe that few write passenger transportation coverage nationwide and very few write coverage for several of the classes of passenger transportation insurance written by us and our subsidiaries. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. These niche markets typically possess what we view as barriers to entry, such as being too small, too remote or too difficult to attract or sustain most competitors. Examples of products that we write for these markets include captive programs for transportation companies that we refer to as our alternative risk transfer operations (48.5% of 2007 gross premiums written), property and casualty insurance for transportation companies (26.3%), specialty personal lines, primarily recreational vehicle coverage (15.9%) and transportation and general commercial insurance in Hawaii and Alaska (7.3%). We strive to become a market leader in the specialty markets that we choose and serve by offering what we believe are specialized products, excellent customer service and superior claims response.
By offering insurance products to all sizes of risks, we believe we have hedged against the possibility that there will be a reduction in demand for the products we offer. We believe that we will continue to have opportunities to grow and profit with both traditional and alternative risk transfer customers based on our assumptions regarding future economic and competitive conditions. We generally incur low start-up costs for new businesses, typically less than $500,000 incurred over several quarters. We believe our flexible processes and scalable systems, along with controlled ramp up of businesses, allow us to manage costs and match them with the revenue flow.
The property and casualty insurance industry is cyclical. Historically, the industry has been characterized by periods of price competition and excess capacity (soft market) followed by periods of high premium rates and shortages of underwriting capacity (hard market). Since 2004, we believe that the commercial transportation market has been in the part of the cycle that can best be described as softening as compared to the peak of the hard market in 2002 and 2003. The cyclical nature of the industry impacts our business operations. Our business may be affected by the risks impacting the property and casualty insurance industry related to severe weather conditions, explosions, terrorist attacks and riots. For passenger transportation, distressed operators (whether distressed due to being insured by other insurance companies that have raised rates or exited the market or due to having less than desirable risk characteristics) continue to be heavily marketed to us by brokers causing an increase in our new business declination rates. In addition, insurance rates for renewing policies for all transportation business were down slightly when compared to 2006 and lower than the increases attained from mid-2001 through 2004. Although the current condition of the market can be characterized as softening, the extent of the price competition we are currently experiencing is neither as significant nor as severe as we have previously experienced in other softening markets (e.g. 1999-2000).
Our stable operating expenses at or below the revenue growth rate.
For weather-related events such as hurricanes, tornados and hailstorms, we conduct an analysis at least annually pursuant to which we input our in-force exposures (vehicle values in all states and property limits in Hawaii) into an independent catastrophe model that predicts our probable maximum loss at various statistical confidence levels. Our estimated probable maximum loss is impacted by changes in our in-force exposures as well as changes to the assumptions inherent in the catastrophe model. Hurricane and other weather-related events have not had a material negative impact on our past results.
We derive our revenues primarily from premiums from our insurance policies and income from our investment portfolio. Our underwriting approach is to price our products to achieve an underwriting profit even if it requires us to forego volume. As with all property and casualty companies, the impact of price changes is reflected in our financial results over time. Price changes on our in-force policies occur as they are renewed, which generally takes twelve months for our entire book of business and up to an additional twelve months to earn a full year of premium at the renewal rate. Insurance rates charged on renewing policies have decreased slightly in 2007 compared to 2006.
There are distinct differences in the timing of written premiums in traditional transportation insurance compared to the majority of our alternative risk transfer (captive) insurance component. We write traditional transportation insurance policies throughout all 12 months of the year and commence new annual policies at the expiration of the old policy. Under most captive programs, all members of the group share a common renewal date. These common renewal dates are scheduled throughout the calendar year. Any new captive program participant that joins after the common date will be written for other than a full annual term so its next renewal date coincides with the common expiration date of the captive program it has joined. Historically, most of our group captives had common renewal dates in the first six months of the year, but with the growth from new captive programs, we are now experiencing renewal dates throughout the calendar year. The alternative risk transfer component of our business grew to 48.5% of total gross premium written during 2007 as compared to 44.3% in 2006.
Our specialty personal lines products are also priced to achieve targeted underwriting margins. The average premium per policy for this business component is significantly less than transportation lines.
Interest expenses associated with outstanding debt and “Expense on amounts withheld” are disclosed separately from operating and general expenses. We invest funds in the participant loss layer for several of our alternative risk programs. We receive investment income and incur an equal expense on the amounts owed to alternative risk transfer participants. “Expense on amounts withheld” represents investment income that we remit back to alternative risk transfer participants. The related investment income is included in the “Net Investments Income” line on our Consolidated Statements of Income.
Our net earnings for 2007 were $43.6 million or $2.25 per share (diluted), compared to $35.7 million or $1.85 per share (diluted) recorded in 2006. Our earnings increased $7.9 million, or 22.1%, compared to the same period in 2006. There are several factors that contributed to the increase in net earnings, including continued growth in earned premium of $40.2 million, or 18.5%, primarily due to the addition of a large new transportation captive program early in 2007, an increase in the number of participants in our existing captive programs and expanded insurance offerings in two of our captive programs. We also had favorable losses and LAE for 2007, which is evidenced by our 2007 loss and LAE ratio of 58.0%, a decrease from prior year of 1.6 percentage points. The losses and LAE include favorable development from prior years of $5.7 million compared to $7.5 million of favorable development in 2006.
Gross premiums written includes both direct premium and assumed premium. During 2007, as a percent of total gross premiums written, the alternative risk transfer component of the business had the largest increase of $32.4 million or 24.0% compared to 2006. The growth in the alternative risk transfer component is primarily attributable to the addition in 2007 of one large transportation captive, which accounted for $13.2 million, or 40.7%, of the increase, as well as expanded insurance offerings in one of our existing captive programs, which accounted for $13.0 million, or 40.1% of the increase.
The increase in the transportation component of $1.6 million for the year ended December 31, 2007 compared to 2006 is attributable to an increase in the number of insureds in both our community and medical transportation product and our truck product. Our underwriting approach is to price our products to achieve an underwriting profit even if we forgo volume as a result. Based on the number of accounts, our retention rates for traditional transportation are comparable between 2007 and 2006; however, we are experiencing a trend of competitive
Our net premiums earned increased $22.9 million, or 11.8%, to $217.3 million during the year ended December 31, 2006 compared to $194.4 million for the year ended December 31, 2005. Our alternative risk transfer component increased 25.7% during 2006 compared to the same period in 2005, primarily due to new captive programs that were written in 2006 and the fourth quarter of 2005 and new participants in existing group captive programs. Due to moderate rate increases and an increase in the number of policies in force primarily from expanded distribution, our specialty personal lines component increased 20.4% in 2006 compared to 2005. The transportation component remained relatively constant in 2006 compared to 2005. Our Other component, which is comprised primarily of premium from assigned risk plans from the states in which our insurance company subsidiaries operate, decreased $2.0 million, or 19.8%, to $8.2 million in 2006.
Commissions and other underwriting expenses consist principally of brokerage and agent commissions reduced by ceding commissions received from assuming reinsurers, and vary depending upon the amount and types of contracts written and, to a lesser extent, premium taxes. The underwriting expense ratio was 22.9% for both years ended December 31, 2007 and 2006.
2007 compared to 2006. Net investment income increased $4.6 million, or 26.0% to $22.1 million in 2007 compared to 2006. The net investment income improvement reflects higher average invested assets due to continued strong cash flows from operations as well as a higher tax equivalent yield of the portfolio. We have historically maintained a conservative, diversified and high quality investment portfolio. During 2007 higher yields on our short-term portfolio compared to 2006 favorably impacted our net investment income. Also favorably impacting our yields, during 2007 we diversified our portfolio into agency guaranteed collateralized mortgage obligations which did not expose us to the subprime lending sector.
2006 compared to 2005. Net realized gains increased $0.9 million to $1.2 million for 2006 compared to net realized gains of $0.3 million for 2005. The realized gains in 2006 and 2005 were primarily generated from sales of equity holdings.
In addition, a portion of the increase in the other operating and general expenses is related to an increase in facilities expenses from office space that we lease to others; however, this increase is partially offset by an increase in rental income during the same period.
2007 compared to 2006. The Company invests funds in the participant loss layer for several of the alternative risk transfer programs. The Company receives investment income and incurs an equal expense on the amounts owed to alternative risk transfer. “Expense on amounts withheld” represents investment income that we remit back to alternative risk transfer participants. The related investment income is included in the Company’s “Net investment income” line on its Consolidated Statements of Income. Beginning in 2007, this expense is presented as a separate income statement line item and is no longer included as part of “Other operating and general expenses.” For the year ended December 31, 2007 the expense on amounts withheld increased $1.6 million over the same period in 2006. The increase is directly attributable to the growth in our alternative risk transfer component.
2007 compared to 2006. The 2007 effective tax rate was 33.3%, increasing 0.4% from a rate of 32.9% in 2006. See Note 8 to our audited consolidated financial statements for further analysis of items affecting our effective tax rate.
2006 compared to 2005. The 2006 effective tax rate was 32.9%, remaining unchanged from 2005. While the low tax rate on profits generated by HMG slightly reduced the effective tax rate, that reduction was offset by an increase in income tax expense from the non-deductibility of certain expenses.
Fixed maturity investments are generally invested in securities with intermediate-term maturities. At December 31, 2007, the weighted average maturity of our fixed maturity investments was approximately 4.5 years. At December 31, 2007, 99.3% of the fixed maturities in our portfolio were rated “investment grade” (credit rating of AAA to BBB) by Standard & Poor’s Corporation. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. Management believes that our high quality investment portfolio should generate a stable and predictable investment return.
Included in the fixed maturities were $34.7 million of mortgage backed securities (“MBS”), all backed by agency guaranteed collateral, which did not directly expose us to the subprime lending sector. MBS are subject to higher prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be prepaid more rapidly than scheduled as buyers refinance higher rate mortgages to take advantage of declining interest rates. Also included in fixed maturities were $75.5 million of state and local government obligations (“muni bonds”) with the majority supported by credit enhancement provided by bond insurers. Approximately 94% of our muni bonds are rated A- or better giving no effect to credit enhancement.
Investment grade of AAA to BBB by Standard & Poor’s Corporation.
The table below sets forth the scheduled maturities of fixed maturity securities at December 31, 2007 based on their fair values:
Net realized gains on securities sold and charges for “other-than-temporary” impairment on securities held were as follows:
Contractual Obligations. The following table summarizes our long-term contractual obligations as of December 31, 2007:
We plan to exercise the redemption of these debentures in whole on May 23, 2008.
from Great American review the recorded reserves for NIIC, NIIC-HI and TCC utilizing current period data and provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the statutory reserves recorded by these U.S. insurance subsidiaries. The actuarial analysis of NIIC’s, NIIC-HI’s and TCC’s net reserves as of December 31, 2007 and 2006 reflected point estimates that were within 1% of management’s recorded net reserves as of such dates. Using this actuarial data along with its other data inputs, management concluded that the recorded reserves appropriately reflect management’s best estimates of the liability as of each year end.
The judgments and uncertainties surrounding management’s reserve estimation process and the potential for reasonably possible variability in management’s most recent reserve estimates may also be viewed by looking at how recent historical estimates of reserves for all lines of business have developed. If our December 31, 2007, reserves (net of reinsurance) developed at the same rate as the average development of the most recent five years, the effect on net earnings would be an increase of $5.7 million.
A significant portion of our workers’ compensation business is written in California. Significant reforms passed by the California state legislature in 2003 and in 2004 reduced employer premiums and set treatment standards for injured workers. We recorded favorable prior year loss development of $3.0 million in 2007, $2.3 million in 2006 and $0.2 million in 2005 due primarily to the impact of the legislation on medical claim costs being more favorable than previously anticipated. We continually monitor development trends in each line of business as a component of estimating future ultimate loss and related LAE liabilities.
While the standard actuarial techniques do reflect expected favorable impacts from the reforms, the magnitude of future cost savings depends on the implementation and interpretation of the reforms throughout the workers’ compensation system over the next several years. While management applies the actuarial methods mentioned above, more judgment is involved in arriving at the final reserve to be held. For recent accident years, more weight is given to the methods based on claim count and severity. Management reviewed the frequency, severity and loss and LAE ratios implied by the projections from the standard tests in light of the uncertainties of future cost savings and recent rate actions since the reforms, to determine the appropriate reserve level. Due to the long-tail nature of this business, we have been conservative in recognizing the benefits from the reform legislation until a higher percentage of claims have been paid and the ultimate impact of reforms can be determined.
The changes we have recorded in our reserves in the past three years illustrate the potential for revisions inherent in estimating reserves. In 2007, we experienced favorable development of $5.7 million (3.1% of total net reserves) from claims incurred prior to 2007. In 2006, we experienced favorable development of $7.5 million (4.9% of total net reserves) from claims incurred prior to 2006. In 2005, we experienced favorable development of $5.2 million (4.7% of total net reserves) from claims incurred prior to 2005. We did not significantly change our reserving methodology or our claims settlement process in any of these years. The development reflected settlements that differed from the established case reserves, changes in the case reserves based on new information for that specific claim or the differences in the timing of actual settlements compared to the payout patterns assumed in our accident year IBNR reductions. The types of coverages we offer and risk levels we retain have a direct influence on the development of claims. Specifically, short duration claims and lower risk retention levels generally are more predictable and normally have less development. Future favorable or unfavorable development of reserves from this past development experience should not be assumed or estimated. The reserves reported in the financial statements are our best estimate.
estimates about the operations of the issuer and its future earnings potential. Considerations we use in the impairment evaluation process include, but are not limited to:
We closely monitor each investment that has a market value that is below its amortized cost and make a determination each quarter for other-than-temporary impairment for each of those investments. During the year ended December 31, 2007, we recorded $1.0 million in impairment adjustments, primarily related to preferred stocks in the financial and real estate sectors. The write-down’s were directly related to adverse market conditions that began in the last half of 2007 and all of the individual preferred stocks affected are current with dividend payments. We recorded no impairment adjustments in 2006 and a $0.3 million impairment adjustment in 2005. Because total unrealized losses are a component of shareholders’ equity, any recognition of other-than-temporary impairment losses has no effect on our comprehensive income or book value. See “Management’s Discussions and Analysis of Financial Condition and Results of Operations - Investments.”
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Interstate Corporation and subsidiaries at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We have audited National Interstate Corporation’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). National Interstate Corporation’s management is responsible 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’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the National Interstate Corporation’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of National Interstate Corporation and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007 of National Interstate Corporation and our report dated March 7, 2008 expressed an unqualified opinion thereon.
National Interstate Corporation (the “Company”) and its subsidiaries operate as an insurance holding company group that underwrites and sells traditional and alternative risk transfer property and casualty insurance products primarily to the passenger transportation industry and the trucking industry, general commercial insurance to small businesses in Hawaii and Alaska and personal insurance to owners of recreational vehicles and watercraft throughout the United States.
The Company has four property and casualty insurance subsidiaries, National Interstate Insurance Company (“NIIC”), National Interstate Insurance Company of Hawaii, Inc. (“NIIC-HI”), Triumphe Casualty Company (“TCC”), Hudson Indemnity, Ltd. (“HIL”) and six other agency and service subsidiaries. The Company writes its insurance policies on a direct basis through NIIC, NIIC-HI and TCC. NIIC is licensed in all 50 states and the District of Columbia. NIIC-HI is licensed in Hawaii, Michigan and New Jersey. The Company purchased TCC effective January 1, 2006. TCC, a Pennsylvania domiciled company, holds licenses for multiple lines of authority, including auto-related lines, in 24 states and the District of Columbia. HIL is domiciled in the Cayman Islands and provides reinsurance for NIC, NIIC-HI and TCC primarily for the alternative risk transfer product. The Company also assumes a portion of premiums written by other affiliate companies whose passenger transportation insurance business it manages. Insurance products are marketed through multiple distribution channels including, independent agents and brokers, affiliated agencies and agent internet initiatives. The Company uses its six agency and service subsidiaries to sell and service the Company’s insurance business. This includes Hudson Management Group, Ltd. (“HMG”), a Virgin Islands corporation based in St. Thomas, which commenced operations in the first quarter of 2006. Approximately 17.1% of the Company’s premiums are written in the state of California, and an additional 31.4%, collectively, in the states of Hawaii, New York, North Carolina, Florida and Texas.
The costs of acquiring new business, principally commissions and premium taxes and certain underwriting expenses directly related to the production of new business, are deferred and amortized over the period in which the related premiums are earned. Policy acquisition costs are limited based upon recoverability without any consideration for anticipated investment income and are charged to operations ratably over the terms of the related policies. The Company accelerates the amortization of these costs for premium deficiencies. The amount of deferred policy acquisition costs amortized to income during the years ended December 31, 2007, 2006 and 2005 were $44.6 million, $37.7 million and $33.5 million, respectively. There were no premium deficiencies for the years ending December 31, 2007, 2006 and 2005.
Property and equipment are reported at cost less accumulated depreciation and amortization. Property and equipment are depreciated or amortized over the estimated useful lives on a straight-line basis. The useful lives range from 3 to 5 years for computer equipment, 20 to 40 years for buildings and improvements and 5 to 7 years for all other property and equipment. Property and equipment include capitalized software developed or acquired for internal use. Upon sale or retirement, the cost of the asset and related accumulated depreciation are eliminated from their respective accounts and the resulting gain or loss is included in operations. Repairs and maintenance are charged to operations when incurred.
Comprehensive income includes the Company’s net income plus the changes in the unrealized gains or losses (net of income taxes) on the Company’s available-for-sale securities and securities lending collateral. The details of the comprehensive income are reported in the Consolidated Statements of Shareholders’ Equity.
In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS Nos. 133 and 140. SFAS No. 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 was effective for all financial instruments acquired or issued after January 1, 2007. The adoption of this statement had no impact on the Company’s financial condition, results of operations or liquidity.
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 and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company will adopt SFAS No. 157 on January 1, 2008 and such adoption will not have a material impact on financial condition, results of operations or liquidity.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to elect to measure many financial instruments and certain other items at fair value. Upon adoption of SFAS No. 159, an entity may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option should only be made at the initial recognition of the asset or liability or upon a re-measurement event that gives rise to the new-basis of accounting. All subsequent changes in fair value for that instrument are reported in earnings. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be recorded at fair value nor does it eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective January 1, 2008, for calendar year companies. The Company did not elect the fair value option for any of its eligible assets or liabilities at the effective date.
At December 31, 2007, the unrealized losses on the Company’s fixed maturities portfolio were primarily caused by interest rate changes. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 99.3% of the fixed maturity unrealized losses, which is an indication of the credit quality of those investments. Approximately 50% of the fixed maturities unrealized losses related to eight bonds, whose market value has declined primarily because of interest rates. The Company has represented that it will hold these bonds until maturity or recovery. The Company has the ability to hold the fixed-maturity securities that are adversely impacted by interest rates to recovery, and will do so, as long as the securities continue to remain consistent with the Company’s investment strategy. If the Company’s strategy was to change or these securities were determined to be other-than-temporarily impaired, the Company would recognize a write-down in accordance with its stated policy.
The 2007 unrealized losses in the equity securities were the result of overall investment market conditions, primarily related to the financial and real estate sectors. Management believes these unrealized losses are temporary and that no individual unrealized loss is material to the financial statements. The Company has represented that it will hold until recovery, four floating rate preferred stocks representing approximately 10% of the equity securities unrealized loss that were primarily due to their structure and general market conditions.
The Company uses office facilities in five other locations under leases, which expire through 2013. In February 2008, the Company signed a five year lease agreement extension at one of these locations. Minimum future operating lease obligations for these leases at December 31, 2007 and, including the lease extension signed in February 2008, total $1.3 million and are as follows: 2008 - $0.3 million; 2009 - $0.3 million; 2010 - $0.2 million; 2011 - $0.2 million; and 2012 and thereafter - $0.3 million.
Total rental expense (which includes utilities where charged by lessor) charged to operations for the years ended December 31, 2007, 2006 and 2005 were $0.5 million, $0.4 million and $0.3 million, respectively.
On December 19, 2007 the Company replaced its $2.0 million credit agreement with a $50 million five-year unsecured Credit Agreement (the “Credit Agreement”), which includes a sublimit of $10 million for letters of credit. The Company has the ability to increase the line of credit to $75 million subject to the Credit Agreement’s accordion feature. Amounts borrowed bear interest at either (1) a rate per annum equal to the greater of the administrative agent’s prime rate or 0.5% in excess of the federal funds effective rate or (2) rates ranging from 0.45% to 0.90% over LIBOR based on the Company’s A.M. Best insurance group rating, or 0.65% at December 31, 2007. Commitment fees on the average daily unused portion of the Credit Agreement also vary with the Company’s A.M. Best insurance group rating and range from 0.090% to 0.175%, or .125% at December 31, 2007.
In August 2006, the Company’s unsecured four-year term loan matured and the balance was paid off.
The Company recognized no liability for unrecognized tax benefits at January 1, 2007. In addition, the Company has not accrued for interest and penalties related to unrecognized tax benefits. However, if interest and penalties would need to be accrued related to unrecognized tax benefits, such amounts would be recognized as a component of the provision for federal income taxes.
The Company files income tax returns in the U.S. federal jurisdiction and various state and U.S. territory jurisdictions. The Company is no longer subject to U.S. federal or state income tax examination for years before 2004. There are no ongoing examinations of income tax returns by federal or state tax authorities.
On January 1, 2006, the Company adopted SFAS No. 123(R) (revised version of SFAS No. 123) which requires measurement of compensation cost for all stock-based awards based on the grant-date fair value and recognition of compensation cost over the requisite service period of stock-based awards. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with the Company’s valuation methodology used for all options granted since the Company’s initial public offering in 2005. The Company adopted SFAS No. 123(R) using the modified prospective method for awards issued subsequent to the Company’s initial public offering, which provides for no retroactive application to prior periods and no cumulative adjustment to equity accounts. It also provides for expense recognition, for both new and existing stock-based awards, as the required services are rendered. The Company adopted SFAS No. 123(R) using the prospective method for awards issued prior to the Company’s initial public offering. Awards issued prior to the initial public offering were valued for disclosure purposes using the minimum value method. No compensation cost will be recognized for future vesting of these awards.
The Company grants options and other stock awards to officers of the Company under the LTIP. At December 31, 2007, there were 906,691 of the Company’s common shares reserved for issuance under the LTIP and options for 623,050 shares were outstanding. In 2007, the Company granted restricted stock awards and a stock bonus award under the LTIP. Treasury shares are used to fulfill the options exercised and other awards granted. Options and restricted shares vest pursuant to the terms of a written grant agreement. Options must be exercised no later than the tenth anniversary of the date of grant. As set forth in the LTIP, the Compensation Committee of the Board of Directors may accelerate vesting and exercisability of options. The Compensation Committee of the Board of Directors must approve all grants.
For the years ended December 31, 2007 and 2006, respectively, the Company recognized stock-based compensation expense of $1.2 million and $0.8 million. The expense for 2007 includes $0.4 million for stock bonus and restricted stock awards. Related income tax benefits were approximately $0.2 million and $0.1 million for 2007 and 2006, respectively. The Company has included stock-based compensation expense with the “Other operating and general expenses” line item in the Consolidated Statements of Income.
The Company uses the Black-Scholes option pricing model to calculate the fair value of its option grants. Due to a lack of historical data, the Company uses the Securities and Exchange Commission’s (the “SEC”) simplified method of calculating expected term for all grants made in 2007 and 2006. The fair value of options granted was computed using the following weighted-average assumptions as of grant date:
The following table sets forth the remaining compensation cost yet to be recognized for unvested stock-option awards and nonvested shares of common stock awards that have been awarded as of December 31, 2007:
The Savings Plan also provides for tax-deferred contributions by employees. Participants may elect to have their funds (savings contributions and allocated profit sharing distributions) invested in their choice of a variety of investment vehicles offered by an unaffiliated investment manager. The Savings Plan does not provide for employer matching of participant contributions. The Company does not provide other postretirement and postemployment benefits.
For the year ended December 31, 2007 there were no outstanding options excluded from dilutive earnings because they were anti-dilutive. For the years ended December 31, 2006 and 2005 there were 285,000 and 215,000, respectively, outstanding options excluded from dilutive earnings per share because they were anti-dilutive.
also serving as Chief Executive Officer, obtained a limited partnership interest in the fund. As of December 31, 2007, the Chairman held a limited partnership interest in Clutterbuck of approximately 7%.
Does not reflect a $10.7 million letter of credit that is held as collateral for the net receivable from TRAX Insurance Ltd., a member-owned captive insurance program.
The foregoing reconciliation shows decreases of $5.7 million, $7.5 million and $5.2 million in the years ended December 31, 2007, 2006 and 2005, respectively, representing favorable development in claims incurred in years prior to 2007, 2006 and 2005, respectively. The favorable development in these three years resulted from the combination of settling cases and adjusting current estimates of case and incurred but not reported losses (“IBNR”) for amounts less than the case and IBNR reserves carried at the end of the prior year for most of the Company’s lines of business. Management of the Company evaluates case and IBNR reserves based on data from a variety of sources including the Company’s historical experience, knowledge of various factors and industry data extrapolated from other insurers writing similar lines of business.
For the years ended December 31, 2007, 2006 and 2005 balances related to alternative risk transfer programs were as follows:
NIIC, NIIC-HI and TCC are subject to insurance regulations that limit the payment of dividends without the prior approval of their respective insurance regulators. Without prior regulatory approval, the maximum amount of dividend that may be paid by NIIC to the Company based on the greater of 10% of prior year surplus or net income is $37.7 million. NIIC-HI’s maximum distribution to NIIC based on the lesser of 10% of prior year surplus or net income is $0.8 million. TCC’s maximum distribution to NIIC based on the lesser of 10% of prior year surplus or net income is $0.5 million.
We are subject at times to various claims, lawsuits and legal proceedings arising in the ordinary course of business. All legal actions relating to claims made under insurance policies are considered in the establishment of our loss and loss adjustment expense reserves. In addition, regulatory bodies, such as state insurance departments, the SEC, the Department of Labor and other regulatory bodies may make inquiries and conduct examinations or
As a direct writer of insurance, the Company receives assessments by state funds to cover losses to policyholders of insolvent or rehabilitated companies and other authorized fees. These mandatory assessments may be partially recovered through a reduction in future premium taxes in some states over several years. At December 31, 2007 and 2006, the liability for such assessments was $3.6 million and $3.3 million, respectively, and will be paid over several years as assessed by the various state funds.
Earnings per share are computed independently for each quarter and the full year based upon respective average shares outstanding. Therefore, the sum of the quarterly earnings per share amounts may not equal the annual amounts reported.