Owned Properties. The Company owns two parcels of unimproved property consisting of a total of approximately seven acres located in Fulton and Washington Counties, Georgia. At December 31, 2001, the aggregate book value of such properties was approximately $46,000.
American Southern leases space for its offices in a building located in Atlanta, Georgia. The lease term expires January 31, 2010. Under the terms of the lease, American Southern occupies approximately 17,014 square feet.
Association Casualty leases space for its principal offices in a building located in Austin, Texas. The lease term expires December 31, 2005. Under the terms of the lease, Association Casualty occupies 18,913 square feet.
Atlantic American is an insurance holding company whose operations are conducted through a group of regional insurance companies: American Southern Insurance Company and American Safety Insurance Company (together known as “American Southern”); Association Casualty Insurance Company and Association Risk Management General Agency, Inc. (together known as “Association Casualty”); Georgia Casualty & Surety Company (“Georgia Casualty”); and Bankers Fidelity Life Insurance Company (“Bankers Fidelity”). Each operating company is managed separately based upon the geographic location or the type of products it underwrites.
The accounting and reporting policies of Atlantic American Corporation and its subsidiaries are in accordance with accounting principles generally accepted in the United States and, in management’s belief, conform to general practices within the insurance industry. The following is an explanation of the Company’s accounting policies considered most significant by management. These accounting policies inherently require estimation and actual results could differ from these estimates. Atlantic American does not expect that changes in the estimates determined under these policies would have a material effect on the Company’s financial condition or liquidity, although changes could have a material effect on its consolidated results of operations.
Reinsurance receivables are amounts due from reinsurers and comprise 12% of the Company’s total assets at December 31, 2001. Allowances for uncollectible amounts are established against reinsurance receivables owed to the Company under reinsurance contracts, if appropriate. Failure of reinsurers to meet their obligations due to insolvencies or disputes could result in uncollectible amounts and losses to the Company.
Deferred income taxes comprise less than 1% of the Company’s total assets at December 31, 2001. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for tax purposes. These deferred taxes are measured by applying currently enacted tax laws. Valuation allowances are recognized to reduce the deferred tax assets to the amount that is more likely than not to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income.
Deferred acquisition costs comprise 6% of the Company’s total assets at December 31, 2001. Deferred acquisition costs are commissions, allowances, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to income in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance).
Future policy benefits comprise 14% of the Company’s total liabilities at December 31, 2001. These liabilities relate to life insurance products, and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from these assumptions, the amount of the Company’s recorded liability could require adjustment.
On a consolidated basis the Company’s net income for 2001 was $3.6 million or $.10 per diluted share. Net income was $3.6 million ($.12 per diluted share) in 2000 and $10.9 million ($.46 per diluted share) in 1999. In 1999, net income was favorably impacted by a $7.0 million deferred tax benefit related primarily to a reduction in the Company’s valuation allowance that had previously been established against its net deferred tax asset as compared to a benefit of $0.5 million in 2000 and $0.8 million in 2001. Pre-tax income decreased from $4.8 million in 2000 to $4.3 million in 2001. The decline in pre-tax income for 2001 was due primarily to unsatisfactory underwriting results in Association Casualty related to adverse development on prior year losses. Excluding Association Casualty, all of the Company’s operating units reported profitable results.
Ceded premiums at American Southern increased $1.3 million or 28.9% during 2001. The increase in ceded premiums is due to several factors. First, the rates charged by reinsurance companies increased approximately 10% over 2000. In addition, American Southern’s premiums are ceded on an earned basis as opposed to on a written basis, which results in an increase in ceded premiums when earned premiums increase. Lastly, the company collected $0.4 million in penalty premiums from a specific reinsurance agreement (the “Reinsurance Agreement”) and remitted them to the reinsurer. The Reinsurance Agreement is related to certain program business and provides for additional penalty premiums based on losses. During 2000, there were no penalty premiums collected by American Southern and, as a result, ceded premiums increased in 2001 over ceded premiums in 2000.
The performance of an insurance company is often measured by the combined ratio. The combined ratio represents the percentage of losses and other expenses that are incurred for each dollar of premium earned by the company. A combined ratio of under 100% represents an underwriting profit while a combined ratio of over 100% indicates an underwriting loss. The combined ratio is divided into two components, the loss ratio (the ratio of losses incurred to premiums earned) and the expense ratio (the ratio of expenses incurred to premiums earned).
The combined ratio for American Southern decreased from 97.8% in 2000 to a combined ratio of 94.8% in 2001. The loss ratio decreased from 70.4% in 2000 to 66.8% in 2001. During 2001, American Southern released approximately $1.4 million of redundant reserves related to certain program business that favorably impacted the loss ratio for 2001. The expense ratio for 2001 is up to 28.0% from 27.4% in 2000. The combined ratio for American Southern for 2000 was 97.8%, up slightly from the 1999 combined ratio of 95.9%. The loss ratio decreased slightly to 70.4% in 2000 from 70.6% in 1999. The decrease in the loss ratio was the result of lower than anticipated losses on the personal auto line of business. The expense ratio for 2000 was 27.4% compared to 25.3% in 1999. The increase in the expense ratio in 2001 and 2000 is a direct result of American Southern’s business structure. The majority of American Southern’s business is structured in such a way that the agents are rewarded or penalized based upon the loss ratio of the business they submit to the company. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with the company. As a result of this arrangement, in periods where losses and the loss ratio decrease, commission and underwriting expenses increase.
The following table summarizes Association Casualty’s premiums and losses (dollars in thousands):
Includes results for the period July 1, 1999 	through December 31, 1999.
In 2001, the company had net earned premiums of $25.7 million of which 88.6% was workers’ compensation business compared to 94.7% during 2000 as illustrated in the following table.
Includes results for the period July 1, 1999 	through December 31, 1999
Net earned premiums declined 10.5% or $3.0 million during 2001 primarily due to the quota share reinsurance agreement discussed previously. As presented in the table above, Georgia Casualty continues to diversify its book of business into commercial lines other that workers’ compensation, repositioning the company as a one-stop commercial lines carrier. Furthermore, the company is attempting to spread its geographical exposure by reducing its concentration in Georgia and expanding in its other key southeastern states.
The combined ratio for Georgia Casualty decreased from 116.0% in 2000 to 103.3% in 2001. The loss ratio declined from 77.7% in 2000 to 69.0% in 2001. During 2000, in an effort to strengthen loss reserves and better position the company to capitalize on market opportunities, a comprehensive review of all loss reserves and open claims was performed. These initiatives resulted in reserve increases and consequently, an unusually high loss ratio which accounts for the decline in the loss ratio during 2001. In addition, the decrease is also attributable to the company’s strict adherence to underwriting discipline and premium rate increases. The expense ratio decreased from 38.3% in 2000 to 34.3% in 2001 primarily as a result of the ceding commission the company is receiving from the quota share contract put into place during 2001.
The following summarizes Bankers Fidelity’s premiums and operating results (dollars in thousands):
For the year 2000, premium revenue at Bankers Fidelity increased 14.7%, or $6.1 million over 1999 results. The most significant increase in premiums during 2000 was in the Medicare supplement line of business. The increase in premium revenue from 1999 to 2000 was primarily due to the expansion of the company’s market presence in the Mid-Atlantic and Western regions in addition to significant rate increases.
Effective December 31, 2001, the Revolving Credit Facility and letter of credit were both amended by Wachovia. The amendment establishes new covenants pertaining to ratios related to interest coverage and eliminates funded debt to EBITDA except for use in determining the applicable margin. In addition, the Company is required to consolidate the Revolving Credit Facility and the Bonds into a term loan (“Term Loan”), effective on April 2, 2002, which will mature June 30, 2004. The Company has notified the holders of the Bonds that they will be redeemed as of April 2, 2002. The Company must repay the principal of the Term Loan in annual installments in the amount of $2.0 million on or before December 31 of 2002 and 2003, together with one final installment at maturity in 2004. As of December 31, 2001, the Company was in compliance with all debt covenants, as revised on December 31, 2001.
The Company believes that the cash flows it receives from its subsidiaries and, if needed, additional borrowings from banks and affiliates of the Company, will enable the Company to meet its liquidity requirements for the foreseeable future. Management is not aware of any current recommendations by regulatory authorities which, if implemented, would have a material adverse effect on the Company’s liquidity, capital resources or operations.
In 1999, the NAIC completed a process to codify statutory accounting practices for certain insurance enterprises (“Codification”). The Company adopted Codification on January 1, 2001. The cumulative effect of this accounting change increased statutory surplus by approximately $1.4 million. The most significant increase to statutory surplus was the recognition of deferred taxes. The Codification did not impact the Company’s financial statements prepared in accordance with generally accepted accounting principles in the United States.
In August 2001, SFAS No. 143, “Accounting for Asset Retirement Obligations” (effective for fiscal periods commencing after June 15, 2002) and SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (effective for fiscal periods commencing after December 15, 2001) were issued. SFAS No. 143 requires that entities recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. The statement superseded SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” and among other factors, establishes criteria beyond that previously specified in Statement 121 to determine when a long-lived asset is to be considered
We have audited the accompanying consolidated balance sheets of ATLANTIC AMERICAN CORPORATION (a Georgia corporation) and subsidiaries (the “Company”) as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements and the schedules referred to below are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) which, as to insurance companies, differ from the statutory accounting practices prescribed or permitted by regulatory authorities. These financial statements include the accounts of Atlantic American Corporation (the “Company”) and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Life insurance premiums are recognized as revenues when due, whereas accident and health premiums are recognized over the premium paying period. Benefits and expenses are associated with premiums as they are earned so as to result in recognition of profits over the lives of the contracts. This association is accomplished by the provision of a future policy benefits reserve and the deferral and subsequent amortization of the costs of acquiring business, “deferred policy acquisition costs” (principally commissions, premium taxes, advertising and other expenses of issuing policies). Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. The deferred policy acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance).
Deferred income taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from differences between the financial reporting and tax basis of assets and liabilities and are adjusted for changes in tax laws and tax rates as those changes are enacted. The provision for income taxes represents the total amount of income taxes due related to the current year, plus the change in deferred taxes during the year.
In August 2001, SFAS No. 143, “Accounting for Asset Retirement Obligations” (effective for fiscal periods commencing after June 15, 2002) and SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (effective for fiscal periods commencing after December 15, 2001) were issued. SFAS No. 143 requires that entities recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. The statement superseded SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” and among other factors, establishes criteria beyond that previously specified in Statement 121 to determine when a long-lived asset is to be considered as held for sale. The Company believes that the adoption of SFAS No. 143 and SFAS No. 144 will not have significant impact on the Company’s financial statements.
Bonds and cash having an amortized cost of $15,925 and $16,187 were on deposit with insurance regulatory authorities at December 31, 2001 and 2000, respectively, in accordance with statutory requirements.
Annualized premiums for accident and health insurance policies were $44,763 and $39,361 at December 31, 2001 and 2000, respectively.
experience, and (c) estimates of loss adjustment expenses. The estimated liability is continually reviewed by management and independent consulting actuaries and updated with changes to the estimated liability recorded in the statement of operations in the year in which such changes are known.
A reconciliation of the differences between income taxes computed at the federal statutory income tax rate and the provision (benefit) for income taxes is as follows:
As of December 31, 2001 and 2000, a valuation allowance of $5,610 and $6,437, respectively, has been established for deferred income tax benefits relating primarily to net operating loss carryforwards scheduled to expire between 2002 and 2003 that may not be realized. In 2001 and 2000, respectively, the decrease of $827 and $537 in the valuation allowance is due primarily to the utilization of a portion of these benefits that were previously reserved for. Since the Company’s ability to generate taxable income from operations and utilize available tax-planning strategies in the near term is dependent upon various factors, many of which are beyond management’s control, management believes that it is more likely than not that the remaining deferred income tax benefits relating primarily to the carryforwards scheduled to expire in 2002 and 2003 will not be realized. However, realization of the remaining deferred income tax benefits will be assessed periodically based on the Company’s current and anticipated results of operations and amounts could increase or decrease in the near term if estimates of future taxable income change. The Company has formal tax-sharing agreements and files a consolidated income tax return with its subsidiaries.
The Company is required, under both instruments, to maintain certain covenants including, among others, ratios that relate funded debt to total capitalization and interest coverage. The Company must also comply with limitations on capital expenditures and additional debt obligations.
Effective December 31, 2001, the Revolving Credit Facility and letter of credit were both amended by Wachovia. The amendment establishes new covenants pertaining to ratios related to interest coverage and eliminates funded debt to EBITDA except in determining the applicable margin. In addition, the Company is required to consolidate the Revolving Credit Facility and the Bonds into a term loan (“Term Loan”), effective on April 2, 2002 which will mature June 30, 2004. The Company has notified the holders of the Bonds that they will be redeemed as of April 2, 2002. The Company must repay the principal of the Term Loan in annual installments in the amount of $2,000 on or before December 31 of 2002 and 2003, together with one final installment at maturity in 2004.
On March 21, 2001, the Company entered into an interest rate swap agreement with Wachovia to hedge its interest rate risk on a portion of the outstanding borrowings under the revolving credit facility. The interest rate swap was effective on April 2, 2001 and matures on June 30, 2004. The Company has agreed to pay a fixed rate of 5.1% and receive 3-month LIBOR until maturity. The settlement date and the reset date will occur every 90 days following April 2, 2001 until maturity. The following table summarizes the notional amount, fair value and carrying value of the Company’s derivative financial instruments at December 31, 2001, as follows:
The following summarizes the Company’s proforma unaudited results of operations for the year ended December 31, 1999 assuming the purchase of ACIC and ARMGA had been consummated as of January 1, 1999.
This proforma financial information has been prepared for informational purposes only and is not necessarily indicative of the results of operations had the transaction been consummated on January 1, 1999, nor is it indicative of results of operations that may be obtained in the future.
During 2000, American Southern renewed one of its larger accounts. Although this contract was renewed through a competitive bidding process, one of the parties bidding for this particular contract contested the award of this business to American Southern and filed a claim to obtain the nullification of the contract. During the fourth quarter of 2000, American Southern received an unfavorable judgment relating to this litigation and has appealed the ruling. The contract, which accounts for approximately 10% of annualized premium revenue, is to remain in effect pending appeal. While management at this time cannot predict the potential outcome in this case, or quantify the actual impact of an adverse decision, it may have a material impact on the future results of operations of the Company.
From time to time, the Company and its subsidiaries are involved in various claims and lawsuits incidental to and in the ordinary course of their businesses. In the opinion of management, such claims will not have a material effect on the business or financial condition of the Company.
In accordance with the Company’s 1992 Incentive Plan, the Board of Directors may grant up to 1,800,000 stock options or share awards. The Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company’s common stock and other stock unit awards; (e) deferred shares of common stock; or (f) all or any combination of the foregoing to officers and key employees. Options granted under this plan expire five or ten years from the date of grant. Vesting occurs at 50% upon issuance of an option, and the remaining portion is vested at 25% increments in each of the following two years. In accordance with the Company’s 1996 Director Stock Option Plan, a maximum of 200,000 stock options may be granted that fully vest six months after the grant date. As of December 31, 2001, an aggregate of sixty-six employees, officers and directors held options under the two plans.
A summary of the status of the Company’s stock option plans at December 31, 2001 and 2000, is as follows:
The following assumptions were used to measure the projected benefit obligation for the benefit plans at December 31, 2001, 2000, and 1999:
The following table sets forth the benefit plans’ funded status at December 31, 2001 and 2000:
The Company has 25,000 shares of Series C Preferred Stock (“Series C Preferred Stock”) outstanding, having a stated value of $100 per share. Annual dividends are $9.00 per share and are cumulative. The Series C Preferred Stock is not currently convertible but may become convertible into shares of the Company’s common stock under certain circumstances. In such event, the Series C Preferred Stock would be convertible into an aggregate of approximately 627,000 shares of the common stock at a conversion price of $3.99 per share. The Series C Preferred Stock is redeemable at the option of the Company. The Company paid $225 in dividends to the holders of the Series C Preferred Stock during 2001.
In the normal course of business and, in management’s opinion, at terms comparable to those available from unrelated parties, the Company has engaged in transactions with its Chairman and his affiliates from time to time. These transactions include leasing of office space, investing and financing. A brief description of each of these is discussed below.
The Company leases approximately 65,489 square feet of office and covered garage space from an affiliated company. In the years ended December 31, 2001, 2000, and 1999, the Company paid $961, $904 and $898, respectively, under the leases.
In 1998, Georgia Casualty began assuming workers’ compensation premiums from Delta Fire & Casualty Insurance Company which is controlled by certain affiliates of the Company. Premiums assumed and commissions paid in 2001 were $1,554 and $212, respectively, and in 2000 were $2,238 and $288, respectively.
In 1998, American Southern formed the American Auto Insurance Agency (the “Agency”) in a joint venture with the AAA of Carolinas motor club to market personal automobile insurance to the members of the automobile club. American Southern holds a 50% interest in the joint venture and underwrites the majority of the standard automobile business written by the Agency. This program, which began writing business in 1999, had gross written premiums of approximately $6,084 and $7,200 in 2001 and 2000, respectively.
The fair value estimates as of December 31, 2001 and 2000 are based on pertinent information available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, current estimates of fair value may differ significantly from amounts that might ultimately be realized.
The Company’s comprehensive income consists of net income and unrealized gains and losses on securities available for sale, net of applicable income taxes.
Other than net income, the other components of comprehensive income (loss) for the years ended December 31, 2001, 2000 and 1999 are as follows:
The following table sets forth a summary of the quarterly unaudited results of operations for the two years ended December 31, 2001 and 2000: