Our offices are located at 31 Queen Street, Hamilton, Bermuda, and the telephone number is (441) 296-8560. The principal corporate offices of our U.S. subsidiaries are located at 100 Galleria Parkway, Suite 700, Atlanta, Georgia 30339, and the telephone number is (770) 916-1908.
Common shares and common share equivalents used in computing net basic earnings per share
In our ART segment, Specialty Programs facilitate the offering of insurance to homogeneous niche groups of risks. Fully funded provides a mechanism for insureds to post collateral so as to fully self-insure their risks. In addition we offer a partially funded product complementing our fully funded product and allowing our customers to partially self-insure their risks. We are paid a fee for arranging this type of transaction and, in the case of partially funded business, we may assume some underwriting risks.
Our runoff segment includes lines of business that we have placed in run-off, such as workers’ compensation, excess liability insurance for municipalities and commercial lines.
Year Ended December 31, 2007 compared to Year Ended December 31,
Net premiums earned totaled $148.8 million in 2007, an increase of 1.4% over 2006. Net premiums earned by line of business are described below:
Excess. Net premiums earned remained relatively level at $527,000 for the year ended December 31, 2007. The Company’s excess product offering is focused primarily in the construction and products liability area. During 2006, we expanded our product to write over other carriers’ primary policies and to offer umbrella liability coverage. In 2007 the Company increased the available policy limits to $10 million.
Surety. Net premiums earned increased 113.1% to $5.5 million for the year ended December 31, 2007 compared to $2.6 million for 2006. Effective June 1, 2006 the Company did not renew the quota share reinsurance treaty in its surety line contributing to the increase in net premiums earned. The increase in surety premiums is also due to the Company continuing to focus its growth efforts in the environmental contractor surety market due to the lack of capacity serving this segment of the market. The Company also recently expanded its offerings to include non-environmental contractor bonds. During 2007 we entered into an agreement with a small specialty carrier to provide contract surety to small non-environmental contractors that do not fit the standard surety market.
Specialty Programs. Net premiums earned increased 44.1% to $27.7 million for the year ended December 31, 2007 compared to $19.3 million for 2006. Net premiums earned increased primarily due to increased retention levels on selected programs thereby allowing the Company the opportunity to increase
Fee income earned on fully funded polices increased 27% to $2.1 million for the year ended December 31, 2007 compared to $1.7 million for 2006. The Company has seen some adverse impact from the overall market softening on its production efforts in this line as traditional insurance provides a cost effective alternative to self-insurance.
Net investment income increased 39% to $30.3 million for the year ended December 31, 2007 from $21.8 million for 2006 due to an increase in the Company’s invested assets and higher investment yields. Average invested assets increased to $584.2 million as of December 31, 2007 from $483.6 million as of December 31, 2006. The increase in invested assets was due to $67.0 million of cash flow from operations and the $53 million secondary equity offering completed in June 2006. The average pre-tax investment yield increased from 4.5% to 5.1% from 2006 to 2007.
The table below sets forth the prior year reserve development by the Company for the years ended December 31, 2007 and 2006 (in thousands):
Payroll expenses increased to $17.3 million for the year ended December 31, 2007 from $14.9 million for 2006. The change is primarily due to an increased number of employees which was 178 at December 31, 2007 compared to 145 at the same date 2006.
Interest and other expenses remained flat at $15.6 million for the year ended December 31, 2007 from $15.5 million for 2006 as increased depreciation due to investments in systems and facilities was offset by lower legal fees.
Income tax expense totaled $737,000 or 2.6% of pre-tax earnings for the year ended December 31, 2007, compared to $2.3 million or 10.1% of pre-tax earnings for 2006. The reduction in expense is primarily the result of the prior year reserve development which reduced taxable income in our U.S. subsidiaries. Included in tax expense for 2006, is the establishment of a valuation allowance for American Safety RRG of $1.1 million and 2005 provision to return adjustments for permanent differences in the 2005 federal and state income tax returns of $483,000. The establishment of the valuation allowance is reflected in minority interest on the consolidated financial statements. Absent these adjustments, the effective tax rate for 2006 would have been 5.1%. The reduction in the effective rate is due to lower earnings from U.S. operations from the impact of reinstatement premiums and prior-year loss development.
The Company operates through its subsidiaries in the U.S. and Bermuda. Significant differences exist in the regulatory environment in each country. The table below describes the Company’s operations by geographic segment for the years ended December 31, 2007 and 2006 (in thousands):
Net Income. Netincome from Bermuda operations increased to $26.2 million for the year ended December 31, 2007, compared to $17.0 million for 2006, due to higher investment income as a result of increased invested assets from our $53.0 million secondary offering in 2006 and the addition of the third party assumed reinsurance business in 2007. Net income from U.S. operations decreased to $2.0 million for the year ended December 31, 2007, compared to $3.5 million for 2006, primarily due to prior year loss development and accrued ceded reinsurance reinstatement premium.
Year Ended December 31, 2006 compared to Year Ended December 31,
products to small and middle market accounts. The Company does not intend to write certain high severity classes of risks such as invasive, medical products, pharmaceuticals and neutraceuticals.
Excess. Net premiums earned increased 16.4% to $532,000 for the year ended December 31, 2006 compared to 2005. The Company experienced strong submission activity and production continued to increase. The Company’s excess product offering is focused primarily in the construction and products liability area. The addition of the new underwriting team in Middletown, New Jersey has allowed the Company to expand its excess liability product to write over other carriers’ primary policies and to offer umbrella liability coverage. The Company also increased the available policy limits up to $5.0 million during 2006.
Surety. Net premiums earned increased 123.5% to $2.6 million for the year ended December 31, 2006 compared to $1.1 million for 2005. In line with the Company’s strategy to increase its retention level, effective June 1, 2006 the Company did not renew the quota share reinsurance treaty in its surety line resulting in an increase in net premiums earned. The increase in Surety premiums is also due to the Company continuing to focus its growth efforts in the environmental contractor surety due to the lack of capacity serving this segment of the market. The Company also recently expanded its offerings to include non-environmental contractor bonds.
We introduced a partially funded product during the fourth quarter of 2006 to complement our fully funded product. This product is used for entities that want to self insure a portion of their risk and combines a level of underwriting risk with a self insured component.
million of net proceeds from the Company’s secondary equity offering completed in June 2006. Average invested assets increased to $483.6 million as of December 31, 2006 from $371.3 million as of December 31, 2005. The average pre-tax investment yield increased from 3.9% to 4.5% from 2005 to 2006.
Other expenses increased to $15.5 million for the year ended December 31, 2006 from $13.2 million for 2005. The increase is primarily due to interest expense increasing by $2.1 million due to the November 2005 issuance of $25.0 million of trust preferred securities.
Minority interest expense was negative $1.9 million for the year ended December 31, 2006 compared to $515,000 at December 31, 2005. Our minority interest expense relates to our non subsidiary affiliate, American Safety RRG. In 2006 American Safety RRG had a net loss due to reserve development on its environmental line of business, which produced the negative $1.9 million in minority interest expense.
During 2005, the Company settled litigation related to the rescission of an acquisition of a brokerage firm and related entities. The settlement was for $1.4 million less than the amount previously accrued. There was no such activity in 2006.
Assets. Assets from Bermuda operations increased to $337.6 million at the end of 2006 compared to $167.3 million at the end of 2005. This increase is primarily a result of $53 million raised through a secondary offering in 2006 and loss portfolio transfer from our U.S. insurance subsidiaries to our Bermuda reinsurance subsidiary of $34 million of environmental business related to accident years 2002 through 2006. Assets from U.S. operations at the end of 2006 decreased to $509.5 million as compared to $527.6 million at the end of 2005. The primary reason for the decrease is due to the loss portfolio transfer mentioned above.
The Company meets its cash requirements and finances its growth principally through cash flows generated from operations. Due to the soft market, the Company has experienced a softening of premiums rates due to the entrance of new insurance competitors and overall market conditions. The Company’s primary sources of short-term cash flow are premium writings and investment income. Short-term cash requirements relate to claims payments, ceded reinsurance premiums, commissions, salaries, employee benefits and other operating expenses. Due to the uncertainty regarding the timing and amount of settlements of unpaid claims, the Company’s future liquidity requirements may vary; therefore, the Company has structured its investment portfolio maturities to help mitigate the variations in those factors. The Company believes its current cash flows are sufficient for the short-term needs of its business and its invested assets are sufficient for the long-term needs of its insurance business.
Safety Capital Trust III, respectively as of December 31, 2007. These rates are used to calculate the variable interest rate obligations through maturity. Fixed rates include, where applicable, the effects of interest rate derivatives employed to manage such interest rate risk.
(2) The above table includes the expected settlement of our gross loss reserves. The Company relies on reinsurance to reduce current risk exposures. The expected payoff of gross loss reserves net of reinsurance recoverables is as follows (in thousands): Total $329,298; $84,487 less than a year, $180,118, 1-3 years, $29,410, 3-5 years $35,283, more than 5 years. More information about our unpaid loss and loss adjustment expenses appears in Note 12 to our consolidated financial statements.
• Percentage decline in value and the length of time during which the decline has occurred;
• Adverse changes in the issuer’s availability of production resources, revenue sources, technological conditions; and
Environmental. Most exposures involved common types of bodily injury and property damage claims. These claims tend to be reported sooner but take longer to settle because often times multiple parties are involved in a claim. The loss development patterns and the expected loss ratios are estimated based on our actual emerged losses.
The carried gross loss reserves for material lines of business are as follows (in thousands of dollars):
(1) Represents 30 different programs with diverse risks. Some programs are in runoff.
Our experience with construction claims remains limited and, prior to the fourth quarter of 2005, our reserve calculations were based upon a combination of industry and Company loss development patterns. During that quarter, we retained an actuarial consulting firm that provided us with construction defect claim counts based upon a larger population that we now use to calculate reserves.
(1) Represents 30 different programs with diverse risks. Some programs are in runoff. Each individual program is not material to our total net carried reserves therefore no variability has been shown.
Effective September 1, 2007 the Company entered into a consolidated property reinsurance treaty providing $10 million of limits with a $500,000 per occurrence retention by the Company. This treaty applies to the Company’s property line, as well as certain of its specialty program line.
Policy Acquisition Costs. We defer commissions, premium taxes and other expenses that are related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. This would also give effect to the premiums to be earned and anticipated losses and settlement expenses as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the premiums written.