The Company leases office space at 5215 Monroe Street, Sylvania, Ohio. The lease covers approximately 3,400 square feet and expires in December, 2012, with an option to renew for an additional five years.
4 Data is for all coverages combined, does not include fee income and is presented based upon U.S. generally accepted accounting principles.
For several years, the Company’s investment philosophy has emphasized the purchase of short-term bonds with maximum quality and liquidity. As flat yield curves have not provided a strong incentive to lengthen maturities in recent years, the Company has continued to maintain its fixed maturity portfolio at short-term levels. The average contractual life of the Company’s bond and short-term investment portfolio increased from 3.0 to 3.8 years during 2009. The average duration of the Company’s fixed maturity portfolio is shorter than the contractual maturity average and much shorter than the duration of the Company’s liabilities. The Company also remains an active participant in the equity securities market using capital which is in excess of amounts considered necessary to fund current operations. The long-term horizon for the Company’s equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by the Company’s domestic insurance subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners which are designed to provide protection for both policyholders and shareholders.
The Company’s assets at December 31, 2009 included $86.8 million in short-term and cash equivalent investments which are readily convertible to cash without market penalty and an additional $168.7 million of fixed maturity investments (at par) maturing in less than one year. The Company believes that these liquid investments, plus the expected cash flow from current operations, are more than sufficient to provide for projected claim payments and operating cost demands. In the event competitive conditions produce inadequate premium rates and the Company chooses to further restrict volume, the liquidity of its investment portfolio would permit management to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, the Company’s reinsurance program is structured to avoid significant cash outlays that accompany large losses.
Net premiums written by the Company’s U.S. insurance subsidiaries for 2009 equaled approximately 40% of the combined statutory surplus of these subsidiaries. Premium writings of 100% to 200% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
At December 31, 2009, $68.0 million, or 18% of shareholders’ equity, represented net assets of the Company’s insurance subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company maintains a $20 million unsecured line of credit and has $10.0 million of drawings outstanding on this line at December 31, 2009, the proceeds of which were used largely for the repurchase of treasury shares.
Direct premiums written for 2009 totaled $209.1 million, an increase of $26.3 million (14%) from 2008. The increase is primarily attributable to $19.0 million in premiums generated by new product lines and a $6.1 million (30%) increase in the Company's Private Passenger Automobile business. New product premiums are derived from commercial property and business owners’ liability business. Premiums ceded to reinsurers on direct business increased $18.8 million (47%) during 2009 to $58.6 million as the consolidated percentage of premiums ceded to direct premiums written increased to 28.0% for 2009 from 21.8% for 2008. This increase is reflective of expansion of the workers’ compensation component of Fleet Transportation business, increased use of facultative reinsurance and the Company's expansion into commercial property and business owners’ liability business.
Pre-tax investment income of $14.0 million reflects a decrease during 2009 compared to 2008 as pre-tax yields were down 11% on average reflecting worldwide lower available rates, principally on short-term investments. After tax investment income decreased by 20% during 2009, compared to the prior year.
Net gains on investments, before taxes, totaled $30.8 million in 2009 compared to a net loss on investments of $47.7 million last year. The gains in 2009 are attributable to $5.2 million in fixed maturity and equity security net direct trading gains and $25.6 million in limited partnerships net gains. Limited partnership ventures utilized by the Company are primarily engaged in the trading of public and private securities, including foreign securities and, to a lesser extent, small venture capital activities and real estate development. The aggregate of the Company’s share of earnings in these entities represented a positive return of 57% for 2009 versus a negative return of 43% for 2008. To the extent that accounting rules require the limited partnerships to include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include the results as reported to the Company by the various general partners. Adjustments attributable to "other-than-temporary impairment" of $2.5 million in recoveries during 2009 increased fixed maturity and equity security net gains as stated above.
The Fleet Transportation loss ratio for 2009 was impacted by lower current year losses primarily from the independent contractor product. Factors such as fluctuations in premium volume, the levels of self-insured retentions and the Company’s higher net retention under reinsurance treaties in recent years allow for more volatility in losses. The increase in the Private Passenger Automobile loss ratio is due primarily to higher current year losses and also reflects the higher premium volume
The Company produced an overall savings on the handling of prior year claims during 2009 of $9.6 million. This net savings is included in the computation of loss ratios shown in the previous table, as is the $17.1 million savings produced during 2008 on prior year claims. This net savings included a $4.6 million deficiency attributable to reinsurance, principally resulting from increases to Hurricane Ike losses not reported to the Company until 2009. The $14.2 million net savings attributable to direct business was distributed among all of the Company’s products, with the majority attributable to the Company's independent contractor and large Fleet Transportation businesses, and is generally consistent with recent prior years. Because of the high limits provided by the Company to its Fleet Transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the Fleet Transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company's reinsurance structure for its Fleet Transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
A portion of the Company’s Fleet Transportation business is produced by direct sales efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not incur commission expense on a consolidated basis. Instead, the expenses of the agency operations, including salaries and bonuses of salesmen, travel expenses, etc. are included in operating expenses. In general, commissions paid by the insurance subsidiaries to the parent company exceed related acquisition costs incurred in the production of the property and casualty insurance business. The ratio of net operating expenses of the insurance subsidiaries to net premiums earned was 35.8% in 2009 and 30.9% in 2008. Including the agency operations and corporate expenses, and after elimination of inter-company commissions, the ratio of operating expenses to operating revenue (defined as total revenue less gains (losses) on investments) was 34.2% for 2009 compared with 28.6% for 2008.
Premiums assumed from other insurers and reinsurers totaled $39.1 million during 2008, an increase of $8.0 million (26%) from 2007. The reinsurance increase resulted from increased premiums generated by most of the Company’s programs
Net losses on investments, before taxes, totaled $47.7 million in 2008 compared to a net gain on investments of $40.1 million last year. These totals include gains and losses from both direct securities trading and investments in limited partnerships. The losses in 2008 are attributable to $11.9 million in fixed maturity and equity security net direct trading losses, $33.6 million in limited partnerships net losses and $2.2 in derivative security net losses. Limited partnership ventures utilized by the Company are primarily engaged in the trading of public and private securities, including foreign securities and small venture capital activities and, to a lesser extent, real estate development. The estimated market value of limited partnership ventures investments was $44.9 million at December 31, 2008 compared to a cost basis of $32.0 million. The aggregate of the Company’s share of earnings in these entities represented a loss of 43% for 2008 versus a positive return of over 40% for 2007. The Company follows the equity method of accounting for its investments in limited partnerships. To the extent that accounting rules require the limited partnerships to include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include unrealized as well as realized gains or losses. The current year limited partnership total is composed of estimated realized gains of $3.4 million and estimated unrealized losses of $37.0 million, as reported to the Company by the general partners. Inception to date unrealized losses included in the December 31, 2008 asset valuation total $6.9 million. Adjustments attributable to "other-than-temporary impairment," of $9.0 million during 2008 are reflected in fixed maturity and equity security net losses as stated above. Further explanation of “other-than-temporary impairment” can be found in Note B to the consolidated financial statements.
The Fleet Transportation loss ratio for 2008 was adversely impacted by increases in reported loss amounts on a handful of severe claims. Also, the loss ratio for the independent contractor product is higher in 2008 as a significant number of insured contractors altered their business structure and therefore transitioned from accident and health to workers’ compensation coverage. Factors such as fluctuations in premium volume, the levels of self-insured retentions and the Company’s higher net retention under reinsurance treaties in recent years allow for more volatility in losses. The decrease in the Private Passenger Automobile loss ratio is due primarily to increased savings on prior years’ losses. The reinsurance loss ratio was higher in 2008 as the result of hurricane losses, principally Hurricane Ike, which added almost 16 points to the
loss ratio for this segment for the year end more than offset a decline in the unusually large amount of tornado and hail losses experienced during 2007.
The Company produced an overall savings on the handling of prior year claims during 2008 of $17.1 million. This net savings is included in the computation of loss ratios shown in the previous table, as is the $21.3 million savings produced during 2007 on prior year claims. This savings was distributed among all of the Company’s products, with the majority attributable to the Company's large Fleet Transportation business, and is generally consistent with recent prior years before consideration of savings related to retrospectively-rated contracts. Because of the high limits provided by the Company to its Fleet Transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the Fleet Transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process. As claims are settled in years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. Changes in both gross premium volumes and the Company's reinsurance structure for its Fleet Transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
Reinsurance ceded credits were $1.2 million (62%) higher in 2008, resulting from the Company ceding a higher percentage of the gross premium to other companies under reinsurance treaties. After consideration of these expense offsets, operating expenses increased $2.2 million, or 4% from the prior year.
The effective federal tax rate on the consolidated loss for 2008 was a benefit of 60.8%. The effective rate differs from the normal statutory rate as a result of tax-exempt investment income.
For the Company’s large fleet trucking risks, which are covered by annually-changing reinsurance agreements and which contain wide-ranging self-insured retentions (“SIR”) as low as $25,000 per loss occurrence and as high as several million dollars per occurrence, traditional actuarial methods are supplemented by other methods in consideration of the Company’s exposures to loss. In situations where the Company’s reinsurance structure, the insured’s SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous with historical loss data to allow for reliable projection of future developed losses. Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from our databases to arrive at the reserve for losses incurred but not reported for the calendar/accident period under review. Management relies on its extensive historical pricing and loss history databases to produce reserve factors unique to this specialty business. As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a quarterly basis and will adjust reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses. This process continues until all losses are settled for each period subject to this method.
Expected loss ratios for the current book of business, particularly the Company’s large fleet excess product, where the number of accounts insured, selected self-insured retentions, policy limits and reinsurance structure may vary widely period to period
Under reasonably possible scenarios, it is conceivable that the Company’s selected loss reserve estimates could be 10%, or more, redundant or deficient. As shown in the table on page 29, the majority of the Company’s reserves for losses and loss expenses, on either a gross or a net of reinsurance basis, relates to the Fleet Transportation product. Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for the Company’s large fleet excess product for policies subject to certain recent major reinsurance treaties (approximately $91.7 million, or approximately 31% of carried direct reserves for Fleet Transportation).
A 10 percentage point increase or decrease in the loss factors actually utilized in the Company’s reserve determination at December 31, 2009 would increase or decrease gross loss reserves by approximately $20.7 million. On a net basis, a 10 percentage point increase in loss ratio would increase net loss reserves by approximately $7.6 million whereas a 10 percentage point decrease would decrease net loss reserves by approximately $10.9 million. Similarly, a 20 percentage point increase or decrease would increase or decrease gross loss reserves by approximately $41.3 million. On a net basis, a 20 percentage point increase in loss ratio would increase net loss reserves by approximately $17.0 million whereas a 20 percentage point decrease would decrease net loss reserves by approximately $22.0 million with the lower impact from loss ratio increases attributable to minimum and maximum factors included in the various reinsurance contracts.
Any forward-looking statements in this report including, without limitation, statements relating to the Company’s plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including, without limitation, the following: (i) the Company’s plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company’s business is highly competitive and the entrance of new competitors into or the expansion of the operations by existing competitors in the Company’s markets and other changes in the market for insurance products could adversely affect the Company’s plans and results of operations; and (iii) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission.
To the extent possible, the Company attempts to recover the costs of inflation by increasing the premiums it charges. Within the Fleet Transportation business, a majority of the Company’s premiums are charged as a percentage of an insured’s gross revenue or payroll. As these charging bases increase with inflation, premium revenues are immediately increased. The remaining premium rates charged are adjustable only at periodic intervals and often require state regulatory approval. Such periodic increases in premium rates may lag far behind cost increases.
The table below sets forth the amounts of the Company's contractual obligations at December 31, 2009.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, 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.
Other investments, if any, are carried at either market value or cost, depending on the nature of the investment. Short-term investments are carried at cost which approximates their fair values.
In April 2009, the Financial Accounting Standards Board (“FASB”) issued guidance on the recognition and presentation of other-than-temporary impairments, or FASB OTTI guidance. The FASB OTTI guidance applies to fixed maturity securities only and provides new guidance on the recognition and presentation of other-than-temporary impairments. In addition, the FASB OTTI guidance requires additional disclosures related to other-than-temporary impairments. Under this revised guidance, if a fixed maturity security is in an unrealized loss position and the Company has the intent to sell the fixed maturity security, or it is more likely than not that the Company will have to sell the fixed maturity security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to net realized losses on investments in the consolidated statements of operations. For impaired fixed maturity securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in net realized losses on investments in the consolidated statements of operations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholder’s equity (accumulated other comprehensive income).
Goodwill and Other Intangible Assets: Goodwill is not amortized. It is instead tested for impairment in accordance with FASB Guidance, at the reporting-unit level. Goodwill is tested annually (during the fourth quarter) or more often if events or circumstances, such as adverse changes in the business climate, indicate there may be impairment. Intangible assets determined to have indefinite lives are not amortized but instead are tested for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Other acquired intangible assets determined to have finite lives, such as customer relationships and employment agreements, are amortized over their estimated useful lives in a manner that best reflects the economic benefits of the intangible asset. In addition, impairment testing is performed on these amortizing intangible assets if impairment indicators are noted.
The fair value and the cost or amortized cost of fixed maturity investments, at December 31, 2009, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.
Shareholders' equity includes approximately $24,000, net of deferred federal income taxes, of earnings yet undistributed by limited partnerships as of December 31, 2009.
The Company has invested a total of $24,000 in three limited partnerships, with an aggregate estimated market value of $48,469 at December 31, 2009, that are managed by organizations in which two directors of the Company are executive officers, directors and owners. The Company’s ownership interest in these limited partnerships ranges from 3% to 25%. These limited partnerships added $18,591, ($25,502) and $19,177, net of fees, to investment gains (losses) in 2009, 2008 and 2007, respectively. During 2009, 2008 and 2007, the Company has recorded management fees of $632, $781 and $765, respectively, and performance-based fees of $1,247, $0 and $4,902, respectively, to these organizations for management of these limited partnerships. The Company has been informed that the fee rates applied to its investments in these limited partnerships are the same as, or lower than, the fee rates charged to unaffiliated customers for similar investments.
The Company utilized the services of a broker-dealer firm of which two directors of the Company are executive officers and owners. This broker-dealer serves as agent for purchases and sales of securities and manages an equity securities portfolio and fixed maturity portfolio with market values of approximately $2,329 and $18,474, respectively, at December 31, 2009. The Company has been informed that commission and management rates charged by this broker-dealer to the Company are commensurate with rates charged to non-affiliated customers for similar investments. Total commissions and fees earned by the broker-dealer and affiliates on these transactions and for advice and consulting were approximately $173, $171 and $170 during 2009, 2008 and 2007, respectively.
The fair value of regulatory deposits with various insurance departments in the United States and Canada totaled $28,128 at December 31, 2009.
The summarized financial information of the significant limited partnership investment as of and for the years ended December 31 is as follows:
The Company’s fixed maturities are over 91% invested in investment grade fixed maturity investments. The Company has a total of $53.2 million (par value) of fixed maturity investments which were originally issued with guarantees by seven different third party insurance companies, with the largest single exposure to a single insurance company being $17 million. The average S&P credit rating of such investments, with consideration of the guarantee, is AAA. The average S&P underlying credit rating of such investments, without consideration of the guarantee, is AA. The Company does not have any direct exposure to any guarantor.
Favorable loss development is influenced by the Company’s long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Loss reserves pertaining to the Company’s reinsurance business are established largely by the ceding reinsurers although the Company may adjust such reserves if management determines that additional reserves could be necessary. Accordingly, the fluctuation in loss developments related to reinsurance assumed will tend to be more pronounced than those experienced on directly produced business which is reserved by Company personnel. In addition, changes in the Company’s net retention under reinsurance treaties will impact developments as more or less business is retained. These trends were considered in the establishment of the Company’s reserves at December 31, 2009 and 2008.
The Company has not changed its original estimate for the loss sustained as a result of the terrorist attacks of September 11, 2001. Therefore, there is no impact on the loss developments shown in the above table except for payments against the
original established reserves. The Company has paid $11.2 million to date and carries a remaining reserve of $8.8 million at December 31, 2009.
Loss reserves have been reduced by estimated salvage and subrogation recoverable of approximately $5,724 and $5,119 at December 31, 2009 and 2008, respectively.
Net losses and loss expenses incurred for 2009, 2008 and 2007 include approximately $17,070, $22,003 and $14,638, respectively, relating to reinsurance from non-affiliated insurance or reinsurance companies, including involuntary residual market pools.
exercised for the same three year period. No compensation cost was charged against income for the Director Plan for 2009, 2008 and 2007.
Cash received from option exercise under all share-based payment arrangements for the year ended December 31, 2007 was $2,211. The federal tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $253 for the year ended December 31, 2007. Under the terms of the Employee Plan, the entire tax benefit realized was passed on to employees in the form of cash for the year ended December 31, 2007.
During 2002 and 2001, the Company offered loans to certain employees for the sole purpose of purchasing the Company's Class B common stock in the open market. Principal and interest totaling $2,054 and $2,199 relating to such loans was outstanding at December 31, 2009 and 2008, respectively. Loans carry interest rates ranging from 4.75% to 6%, payable annually. The underlying securities, with value in excess of the related debt, serve as collateral for these full-recourse loans, which must be repaid no later than 10 years from the date of issue. This loan program was terminated in 2002.
The Company has two reportable business segments in its operations: property and casualty insurance and reinsurance. The property and casualty insurance segment provides multiple line insurance coverage primarily to Fleet Transportation companies and to independent contractors who contract with Fleet Transportation companies. In addition, the Company offers individual personal automobile coverage, business owners’ policies and commercial property business. The reinsurance segment accepts cessions from other insurance companies as well as retrocessions from selected reinsurance companies, principally reinsuring against catastrophes.
The amount of collateral required of an insured is determined by the financial condition of the insured, the type of obligations guaranteed by the Company, estimated reserves for incurred losses within the SIR or deductible that have been reported to the insured or the Company, estimated incurred but not reported losses, and estimates for losses that are expected to occur, within the SIR or deductible, prior to the next collateral adjustment date. In general, the Company attempts to hold collateral equal to 100% of the ultimate losses that would be paid by or due the Company in the event of an insured’s default. Periodic audits are conducted by the Company to evaluate its exposure and the collateral required. If a deficiency in collateral is noted as the result of an audit, additional collateral is requested immediately. Because collateral amounts contain numerous estimates of the Company’s exposure, are adjusted only periodically and are sometimes adjusted based on the financial condition of the insured, the amount of collateral held by the Company at a given point in time may not be sufficient to fully reimburse the Company for all of its guarantees or amounts due in the event of an insured’s default. Further, the Company is not fully collateralized for the guarantees made for, or the deductible amounts that may be due from FedEx Ground and certain of its subsidiaries and related entities, and in the event of their default, such default may have a material adverse impact on the Company. The Company estimates its uncollateralized exposure related to this customer to be as much as 32% of shareholders' equity at December 31, 2009.
In addition, the Company's balance sheet includes paid and estimated unpaid amounts recoverable from reinsurers under various agreements totaling $155,451 at December 31, 2009, as more fully discussed in Note D - Reinsurance. These recoverables are largely uncollateralized. The two largest estimated amounts due from individual reinsurers were $29,681 and $27,709 at December 31, 2009.
Investments in limited partnerships include an aggregate of $48,469 invested in three limited partnerships, New Vernon India Fund, New Vernon Global Opportunity Fund and New Vernon North American Opportunity Fund that are managed by organizations in which two directors of the Company are executive officers, directors and owners.
The Company had amortization of intangible assets of $47, $8 and $0 during 2009, 2008 and 2007, respectively.
In September 2006, the FASB issued guidance on fair value measurement, which provides a common definition of fair value and establishes a framework to make the measurement of fair value more consistent and comparable. The FASB guidance also requires expanded disclosures about (1) the extent to which companies measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair value and (3) the effect of fair value measures on earnings. The Company adopted the FASB guidance, effective January 1, 2008 for financial assets and liabilities. The FASB guidance did not have a significant impact on the Company’s consolidated financial condition or results of operations.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows for the years ended December 31:
Net income of the insurance subsidiaries, as determined in accordance with statutory accounting practices, was $22,855, $19,064 and $35,605 for 2009, 2008 and 2007, respectively. Consolidated statutory surplus for these subsidiaries was $356,658 and $315,529 at December 31, 2009 and 2008, respectively.