Our main office and corporate headquarters is located at 10 North Highway 31, Pennington, New Jersey in a facility of approximately 25,000 square feet owned by MIC. We also own a tract of land adjacent to our main office property.
FPIC leases approximately 25,000 square feet for the Group’s west coast operations in Rocklin, California. That lease expires on December 31, 2009, subject to extension. FPIC began construction on a new 41,000 square foot building on the 2.9 acres of land it owns adjacent to the leased building, to which the Rocklin operations will be moved. The cost of the project is expected to be $6.7 million, including improvements and building permits and fees. The land is carried at $1.3 million. FPIC also owns a townhouse, used for corporate purposes, in Rocklin, California carried at $0.4 million.
The ratio of net premiums written divided by ending statutory surplus
Unallocated ESOP shares at December 31 of each year are not reflected in weighted average shares.
We maintain bulk and IBNR reserves (usually referred to as “IBNR reserves”) to provide for claims already incurred that have not yet been reported (and which often may not yet be known to the insured) and for future developments on reported claims. The IBNR reserve is determined by estimating our insurance companies’ ultimate net liability for both reported and incurred but not reported claims and then subtracting both the case reserves and payments made to date for reported claims; as such, the “IBNR reserves” represent the difference between the estimated ultimate cost of all claims that have occurred or will occur and the reported losses and loss adjustment expenses. Reported losses include cumulative paid losses and loss adjustment expenses plus aggregate case reserves. A relatively large proportion of our gross and net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses. More than 74% and 75% of our aggregate loss reserves at December 31, 2008 and 2007, respectively, were bulk and IBNR reserves.
1. Retrospective tests of the ratios of IBNR reserves to earned premiums and to estimated ultimate incurred losses;
For the casualty lines (commercial multi-peril liability, other liability, personal auto liability, commercial auto liability, workers’ compensation) the paid loss development method yielded less than reliable results for the immature years, and we did not use the method in selecting ultimate losses and reserves. For these lines we primarily relied on the incurred Bornhuetter-Ferguson method for the most recent accident years and both of the incurred loss development methods for the remaining years.
The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and mold, and other uncertain or environmental exposures. We have not experienced significant losses from these types of claims.
We compute our estimated ultimate liability using these principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on the Group’s results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.
In evaluating the potential impairment of fixed income securities, the Investment Committee will evaluate relevant factors, including but not limited to the following: the issuer’s current financial condition and ability to make future scheduled principal and interest payments, relevant rating history, analysis and guidance provided by rating agencies and analysts, the degree to which an issuer is current or in arrears in making principal and interest payments, and changes in price relative to the market.
In the years ended December 31, 2008, 2007 and 2006, we recorded a pre-tax charge to earnings of $6.2 million, $0.1 million and $0.1 million, respectively, for write-downs of other than temporarily impaired securities (OTTI).
During the second half of 2008, there were significant disruptions to the financial and equity markets. This resulted from, in part, failures of financial institutions on an unprecedented scale, and caused a significant reduction in liquidity and trading flows in the credit markets in addition to a dramatic widening in credit spreads. Such impacts affected the valuations of both the fixed income and equity securities we held. The loss of confidence and the so-called, “credit freeze” in the capital markets during 2008 led to several significant events, including the conservatorship of Fannie Mae and Freddie Mac, the bankruptcy filing of Lehman Brothers, and an agreement for Merrill Lynch to be acquired by Bank of America, among others.
We write homeowners insurance only in New Jersey and Pennsylvania, and personal automobile insurance only in Pennsylvania. Personal lines insurance is not written in any other states in which we do business.
The key elements of our business model are the sales of properly priced and underwritten personal and commercial property and casualty insurance through independent agents and the investment of the premiums in a manner designed to assure that claims and expenses can be paid while providing a return on the capital employed. Loss trends and investment performance are critical factors in influencing the success of the business model. These factors are affected by the factors impacting the insurance industry in general and factors unique to us as described in the following discussion.
The components of income for 2008 and 2007, and the change and percentage change from year to year, are shown in the charts below. The accompanying narrative refers to the statistical information displayed in the chart immediately above the narrative.
We received $4.3 million in 2007 as a reimbursement of protested payments of retaliatory tax, including accrued interest thereon, previously made by us for the periods 1999-2004. The refund was recorded, after reduction for Federal income tax, in the amount of $2.8 million in the 2007 consolidated statement of earnings. The allocation of the refund to 2007 pre-tax earnings included an increase to net investment income of $720,000 for the interest received on the refund, and $3.6 million as a reduction to other expense to recognize the recovery of amounts previously charged to other expense. This is a non-recurring item which significantly affected the earnings for the year ended December 31, 2007, and related performance metrics such as the combined ratio.
Net investment income increased $0.9 million or 6.8% to $13.9 million in 2008 as compared to $13.1 million in 2007. This increase was driven by an increase in average cash and invested assets. Net investment income for
The decline in year-to-date direct premiums written reflects a continuing competitive marketplace and declining levels of economic activity in our operating territories. The current market is highly competitive, with pricing and coverage competition being seen in virtually all classes of commercial accounts, package policies, commercial automobile policies and in the Pennsylvania personal auto market and Pennsylvania and New Jersey homeowners markets, all of which makes it more challenging to retain our accounts on renewal, or to renew a policy at the expiring premium. Competition also continues on large accounts, particularly in the East Coast habitational and California construction contracting programs, as competitors aggressively compete for these higher premium accounts. Pricing in the property and casualty insurance industry historically has been and remains cyclical. During a soft market cycle, such as the current market condition, price competition is prevalent, which makes it challenging to write and retain properly priced personal and commercial lines business. We continue to work with our agents to target classes of business and accounts compatible with our underwriting appetite, which includes certain types of religious institution risks, contracting risks, small business risks and property risks. Despite the pricing pressures of the marketplace, management maintains a strong focus on its policy of disciplined underwriting and pricing standards, declining business which it determines is inadequately priced for its level of risk. In spite of these competitive market conditions, ourGroup’s policy retention on renewal has been favorable across most product lines.
In the fourth quarter of 2008, a new Business Owners Policy for California risks was introduced. This product targets small to medium sized businesses, which have been shown to be somewhat less price sensitive than larger accounts. This product also helps to balance FPIC’s business between property and casualty exposures. Additionally, a new contracting product which specializes in covering artisan contractors is being developed for Arizona, California, Nevada and Oregon and is targeted for introduction in early 2009. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations compared to the real estate construction industry.
Effective January 1, 2008, the Group increased its reinsurance retention to $850,000 (from a maximum retention of $750,000 in 2007) on the casualty, property and workers’ compensation lines of business. Pollution coverage written by FPIC is now fully retained with a standard sub-limit of $150,000 (and up to $300,000 on an exception basis). Prior to 2008, FPIC reinsured 100% of its pollution coverage, which in the twelve months ended December 31, 2007 represented $1.8 million of ceded written premium. We also purchased an additional $1.0 million of surety coverage (subject to a 10% retention), which resulted in an increased reinsurance coverage to $4.5 million from $3.5 million per principal and a maximum retention of $900,000 per principal as compared to
In 2008 net investment income increased $0.9 million, or 6.8%, to $13.9 million, as compared to $13.1 million in 2007. Net investment income in 2007 benefited from the $720,000 non-recurring impact of the retaliatory tax refund. The increase in net investment income in 2008 is the result of an increase in average cash and invested assets. Average cash and invested assets totaled $367 million for 2008 as compared to $333 million for 2007, representing an increase of $33 million. The increase in invested assets is driven primarily by operating cash flow, including the benefits of the 2008 and 2007 reinsurance agreement changes, which result in less premium being ceded to reinsurers.
Dividend income remained consistent at $351,000 in 2008 as compared to $319,000 in 2007. Interest income on cash and cash equivalents declined $1.0 million or 67.2% to $0.5 million in 2008, as compared to $1.4 million in 2007, primarily as a result of the $720,000 of non-recurring interest received on the retaliatory tax refund in 2007. Investment expenses declined $0.3 million or 14.8% to $1.8 million in 2008, from $2.1 million in 2007.
Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment and anomalies in pricing in the current difficult market. At December 31, 2008 we had 11 fixed maturity securities with unrealized losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them have fair values of no less than 72% of book value. We do not believe these declines are other than temporary due to the credit quality of the holdings. We currently have the ability and intent to hold these securities until recovery.
The following table summarizes the period of time that equity securities sold at a loss during 2008 had been in a continuous unrealized loss position:
The components of income for 2007 and 2006, and the change and percentage change from year to year, are shown in the charts below. The accompanying narrative refers to the statistical information displayed in the chart immediately above the narrative. In 2007, we evaluated our methodology for allocating costs to its lines of business and adopted changes to such methodology in order to more accurately reflect the allocation of joint costs. This resulted in allocating less joint cost to the personal lines of business and more joint cost to the commercial lines of business, but with no net change in cost allocated to personal lines and commercial lines in the aggregate. Related 2006 amounts have been reclassified to reflect this change in allocation methodology:
As previously disclosed in our SEC filings, we paid an aggregate of $3.5 million, including accrued interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, we filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division.
Net investment income increased $3.0 million or 29.6% to $13.1 million in 2007 as compared to $10.1 million in 2006. Included in this increase is $720,000 attributable to the non-recurring impact of the retaliatory taxes described above. The balance of the increased investment income is due to increased cash and invested assets,
Net investment income totaled $13.1 million in 2007, as compared to $10.1 million in 2006, representing a 29.6% or $3.0 million increase. The increase in net investment income in 2007 is primarily driven by an increase in average cash and invested assets and a favorable interest rate environment, as well as the $720,000 non-recurring impact of the retaliatory tax refund. Realized investment gains amounted to $24,000 in 2007 as compared to $151,000 in 2006. Net realized gains in 2007 and 2006 include the mark-to-market fair value adjustment on the interest rate swaps related to the floating-rate trust preferred securities. The mark-to-market on the swaps resulted in a realized loss of $774,000 and $94,000 in 2007 and 2006, respectively. See the investment income discussion below for further information.
with local construction activity as well as changes in the nature of the contractor’s operations. The decline in construction related activity has impacted both the volume of premium for the contractor in-force book of business (and related exposures) and the related audit premium on expiring policies. Audits, primarily of construction related policies, generated $3.1 million of premiums in 2007, representing a decline of $8.9 million as compared to $12.0 million of premium that was generated in 2006.
Effective, January 1, 2007, we Group consolidated the reinsurance program of all our subsidiaries into a single program, and increased our reinsurance retention to $750,000 (from a maximum retention of $500,000 in 2006) on the working layer for all casualty, property and workers’ compensation lines of business. The effect of this change in reinsurance arrangements increased net premiums written for 2007.
Dividend income declined $0.2 million or 37.9% to $0.3 million in 2007, from $0.5 million in 2006. The decline in dividend income is primarily attributable to a decline in dividends received relating to an equity security held in a reinsurance company. Excess Reinsurance Company paid a special dividend to us in 2007 and 2006 in the amount of $1,000 and $228,000, respectively. Interest income on cash and cash equivalents increased $0.6 million or 67.9% to $1.4 million in 2007, as compared to $0.9 million in 2006, primarily as a result of the $720,000 of non-recurring interest received on the retaliatory tax refund. Investment expenses decreased $0.3 million or 12.1% to $2.1 million in 2007, from $2.3 million in 2006.
Net realized gains for 2007 were $24,000, as compared to $151,000 in 2006. In 2007, net realized gains of $24,000 included a loss on the mark-to-market valuation on the interest rate swaps of $774,000, write-down of securities determined to be other than-temporarily impaired of $138,000, and gains of $936,000 on the sale of equity investments. Securities determined to be other-than-temporarily impaired were written down to our estimate of fair market value at the time of the write-down. The Group has entered into four interest rate swap agreements to hedge against interest rate risk on its floating rate trust preferred securities. The estimated fair value of the interest rates swaps is obtained from the third-party financial institution counterparties. we mark the investments to market using these valuations and record the change in the economic value of the interest rate swaps as a realized gain or loss in the consolidated statement of earnings.
The fixed income portfolio is invested 100% in investment grade securities, with the exception of one corporate security held with a market value of $0.4 million. As of December 31, 2007, the fixed income portfolio had an average rating of AA, an average effective maturity of 5.9 years, and an average tax equivalent yield of 5.22%.
Among our portfolio holdings, our only subprime exposure consists of asset-backed securities within the home equity subsector. The ABS home equity subsector totaled $1.7 million (book value) on December 31, 2007, representing 10.4% of the ABS holdings, 2.0% of the total structured product holdings, and 0.5% of total fixed income holdings. The subprime related exposure consists of five individual securities, two of which have a 100% credit enhancement, based on insurance against default as to principal and interest. In the case that the monoline insurance companies were to be downgraded, the ratings on the ABS securities would receive the equivalent rating. Among the three securities without credit enhancement, two are rated Aaa/AAA and one is rated Aa2/AA by Moody’s and S&P. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subsection entitled “Quantitative and Qualitative Information about Market Risk.”
Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2007, we had 74 fixed maturity securities with unrealized losses for more than twelve months. Of the 74 securities with unrealized losses for more than twelve months, 72 of them had
fair values of no less than 94% or more of cost, and the other 2 securities had a fair value greater than 89% of cost. The fixed income portfolio is invested 100% in investment grade securities, with the exception of one corporate security held with a market value of $0.4 million, and these unrealized losses primarily reflect the current interest rate environment. The Group does not believe these declines are other than temporary due to the credit quality of the holdings. The Group currently has the ability and intent to hold these securities until recovery.
The following table summarizes the period of time that equity securities sold at a loss during 2007 had been in a continuous unrealized loss position:
The equity securities sold at a loss had been expected to appreciate in values but due to unforeseen circumstances were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of unforeseen economic conditions.
Results of our Commercial Lines segment were as follows. In 2007, we evaluated our methodology for allocating costs to our lines of business and adopted changes to such methodology in order to more accurately reflect the allocation of joint costs. This resulted in allocating less joint cost to the personal lines of business and more joint cost to the commercial lines of business, but with no net change in cost allocated to personal lines and commercial lines in the aggregate. Related 2006 amounts have been reclassified to reflect this change in allocation methodology:
In 2007, our commercial lines net premiums written increased by $15.5 million, or 12.5%, to $139.4 million as compared to net premiums written in 2006 of $123.8 million. Net premiums earned in 2007 increased 8.6%, or
In the commercial lines segment for 2007, we had underwriting income of $6.0 million, a GAAP combined ratio of 95.2%, a GAAP loss and loss adjustment expense ratio of 60.8% and a GAAP underwriting expense ratio of 34.4%, compared to underwriting income of $4.2 million, a GAAP combined ratio of 96.5%, a GAAP loss and loss adjustment expense ratio of 63.7% and a GAAP underwriting expense ratio of 32.8% in 2006. Our commercial lines loss ratio for 2007 reflects a frequency of losses reported and severity within a normal range of our expectations. The performance of the commercial lines in 2007 was impacted favorably by the non-recurring retaliatory tax refund.
Federal income tax expense was $5.8 million and $4.4 million for 2007 and 2006, respectively. The effective tax rate was 28.8% and 29.5% for 2007 and 2006, respectively. The 2007 effective tax rate was impacted by an unusually high amount of taxable income in the period caused by the retaliatory tax refund, offset by higher tax-advantaged income (municipal bond interest and dividend income, which reduced the effective tax rate).
The principal source of liquidity for the Holding Company (which has modest expenses and does not currently, or for the foreseeable future, need a significant regular source of cash flow to cover these expenses other than its debt service on its indebtedness to MIC, its quarterly dividend to shareholders, and the funding necessary for any stock repurchases pursuant to the currently authorized stock repurchase program) is dividend payments and other fees received from the insurance subsidiaries, and payments it receives on the 10-year note it received from the ESOP (see below) when the ESOP purchased shares at the time of the conversion from a mutual to a stock form of organization (the “Conversion”). The Holding Company also has access to an existing credit line under which it can draw up to $7.5 million dollars.
On April 16, 2008, the Holding Company was authorized by the Board of Directors to repurchase, at management’s discretion, up to 5% of its outstanding stock. Any such purchases will be funded by the Holding Company’s existing resources, dividends from subsidiaries, or the credit line, or any combination of these resources. As of December 31, 2008, the Holding Company had purchased, pursuant to the authority granted by the Board on April 16, 2008, a total of 114,300 shares of outstanding stock at an average cost of $16.03 per share, and is holding the stock as treasury stock. In addition, 1,659 and 2,301 shares of stock were repurchased from employees in 2008 and 2007, respectively, in order to pay the required tax withholdings on the vesting of restricted stock under the stock incentive plan.
repayable in 20 equal annual installments. MIG has no special limitations on its ability to take periodic dividends from its insurance subsidiaries except for normal dividend restrictions administered by the respective domiciliary state regulators as described above. The Group believes that the resources available to MIG will be adequate for it to meet its obligation under the note to MIC, the line of credit and its other expenses.
Total liabilities increased 5% or $18.7 million, to $431.7 million at December 31, 2008 as compared to $413.0 million at December 31, 2007, primarily as a result of the increase in loss and loss adjustment expense reserves of $29.6 million or 11%, offset by a decline in unearned premiums of $7.6 million or 9%, a decline in accounts payable and accrued expenses of $1.3 million or 9% and a decline in other reinsurance balances of $3.2 million or 22%. Unearned premiums declined primarily due to the decline in written premiums. Accounts payable and accrued expenses declined primarily due to cost saving measures reducing operating expenses. Other reinsurance balances declined primarily due to a change in certain of the Group’s reinsurance contracts, whereby fewer premium is ceded.
property and casualty insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense up-front costs and fees associated with the item for which the fair value option is elected. Entities electing the fair value option are required to distinguish on the face of the statement of financial position the fair value of assets and liabilities for which the fair value option has been elected, and similar assets and liabilities measured using another measurement attribute. An entity can accomplish this by either reporting the fair value and non-fair-value carrying amounts as separate line items or aggregating those amounts and disclosing parenthetically the amount of fair value included in the aggregate amount. The Group adopted SFAS 159 effective January 1, 2008 and the adoption did not have a material effect on the Group’s results of operations, financial position or liquidity. The Group did not elect to measure at fair value any assets or liabilities that were not otherwise already carried at fair value in accordance with other accounting pronouncements.
In June 2008, the FASB issued FASB Staff Position (FSP) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities (FSP 03-6-1). FSP 03-6-1 addresses the treatment of unvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents in the calculation of earnings per share and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. The Group is currently evaluating the impact of FSP 03-6-1 on the calculation of earnings per share.
In June 2007, the Emerging Issues Task Force (EITF) of FASB issued EITF Issue No. 06-11 Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (EITF 06-11). EITF 06-11 requires that the tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options be recognized as an increase to additional paid-in capital. EITF 06-11, was effective on a prospective basis beginning with dividends declared in fiscal years beginning after December 15, 2007, and the Group adopted it in the first quarter of 2008. The adoption of EITF 06-11 did not have a material impact on the Group’s results of operations, financial condition, or liquidity.
The timing of the amounts for gross property and casualty insurance reserves are an estimate based on historical experience and expectations of future payment patterns. However, the timing of these payments may vary significantly from the amounts stated above.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
Mercer Insurance Group, Inc. (MIG) and subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and its subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Holding Company, Inc. (FHC) and its subsidiary Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS), Financial Pacific Insurance Group, Inc. (FPIG) and its subsidiaries Financial Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA), which is currently inactive, commencing in October, 2006. FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities (see note 18).
The companies in the Group are operated under common management. The Group’s operating subsidiaries are licensed collectively in twenty two states, but are currently focused on doing business in seven states; Arizona, California, Nevada, New Jersey, New York, Oregon and Pennsylvania. MIC and MICNJ are also licensed to write property and casualty insurance in New York where a limited amount of business is written to support accounts in adjacent states. FPIC holds an additional fifteen state licenses outside of the Group’s current focus area. Currently, only direct mail surety is being written in some of these states.
55%, 27% and 7% of the 2007 direct premium written, and 53%, 28%, and 8% of the 2006 direct premium written. Consequently, changes in the California, New Jersey or Pennsylvania legal, regulatory or economic environment could adversely affect the Group.
For the year ending December 31, 2008, 2007 and 2006, there were no agents in the Group that individually produced greater than 5% of the Group’s direct written premiums.
Investments - The fair values for fixed-income securities available for sale are based on quoted market prices, when available. If not available, fair values are based on readily observable market data for similar securities or valuations based on models where significant inputs are observable. Fair values for marketable equity securities are based on quoted market prices.
The carrying value of property and equipment is reviewed for recoverability including an evaluation of the estimated useful lives of such assets. Impairment is recognized only if the carrying amount of the property and equipment is not deemed recoverable. A change in the estimated useful lives of such assets is treated as a change in estimate and is accounted for prospectively.
The Group applies the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment”, using the modified-prospective-transition method. The after-tax compensation expense recorded in the consolidated statements of earnings for stock options (net of forfeitures) for the years ended December 31, 2008, 2007 and 2006 was $234, $439, and $555 respectively. The after-tax compensation expense recorded in the consolidated statements of earnings for restricted stock (net of forfeitures) for the years ended December 31, 2008, 2007, and 2006 was $195, $336, and $442 respectively.
Earnings per share (EPS) is computed in accordance with SFAS No. 128, “Earnings per Share”. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of Diluted EPS reflects the effect of potentially dilutive securities. The denominator for basic and diluted EPS includes ESOP shares committed to be released.
SFAS 157 establishes a fair value hierarchy to increase consistency and comparability in fair value measurements and disclosures. The hierarchy is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets. The highest possible level should be used to measure fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007.
In December 2007, the FASB issued Revised SFAS No. 141R, Business Combinations (SFAS 141R), a replacement of SFAS 141, Business Combinations (SFAS 141). SFAS 141R provides revised guidance on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. In addition, it provides revised guidance on the recognition and measurement of goodwill acquired in the business combination. SFAS 141R also provides guidance specific to the recognition, classification, and measurement of assets and liabilities related to insurance and reinsurance contracts acquired in a business combination. SFAS 141R applies to business combinations for acquisitions occurring on or after January 1, 2009. Accordingly, SFAS 141R does not impact the Group’s previous transactions involving purchase accounting.
The changes in net unrealized (losses) gains of securities are as follows:
The cost and estimated market value of available-for-sale fixed-income and equity investment securities at December 31, 2008 and 2007 are shown below.
Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2008 the Group has 11 fixed maturity securities with unrealized
losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them have fair values of no less than 72% of book value. The Group does not believe these declines are other than temporary due to the credit quality of the holdings. The Group currently has the ability and intent to hold these securities until recovery. However, future write-downs may become necessary in light of unprecedented market and liquidity disruptions.
During the second half of 2008, there were significant disruptions to the financial and equity markets. This resulted from, in part, failures of financial institutions on an unprecedented scale, and caused a significant reduction in liquidity and trading flows in the credit markets in addition to a dramatic widening in credit spreads. Such impacts affected the valuations of both the fixed income and equity securities held by the Group.
$2.6 million relating to six corporate bonds. These charges were also due to issuer-specific events which lead to a deteriorated financial condition.
$1.4 million on 29 equity securities related to issuer-specific events which led to a deteriorated financial condition.
Proceeds from sales and maturities of securities were $46,845, $39,027 and $152,438 in 2008, 2007, and 2006, respectively.
Accumulated other comprehensive income was net of deferred income taxes of $1,353 and $2,615 applicable to net unrealized investment gains at December 31, 2008 and 2007, respectively.
The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2008 and 2007 was $4,911 and $4,913, respectively.
The following table presents the (increase) decrease in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2008 by line of business. Amounts shown in the 2005 column of the table include all 2005 and prior accident year development for FPIC, which was acquired on October 1, 2005, and accounted for as a purchase business combination.
With $163.0 million, $140.0 million, and $120.1 million of recorded reserves, net of reinsurance, at December 31, 2008, 2007 and 2006, respectively, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 75%, 73%, and 73%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2008, 2007, and 2006.
The adverse development in 2008 and 2007 was driven by higher than expected reported construction defect claim activity, particularly on the 1998 through 2002 accident years. The adverse development in 2006 was driven by increases in case reserve estimates on claims reported prior to 2006. The adverse development in 2008, 2007 and 2006 includes ($0.4) million, $0.7 million and $2.8 million, respectively, in reserve increases related to accident years 1997 and prior which are pre-Montrose claims.
The adverse development in 2008, 2007 and 2006 also includes $1.9 million, $0.5 million and $1.1 million, respectively, in post-commutation reserve increases for losses formerly subject to reinsurance treaties.
In 2008 there was $3.5 million in favorable development on accident years 2003 through 2005, due to lower than expected loss emergence. In 2007 and 2006 there was no development on the 2003 through 2005 accident years. The favorable development was driven by a decrease in claim frequency for accident years 2003 through 2005.
With $8.9 million, $12.4 million, and $9.3 million of recorded reserves, net of reinsurance, at December 31, 2008, 2007, and 2006, respectively, other liability is the Group’s third largest reserved line of business, representing 4%, 6%, and 6%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2008, 2007 and 2006.
The other liability line of business experienced favorable prior year development of $0.9 million in 2008, adverse development of $4.4 million in 2007, and favorable development of $0.3 million in 2006.
With $7.6 million, $7.6 million, and $7.3 million of recorded reserves, net of reinsurance, at December 31, 2008, 2007, and 2006, respectively, workers compensation represents 3%, 4%, and 4%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2008, 2007 and 2006. A portion of this business is assumed from the National Involuntary Pool managed by the National Council on Compensation Insurance (NCCI).
The actuarial data reported to us by the NCCI is very volatile with significant upward and downward swings.
During the fourth quarter of 2008, the Group commuted all reinsurance agreements with St Paul Fire and Marine Insurance Company. These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation the Group received a cash payment of $2.5 million, and recorded a pre-tax net gain on commutation of $0.9 million.
The Group has purchased Company-owned life insurance covering key individuals. The Group’s cost, net of increases in cash surrender value, for the Company-owned life insurance was $125, $(208) and $(23) for the years ended December 31, 2008, 2007 and 2006, respectively. The cash surrender value of the Company-owned life insurance totaled $1,557 and $1,548 at December 31, 2008 and 2007, respectively, and is included in other assets.
On December 15, 2003, MIG was formed from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of ownership (“the Conversion”). The Group established an Employee Stock Ownership Plan (ESOP) and issued 626,111 shares to the ESOP at the Conversion offering price. The ESOP signed a promissory note in the amount of $6,261 to purchase the shares, which is due in 10 equal annual installments with interest at 4%. Shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid, and are allocated to participants based on compensation as described in the plan. During 2008, 2007 and 2006, 62,611 shares were allocated to employee participants. Compensation expense equal to the fair value of the shares allocated is recognized ratably over the period that the shares are committed to be allocated to the employees. In 2008, 2007 and 2006 the Group recognized compensation expense of $1,014, $1,175 and $1,253, respectively, related to the ESOP. As of December 31, 2008, the cost of the 250,445 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.
On January 1, 2007, the Group adopted FIN 48. As a result of adoption, the Group recognized a previously unrecognized tax benefit of approximately $0.2 million relating to merger-related expenses for the FPIG acquisition that took place October 1, 2005. The application of FIN 48 for this unrecognized tax benefit resulted in a corresponding reduction to goodwill relating to the FPIG acquisition of $0.2 million. The adoption of FIN 48 did not result in any adjustments to beginning retained earnings, nor have a significant effect on operations, financial condition or liquidity. As of December 31, 2008, the Group has no unrecognized tax benefits. The Group’s policy is to account for interest and penalties as a component of other expenses. The Group files income tax returns in the federal jurisdiction and various states.
A reconciliation of the Group’s statutory net income and surplus to the Group’s net income and stockholders’ equity, under U.S. generally accepted accounting principles, is as follows:
The Group’s insurance companies are required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective January 1, 2001. The codified principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under U.S. generally accepted accounting principles.
The Group’s insurance companies are required by law to maintain a certain minimum surplus on a statutory basis, and are subject to risk-based capital requirements and to regulations under which payment of a dividend from statutory surplus may be restricted and may require prior approval of regulatory authorities.
(a) statutory net income for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2008, the amount available for payment of dividends from FPIC in 2009, without the prior approval, is approximately $6.4 million.
The Group carries goodwill on its balance sheet in connection with the acquisitions of FHC and FPIG. The change in the carrying amount of goodwill for these acquisitions for the years ended December 31, 2008 and 2007 is as follows:
Information regarding unvested restricted stock activity in the Plan in 2008 is below:
Information regarding 2007 stock option activity in the Plan is presented below:
Information regarding unvested restricted stock activity in the Plan in 2007 is below:
Rental expenses were $422, $437, and $474 were incurred for the years ended December 31, 2008, 2007, and 2006, respectively.
As previously disclosed in the Group’s SEC filings, the Group paid an aggregate of $3.5 million, including accrued interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, the Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division to the Group.
The Group produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis), the owner of which is also a Board member of the Group. In 2008, 2007 and 2006, premiums written through Davis totaled 4%, 4% and 4%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,115, $1,177 and $1,187 in 2008, 2007 and 2006, respectively.
The Group has interest-rate related hedging instruments to manage its exposure on its debt instruments. The type of hedging instruments utilized by the Group are interest rate swap agreements (swaps). Interest differentials to be paid or received because of swap agreements are reflected as an adjustment in the consolidated statement of earnings over the swap period and are recorded as realized gains or losses. By using hedging financial instruments to hedge exposures to changes in interest rates, the Group exposes itself to market risk.
As of December 31, 2008 and 2007 the Group was party to interest-rate swap agreements with an aggregate notional principal amount of $15,500. For the year ended December 31, 2008 and 2007, the Group recognized the change in the economic value of the interest rate swap agreements which is recognized in the consolidated statement of earnings as a realized loss of $1,500 and $774, respectively. The estimated fair value of the interest-rate swap was a liability of $1,879 and $379 as of December 31, 2008 and 2007, respectively.
Equities that trade on a major exchange are assigned a Level 1. Equities not traded on a major exchange are assigned a Level 2 or 3 based on the criteria and hierarchy described above. Short-term investments such as open ended mutual funds where the fund maintains a constant net asset value of one dollar, money market funds, cash and cash sweep accounts and treasuries bills are classified as Level 1. Level 2 short-term investments include commercial paper and certificates of deposit, for which all inputs are observable.
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows: