Our headquarters are located at 72 North Franklin Street, Wilkes-Barre, Pennsylvania. We own this 39,963 square foot facility. We also rent office space in Indianapolis, IN.
Calculated by dividing losses and loss adjustment expenses by net premiums earned.
The sum of the loss and loss adjustment expense ratio and the underwriting expense ratio. A combined ratio greater than 100% means a company has an underwriting loss.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes included thereto.
Net earned premiums of $75,358; $73,641 excluding the impact of the reversal of the stop loss contract
GAAP combined ratio of 103.1% or 99.7% before the impact of the stop loss on 2009 results
Repurchased 217,761 shares of our common stock at a total cost of $2,216 under our share repurchase program
Our Employee Stock Ownership Plan (ESOP) purchased 539,999 of the shares in the offering, which was funded by a loan from Penn Millers Holding Corporation. We implemented the ESOP in order to more closely align our employees’ interests with those of our shareholders, and to promote an atmosphere of “ownership” and accountability within our organization.
The lower losses, in conjunction with our decision to terminate relationships with several under-performing producers in our commercial business segment helped to improve our underwriting profit.
As described in more detail throughout this Management’s Discussion and Analysis, favorable prior year development on the 2008 accident year required us to reverse in 2009 the net favorable 2008 impact of ceding premiums and losses under our aggregate stop-loss reinsurance contract. Furthermore, lower 2009 incurred losses did not allow us to cede losses under the contract for the 2009 accident year. Without the negative impact of the reversal of the stop loss contract on our underwriting results in 2009, the favorable trends in our results would have been even greater.
Competitive pressures in the marketplace are exerting downward pressure on our prices, which is currently affecting our writing of new and renewal business.
We derive our revenue primarily from premiums earned, net investment income and net realized gains (losses) from investments.
Losses and loss adjustment expenses (or LAE) represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims.
Expenses incurred to underwrite risks are referred to as policy acquisition expenses and underwriting and administrative expenses. Policy acquisition costs consist of commission expenses, premium taxes and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business. These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies. Underwriting and administrative expenses consist of salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately, and payments to bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data. Amortization of deferred policy acquisition costs, and underwriting and administrative expenses directly attributable to each segment are recorded in that segment directly. Underwriting and administrative overhead expense not specifically attributable to an individual segment is allocated to those segments based upon factors such as, employee head count, policy count, and premiums written.
We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation reserve is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.
We evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to reviewing our financial performance based on results determined in accordance with generally accepted accounting principles in the United States (GAAP), we utilize certain non-GAAP financial measures that we believe are valuable in managing our business and for comparison to our peers. These non-GAAP measures are underwriting income, combined ratios and written premiums. In addition, where we feel it enhances the presentation to the reader, we may present certain GAAP financial measures in a manner to reflect the impact of certain unusual or non-recurring situations. For the presentation of the years ended December 31, 2009 and 2008, we have presented certain summary results and ratios in such a manner to show the impact of our accounting for our aggregate stop loss reinsurance contract.
The loss and loss adjustment expense ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned. We measure the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that year. A calendar year loss ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of premiums earned during that year.
Our GAAP combined ratio is the sum of the loss ratio and the expense ratio and measures our overall underwriting profit. If the GAAP combined ratio is below 100%, we are making an underwriting profit. If our combined ratio is at or above 100%, we are not profitable without investment income and may not be profitable if investment income is insufficient.
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related footnotes. We evaluate these estimates and assumptions on an ongoing basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.
We maintain reserves for the payment of claims (incurred losses) and expenses related to adjusting those claims (loss adjustment expenses or LAE). Our loss reserves consist of case reserves, which are reserves for claims that have been reported to us, and reserves for “IBNR” which is comprised of estimated development of our case reserves and estimates of claims that have been incurred but have not yet been reported.
We utilize an independent actuary to assist with the estimation of our losses and LAE reserves each quarter. The actuary prepares estimates of the ultimate liability for unpaid losses and LAE based on established actuarial methods described below. Our management reviews these estimates and supplements the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy. We may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the financial statements.
Paid Loss Development Method - The Paid Loss Development Method utilizes historical loss payment patterns to estimate future losses. Estimates using this method are not affected by changes in case reserving practices that might have occurred during the review period, and may be understated as this method does not take into account large unpaid claims. This method is also susceptible to any changes in the rate of claim settlements or shifts in the size of claims settled.
Bornhuetter-Ferguson Method (Paid and Incurred) - The Bornhuetter-Ferguson Method is a blended method that explicitly takes into account both actual loss development to date and expected future loss emergence. This method is applied on both a paid loss basis and an incurred loss basis. This method uses the selected loss development patterns from the Loss Development Methods to calculate the expected percentage of loss unpaid (or unreported). The expected future loss component of the method is calculated by multiplying earned premium for the given exposure period by a selected a priori (i.e. deductive) loss ratio. The resulting dollars are then multiplied by the expected percentage of unpaid (or unreported) loss described above. This provides an estimate of future paid (or reported) losses that is then added to actual paid (or incurred) loss data to produce estimated ultimate loss.
At December 31, 2009, the amount recorded as compared to the actuarially-determined reserve range, net of reinsurance was as follows:
The impact of court decisions on insurance coverage issues, which can impact the ultimate cost of settling claims;
Trends and risks in claim costs, such as risk that medical cost inflation could increase, or that increasing unemployment rates can impact workers compensation claim costs;
Actuaries generally are required to exercise a considerable degree of judgment in the evaluation of all of these and other factors in the analysis of losses and LAE reserves, and the related range of anticipated losses. Because of the level of uncertainty impacting the estimation process, it is reasonably possible that different actuaries would arrive at different conclusions. The method of determining the reserve range has not changed and the reserve range generated by our actuary is consistent with the observed development of our loss reserves over the last few years.
The width of the range in reserves arises primarily from those lines of business for which specific losses may not be known and reported for some period and for losses that may take longer to emerge. These long-tail lines consist mostly of casualty lines including general liability, products liability, umbrella, workers’ compensation, and commercial auto liability exposures. The ultimate frequency or severity of these claims can be very different than the assumptions we used in our estimation of ultimate reserves for these exposures. The high end of the reserve range is limited by our aggregate stop loss reinsurance contract that provides reinsurance coverage for the 2009 and 2008 accident years for loss and allocated loss adjustment expense from all lines of business in excess of a 72% loss and allocated loss adjustment expense ratio up to a 92% loss and allocated loss adjustment expense ratio. This reinsurance contract has been accounted for at December 31, 2009 as if it has been commuted because the estimated experience under the contract at this point in time would lead us to execute a commutation to recognize profit sharing under that contract. However, the contract does not require us to execute the commutation until on or before January 1, 2015. Therefore, we will keep the contract in effect until a later date to continue the stop loss reinsurance protection of future adverse development of reserves for the accident years 2008 and 2009. For additional information concerning the stop loss reinsurance contract, see Item 1 “Business - Reinsurance.”
The rate of increase in labor costs, medical costs, material costs, and commodity prices that underlie insured risks;
Development of risk associated with our expanding producer relationships, new classes of business, and our growth in states where we currently have small market share;
Variability related to asbestos and environmental claims due to issues as to whether coverage exists, the definition of occurrence, the determination of ultimate damages, and the allocation of such damages to responsible parties.
The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled for amounts less than originally estimated (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled for amounts greater than originally estimated (unfavorable development). For the year ended December 31, 2009 we exhibited unfavorable development of $1,555, of which $4,292 was related to the stop loss reversal, partially offset by favorable development of $2,737. For the year ended December 31, 2008 we experienced favorable development of $5,222.
Potential for variability in our reserves is evidenced by this development. As further illustration of reserve variability, we initially estimated our reserve for unpaid losses and LAE net of reinsurance at the end of 2000 at $29,476. As of December 31, 2009, that reserve was re-estimated at $38,315, which is $8,839, or 30.0%, higher than the initial estimate.
The following table provides case and IBNR reserves for losses and loss adjustment expenses by major lines of business as of December 31, 2009 and December 31, 2008. A discussion of each major line of business will follow:
As discussed earlier, the estimation of our reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given line of business and accident year. The ranges presented above represent the expected variability around the actuarially determined central estimate. The width of the range is primarily determined by the specific line of business. For example, long tail casualty lines typically involve greater uncertainty and, therefore, have a wider range of expected outcomes. The magnitude of the line of business (i.e. volume of insured exposures) can also factor into the range such that more significantly sized lines of business provide more statistically significant data to rely upon. The total range around our actuarially determined estimate varies from -9% to +5%, with the ranges around each of our core lines of business (excluding assumed and other lines) ranging from the widest being -18% to +3% (fire & allied) to the narrowest being -5% to +3% (workers’ compensation). As shown in the table below, since 2003 the variance in our originally estimated loss reserves has ranged from 2% deficient to 10% redundant.
The table below summarizes the impact on equity from changes in estimates of unpaid losses and LAE reserves as of December 31, 2009:
If the losses and LAE reserves were to adversely develop to the high end of the range, approximately $2,732 of anticipated future payments for the losses and LAE expenses would be required to be paid, thereby affecting cash flows in future periods as the payments for losses are made.
At December 31, 2009, the commercial multi-peril line of business had recorded reserves, net of reinsurance, of $21,040, which represented 23.8% of our total net reserves. This line of business includes both property and liability coverage provided under a business owner’s policy. This line of business can be prone to adverse development arising from delayed reporting of claims and adverse settlement trends related to the liability portion of the line. No adjustment has been made to the actuarially selected estimate for this line. While management has not identified any specific trends relating to additional reserve uncertainty on prior accident years, a declining economic climate and unfavorable changes to the legal environment could lead to the filing of more claims for previously unreported losses.
At December 31 2009, our liability line of business had recorded reserves, net of reinsurance of $17,060, which represented 19.3% of our total net reserves. This line of business includes general liability, products liability, and umbrella liability coverages. This reserve is $650, or 4.0%, above the actuarially selected estimate. This line can be prone to volatility and adverse development. In particular, many claims in these coverages often involve a complex set of facts and high claim amounts, and litigation often takes place in challenging court environments.
At December 31, 2009, our commercial automobile liability line of business had recorded reserves, net of reinsurance, of $14,501, which represented 16.4% of our total net reserves. This reserve is $525, or 3.8%, above the actuarially selected estimate. This line of business is similar to workers’ compensation in that the reporting of claims is generally timely but understanding the true extent of the liability can be difficult to estimate, both at the claim level and in aggregate. The gathering of important information can be delayed due to a slow legal discovery process. Also, uncertainty about the true severity of injuries and unpredictability of medical cost inflation can make reserving for specific claims a challenge. Medical cost inflation and evolving legal environments can also invoke uncertainty into the process of estimating IBNR.
At December 31, 2009, our assumed lines of business had recorded reserves, net of reinsurance, of $8,272, which represented 9.4% of our total net reserves. This reserve is $300, or 3.8%, above the actuarially selected estimate. These lines comprise the majority of our other segment, with the reserves mostly attributable to a Munich Re America reinsurance pool, in which we terminated our participation in 1986, and the mandatory assumed risk pools in which we are required to participate in the states we do business. The case reserves for these pools are established based on amounts reported to us by the ceding parties. The IBNR is estimated based on observed development trends using the various methodologies described earlier. The exposures within these pools include long tail lines such as workers’ compensation, auto liability, general liability, and products liability; and also include asbestos exposures. Development can occur in these reserves due to such factors as the changing legal environment, the economic climate, and medical cost inflation. In addition, we are dependent on information from third parties which can make it difficult to estimate the IBNR for this business.
The fair value and unrealized losses for our securities that were temporarily impaired as of the years ended December 31, 2009 and December 31, 2008 are as follows:
The fair value estimates of our investments provided by the independent pricing service at December 31, 2009 and 2008 were utilized, among other resources, in reaching a conclusion as to the fair value of our investments. As of December 31, 2009, all of our fixed maturity investments were priced using this one primary service.
Management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. We review all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in common sectors, durations and credit ratings. This review will also include all fixed maturity securities rated lower than “A” by Moody’s or S&P. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service. In our review we did not identify any such discrepancies for the years ended December 31, 2009, 2008 and 2007, and no adjustments were made to the estimates provided by the pricing service for the years ended December 31, 2009, 2008 and 2007. The classification within the fair value hierarchy of FASB ASC 820, Fair Value Measurements and Disclosures, is then confirmed based on the final conclusions from the pricing review.
Certain direct policy acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with, and are primarily related to the production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. At December 31, 2009, 2008 and 2007, deferred policy acquisition costs and the related unearned premium reserves were as follows:
The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off.
For state income tax return purposes, we had $629 and $571 of deferred tax assets associated with state income tax net operating loss (NOL) carryforwards for the years ended December 31, 2009 and 2008, respectively that will completely expire if unused by 2029. The amount and timing of realizing the benefit of state NOL carryforwards depends on future state taxable income and limitations imposed by tax laws. After considering the potential of our ability to generate sufficient state taxable income in the future in order to utilize these state NOLs, we have determined that is not more likely than not that we will be able to do so. Accordingly, we have established a valuation reserve of $629 and $571 for the years ended December 31, 2009 and 2008, respectively to reflect our determination that we will not realize the benefit of these state NOLs in the future.
We sponsor a noncontributory defined benefit pension plan covering substantially all employees. The accounting results for pension benefit costs and obligations are dependent upon various actuarial assumptions applied in the determination of such amounts. These actuarial assumptions include the following: discount rates, expected long-term rate of return on plan assets, future compensation increases, employee turnover, expected retirement age, optional form of benefit and mortality. We review these assumptions for changes annually with our independent actuary. We consider our discount rate assumptions and expected long-term rate of return on plan assets to be our most critical assumptions.
The discount rate is used to value, on a present basis, our pension benefit obligation as of the balance sheet date. The same discount rate is also used in the interest cost component of the pension benefit cost determination for the following year. The measurement date used in the selection of our discount rate is the balance sheet date. Our discount rate assumptions are determined annually with assistance from our actuary based on the pattern of expected future benefit payments and the prevailing rates available on long-term, high quality corporate bonds (rated Aa or higher by an accepted rating agency) with terms similar to our estimated future pension distributions. This discount rate can change from year to year based on market conditions that impact corporate bond yields, and is reasonably likely to change in the future. In conjunction with the pension freeze (described below), we modified our discount rate assumption as of September 30, 2009 from 6.16% to 5.89%. The discount rate was subsequently lowered to 5.84% as of December 31, 2009.
In connection with our public offering, in July 2009 our board of directors approved a resolution to freeze the future accrual of benefits under our defined benefit pension plan effective October 31, 2009. On August 1, 2009, the pension plan administrator authorized the plan freeze, whereby all participants’ accrued benefits under the plan were frozen as of October 31, 2009. We have recorded an estimated curtailment benefit of $1,659 pre-tax, or $1,095 after-tax, which has been reflected in other comprehensive income (loss). The aforementioned reductions in the discount rate assumption partially offset the curtailment benefit by $717 pre-tax, or $473, after-tax.
Consolidated direct premiums earned declined $5,908 primarily from a decline in direct premiums earned in our commercial business segment of $5,675. This decline primarily resulted from our decision to withdraw from certain unprofitable classes of business and terminate relationships with several underperforming producers.
The stop loss reinsurance contract contains a profit sharing provision such that if the net profit to the reinsurers for 2008 and 2009 combined exceeds approximately $1,605, any profit above that amount will be returned to us provided that on or before January 1, 2015 we agree to a commutation whereby the reinsurers are released from any and all past, current and future liabilities under the stop loss contract. At December 31, 2009, profit to the reinsurers under the stop loss reinsurance contract for 2008 and 2009 combined is estimated to be $2,004. Accordingly, we have accrued a profit sharing refund of $399 at December 31, 2009. The accounting for this anticipated profit sharing and commutation reverses the losses and additional premiums ceded recorded in 2008 and accrues the profit sharing as reduced ceded premiums in 2009. The effect on ceded written and earned premiums related to the stop loss in 2009 is to have cumulative ceded premiums under the contract equal the $1,605 maximum profit to the reinsurers under the commutation. For additional information concerning the stop loss reinsurance contract, see Item 1 - “Business - Reinsurance.”
Losses between $500 and $1,000 are retained at 52.5% in 2009 versus our 75% retention rate in 2008.
Net premiums earned increased 10.9% for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to:
Increases in direct premiums written during 2007 and 2008 from growth which was partially offset by:
Ceded premiums earned under the stop loss reinsurance contract for 2008 of $3,322;
And offset by a decrease in all other ceded premiums earned of approximately $5,474 in 2008 compared to 2007, primarily from a change in our reinsurance program for 2008 whereby we retained more of our losses above $500 and reduced our ceded premiums.
The following table sets forth our average invested assets and investment income for the reported periods:
Our initial public offering on October 16, 2009 increased our cash and invested assets on that date by $45,666. Accordingly, we have weighted the average cash and invested assets for 2009 to account for the days in 2009 we were a public company.
Net investment income increased $11 for the year ended December 31, 2008 compared to 2007. The increase is attributable to an increase in the average invested assets of $3,609, which was mostly offset by the impact of declining interest rates.
For the year ended December 31, 2009 we had net realized investment gains of $199, which includes a pre-tax other-than-temporary impairment loss on one security of approximately $197.
The $5,819 of realized investment losses in 2008 was primarily attributable to other-than-temporary impairments of $2,922 and net losses on sales of equity investments of $2,827. In December 2008, we decided to liquidate our investments in equity securities in order to protect our capital position from the risk of further declines in the fair value of equity securities.
Other income primarily consists of premium installment charges and fluctuations in returns on company-owned life insurance (COLI) policies. Other income was $223 and $411 for the years ended 2009 and 2008, respectively. The decline in other income is due primarily to lower returns on COLI policies. The $97 decline in other income for 2008 compared to 2007 is due to a lower rate of investment return on the COLI policies.
Underwriting (loss) income measures the pre-tax profitability of our insurance segments. It is derived by subtracting losses and loss adjustment expenses, amortization of deferred policy acquisition costs, and underwriting and administrative expenses from earned premiums. Each of these captions is presented in our consolidated statements of operations but not subtotaled. The sections below provide more insight into the variances in the categories of losses and loss adjustment expenses and amortization of deferred policy acquisition costs and underwriting and administrative expenses, which impact underwriting profitability.
The components of incurred losses and LAE and the loss and LAE ratio in 2009, 2008 and 2007 are as follows:
Prior year development excludes the impact of the stop loss reversal.
Our loss and loss adjustment expense (LAE) ratio was 70.0% for the year ended December 31, 2009, compared to 72.9% in 2008. Losses and LAE was $52,754 and $57,390 for the years ended December 31, 2009 and 2008, respectively.
Favorable loss development in the commercial multi-peril (approximately $1,812) lines attributable to lower level emergence of incurred losses, relative to expectations, for the 2007 and 2008 accident years.
The favorable development in these lines was partly offset by unfavorable development of approximately $1,501 in our workers’ compensation line due to a higher level of incurred loss emergence relative to expectations for the 2008 and 2007 accident years.
Higher catastrophe losses of $4,882 for 2008, compared to $1,986 for 2007;
Net favorable prior year loss development was $5,222 in 2008, compared to $4,638 in 2007. The development in 2008 is primarily attributable to:
Favorable development of $1,124 in our commercial lines of business due to the general observation of declines in claims severity on prior accident years.
Our underwriting expense ratio represents the ratio of underwriting expenses (amortization of deferred policy acquisition costs and underwriting and administrative expenses directly attributable to our insurance operations) divided by net premiums earned. As one component of the combined ratio, along with the loss and loss adjustment expense ratio, the underwriting expense ratio is a key measure of profitability. The underwriting expense ratio can exhibit volatility from year to year from such factors as changes in premium volume, one-time or infrequent expenses for strategic initiatives, or profitability based bonuses to employees and producers. Our strategy has been to grow our net premium volume while controlling overhead costs.
The underwriting expense ratio was 33.1% for 2009, compared to 32.8% for 2008; an increase of 30 basis points. The increase in the expense ratio is primarily due to:
In 2008, the retentions on our excess of loss reinsurance program were significantly higher than they are in 2009. The lower amount paid for reinsurance in 2008 allowed us to retain more earned premium, which led to a lower underwriting expense ratio in 2008.
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs, increased $2,399 in 2008; 9.9% higher than in 2007.
Interest expense for the year ended 2008 was $184 compared to $125 for the year ended 2007. The increase was primarily due to accrued interest on funds withheld related to the aggregate stop loss reinsurance contract, which we entered into effective January 1, 2008.
Other expense was $209 for the year ended 2009 and $365 for the year ended 2008. The decrease of $156 for the period is due primarily to higher levels of write-offs and aging of receivables in 2008 as compared to 2009, the positive impact of which we attribute to our decision to withdraw from certain unprofitable classes of business.
For the year ended 2009, we had pre-tax income from continuing operations of $3,061 compared to a pre-tax loss of $5,837 for the year ended 2008. This net increase was primarily attributable to:
The favorable effects of these items were offset by the reversal of our stop loss on ceded losses in 2009. The net cost of the stop loss contract in 2009 was $2,489, as compared to a net benefit of $884 in 2008.
For the year ended 2008, the net loss from discontinued operations includes a goodwill impairment charge related to Eastern insurance Group of $2,600 after-tax.
For year ended 2009, we had net income of $2,567 compared to a net loss of $7,379 for 2008. As described above, the overall increase of $9,946 was primarily attributable to:
Lower realized investment losses in 2009 as compared to 2008 of $6,018;
For the year ended December 31, 2008, we had a net loss of $7,379 compared to net income of $1,086 for 2007. This decline in net income is primarily attributable to:
Revenues exclude net realized investment gains (losses) and net investment income. Operating income equals pre-tax net income from continuing operations excluding the impact of net realized investment gains (losses) and net investment income.
The agribusiness marketplace has been very competitive during the last three years, putting pressure on pricing. These competitive pressures are affecting our writing of new and renewal business and putting downward pressure on our existing rates. Our focus on underwriting discipline and rate adequacy in the midst of this soft market has resulted in our premium revenue growth being relatively modest during 2008 and 2009.
Direct premiums written increased from $57,281 for the year ended December 31, 2008 to $58,675 for the same period of 2009. The changes in direct premiums written for the period reflect slightly lower retention rates in 2009 as we continue to hold the line on rates while we believe that our competition often reduces rates below what we feel are adequate levels compared to the risks underwritten. However, we have been able to offset this reduced retention by winning new customers who are seeking a carrier with a stronger financial position or better service levels than their current carrier can provide.
The components of incurred losses and LAE and the loss and LAE ratio in 2009, 2008 and 2007 in our agribusiness segment are as follows:
This decrease in the underwriting expense ratio, when added to the decline in the loss and LAE ratio, resulted in our combined ratio in our agribusiness segment decreasing from 99.3% for 2008 to 95.6% for 2009.
The following table sets forth the direct premiums written, net premiums earned, and calendar year loss and LAE ratios reported for our agribusiness segment by line of business:
Commercial property coverage protects businesses against the loss or loss of use, including its income-producing ability, of company property. As of December 31, 2009, our agribusiness segment had approximately 1,200 property insurance policies in force. The loss ratio for our property lines was adversely impacted by unusually high levels of weather related losses in 2007 and 2008. The 2008 losses were mostly driven by several large, isolated weather related losses and a high frequency of small to moderate losses attributable to an unusually high number of catastrophic events. The 2007 losses were primarily concentrated in an unusual number of large, non-catastrophe related claims. The property loss ratio for 2009 was lower compared to prior years due to lower catastrophe losses and lower claim frequency.
Workers’ compensation coverage protects employers against specified benefits payable under state law for workplace injuries to employees. We consider our workers’ compensation business to be a companion product; we rarely write stand-alone workers’ compensation policies. As of December 31, 2009, our agribusiness segment had approximately 400 workers’ compensation insurance policies in force. Our calendar year loss ratio increased in 2009 as we experienced a lower level of favorable development on prior accident years compared to 2008 and 2007. However, on an accident year basis, the profitability of our workers’ compensation line has improved in recent accident years as a result of stricter underwriting guidelines and improved pricing adequacy.
Other lines of business includes umbrella liability, system breakdown, employment practices liability, and surety insurance.
The commercial insurance marketplace has been very competitive during the last three years, putting pressure on pricing. Our focus on underwriting discipline and rate adequacy in the midst of this soft market has made growth challenging at times;
These unfavorable items were partially offset by the reversal of the stop loss reinsurance contract that reduced ceded premiums for 2009 by $1,102. In 2008, there were ceded premiums of $1,774 recognized, as the commercial business segment ceded losses under the stop loss. For additional information concerning the stop loss reinsurance contract, see Item 1 “Business - Reinsurance.”
In 2009, we introduced our PennEdge product within our commercial business segment to enable us to write customized coverages on mid-size commercial accounts. At December 31, 2009, our PennEdge offering was approved in eight states, and we believe it has been well received by our agents and policyholders. For the year ended December 31, 2009, the direct premiums written of our PennEdge product were $1,202.
Effective January 1, 2008, we modified our reinsurance program by retaining more of our losses above $500, which resulted in a decrease in ceded premiums written compared to 2007. This reduction in ceded premiums was mostly offset by the reinsurance of a new coverage we offered in 2008 and additional ceded premium incurred under our aggregate stop loss reinsurance treaty. We started offering employment practices liability insurance coverage in 2008 and have ceded all of the business to a reinsurer.
The components of incurred losses and LAE and the loss and LAE ratio in 2009, 2008 and 2007 in our commercial business segment are as follows:
The decrease in the 2009 Loss and LAE ratio in our commercial business segment is due to:
Excluding the impact of this stop loss variance of $7,448, total incurred losses and LAE declined by $10,233 during 2009 compared to 2008.
Favorable prior year losses and loss expense development of approximately $117 in 2008, compared to approximately $830 of favorable development in 2007.
Our property and liability coverage includes commercial multi-peril, fire, allied, and general liability insurance. The majority of this business is rated and classified as commercial multi-peril. As of December 31, 2009, our commercial business segment had approximately 4,700 property and liability insurance policies in force. Similar to our agribusiness segment, our commercial business segment experienced unusually high levels of severe property related losses in 2007 and 2008. In 2009, a steep drop in large property losses led to the decline in our property and liability loss ratio.
Workers’ compensation coverage protects employers against specified benefits payable under state law for workplace injuries to employees. We generally write workers’ compensation policies in conjunction with our business owner’s policies and we rarely write workers’ compensation policies on a stand-alone basis. As of December 31, 2009, our commercial business segment had approximately 1,500 workers compensation insurance policies in force. Our workers’ compensation line has experienced increasing loss ratios despite a decline in claim frequency for the past three accident years. This line has been adversely impacted by a higher than usual number of large claims. In addition, we have observed increasing claim severity as medical cost inflation continues to impact ultimate claim costs and economic conditions adversely impact the ability of injured workers to return to work.
For purposes of segment reporting, the other segment includes the runoff of discontinued lines of insurance business and the results of mandatory assigned risk reinsurance programs that we must participate in as a cost of doing business in the states in which we operate. The discontinued lines of insurance business include personal lines, which we began exiting in 2001, and assumed reinsurance contracts in which we previously participated on a voluntary basis. Participation in these assumed reinsurance contracts ceased in the 1980s and early 1990s. The most significant of these is a reinsurance agreement we entered into with Munich Re America (formerly American Re), beginning January 1, 1969 and covering various property and liability lines of business. Penn Millers Insurance Company’s participation percentage ranged from 0.625% to 0.75%. We cancelled the contract effective December 31, 1986. We have experienced adverse development and periodic reserve strengthening over the years, but we believe that Munich Re America has established adequate case and IBNR reserves at this time. At December 31, 2009 we had $5,260 of loss reserves established for our voluntary assumed pools. The mandatory assigned risk programs serve as a secondary market for high risk insureds and include: the Fair Access to Insurance Requirements (FAIR) Plans; beachfront and windstorm plans; Commercial Automobile Insurance Plans (CAIPs); and national and state workers’ compensation pools.
The chart below shows the amount of operating income (loss) arising from each of the components for our other segment:
At December 31, 2009, we had total assets of $263,450, compared to total assets of $220,524 at December 31, 2008. Invested assets and cash and cash equivalents increased $53,502 in 2009 from the gross proceeds received in our public offering of $54,440 which was reduced by the loan to our ESOP of $5,400 and reduced by $3,374 of offering costs paid in 2009. Overall strengthening of the investment markets also contributed favorably to the increase in invested assets. Reinsurance recoverables and receivables were $1,135 lower in 2009 from the reversal of our stop loss.
At December 31, 2009, total liabilities were $163,402, compared to $169,769 at December 31, 2008. The $6,367 decrease was primarily due to the decrease in unearned premiums of $2,009 from reductions in premiums written in 2009; lower losses and LAE reserves of $1,355 from favorable loss experience and timing of claims payments; and debt decreased by $2,382 from extinguishments of debt in 2009.
We generate sufficient funds from our operations and maintain a high degree of liquidity in our investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of recurring funds are premium collections, investment earnings and maturing investments.
On October 27, 2009, our board of directors authorized the repurchase of up to 5% of the issued and outstanding shares of our common stock. The repurchases are authorized to be made from time to time in open market or privately negotiated transactions as, in our management’s sole opinion, market conditions warrant. We will have the right to repurchase issued and outstanding shares of common stock until 5% of the shares, or 272,201, are repurchased, unless our board of directors expands the program. As of December 31, 2009, we repurchased 217,761 shares at an average cost of $10.18 per share. The repurchased shares will be held as treasury shares and may be used in connection with a future stock incentive plan, should such a plan be approved by our shareholders at our annual meeting.
Investing activities used $39,087 and $5,702 of net cash for the years ended December 31, 2009 and 2008, respectively. For 2009, net purchases of investments classified as available for sale were $41,509, as compared to $5,178 in 2008. The proceeds from our public offering were utilized to purchase fixed maturity obligations consistent with our investment policy. Net proceeds from our February 2009 sale of the net assets of Eastern Insurance Group provided $2,576 of net cash, and we received the final contingent payment from the early 2008 sale of the net assets Penn Software of $52.
Cash flows provided by financing activities for the year ended December 31, 2009 reflect gross proceeds from our public offering of $54,440, reduced by the loan to our ESOP of $5,400 and by $3,374 paid for fees and expenses associated with our conversion and public offering. Share repurchases accounted for $2,216 of cash used in financing activities.
In the first quarter of 2009, we borrowed $733 on our $2,000 line of credit that existed at that time. In the third quarter of 2009, we consolidated our long-term loan and lines of credit by entering into a new, four year $3,000 revolving line of credit with a commercial bank. On August 3, 2009, $1,800 of this new line of credit and cash on hand of $1,134 was used to pay off the outstanding long-term loan amount of $1,251 of principal and interest, and our two existing lines of credit, at an aggregate amount of principal and interest of $1,683. On December 1, 2009, the $3,000 line of credit was terminated, and the principal balance of $1,800 was repaid in full with proceeds from our public offering.
For the year ended December 31, 2008, cash flows from operating activities totaled $7,383 compared to $11,017 for the year ended December 31, 2007. This decrease in cash flows from operating activities was primarily due to increased claim payments partially offset by lower reinsurance payments. Cash flows used in investing activities totaled $5,702 for the year ended December 31, 2008, compared to $13,373 for the same period of 2007, primarily reflecting an increase in fixed maturity investments purchased and partially offset by an increase in equity investments sold.
Our principal source of liquidity is the proceeds from our public offering and dividend payments and other fees received from Penn Millers Insurance Company. Penn Millers Insurance Company is restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to us. Under Pennsylvania law, there is a maximum amount that may be paid by Penn Millers Insurance Company during any twelve-month period. Penn Millers Insurance Company may pay dividends to us after notice to, but without prior approval of the Pennsylvania Insurance Department in an amount “not to exceed” the greater of (i) 10% of the surplus as regards policyholders of Penn Millers Insurance Company as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or (ii) the statutory net income of Penn Millers Insurance Company for the period covered by such annual statement. Dividends in excess of this amount are considered “extraordinary” and are subject to the approval of the Pennsylvania Insurance Department.
In connection with our conversion and public offering, we established an ESOP which purchased 539,999 shares in the offering in return for a note from us bearing interest at 4.06% on the principal amount of $5,400. The issuance of the shares to the ESOP was fully recognized in the additional paid-in capital account at the offering closing date, with a contra account established in the shareholders’ equity section of the balance sheet for the unallocated shares at an amount equal to their $10.00 per-share purchase price.
The timing of the amounts of the gross losses and loss adjustment expense payments is an estimate based on historical experience and the expectations of future payment patterns. However, the timing of these payments may vary from the amounts stated above. Defined benefit plan obligations are estimates based on various assumptions such as historical accruals, estimates of future employee service periods, future compensation increases, and mortality rates.
In April 2009, the FASB issued guidance on “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” New authoritative accounting guidance under FASB ASC 820, Fair Value Measurements and Disclosures affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. This guidance was effective for interim and annual reporting periods ending after June 15, 2009, with prospective application. The adoption of this guidance did not have a material impact on our results of operations or financial condition.
Supplementary new authoritative accounting guidance (Accounting Standards Update No. 2010-06) under ASC 820 requires additional disclosures related to transfers between levels in the hierarchy of fair value measurement. The standard is effective for reporting periods beginning after December 15, 2009. The standard does not change how fair values are measured. Accordingly, the standard will not have an impact on us, other than possible additional disclosures.
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital reserves.
We have audited the accompanying consolidated balance sheets of Penn Millers Holding Corporation and subsidiary (the Company) as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules II to VI. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
Upon conversion, and consistent with the terms of the plan of conversion, the board of directors authorized and approved PMMHC to issue 1,000,000 shares of $0.01 par stock to the Corporation at par per share. PMMHC also retired 1,000 shares previously held in PMHC Corp.
The Company reports its operating results in three segments: agribusiness insurance, commercial business insurance, and a third segment, which is referred to as “other.” However, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. The agribusiness insurance segment markets its product in a bundled offering that includes fire and allied lines, inland marine, general liability, commercial automobile, workers’ compensation, and umbrella liability insurance. This segment specializes in writing coverage for manufacturers, processors, and distributors of products for the agricultural industry. The commercial business insurance segment markets policies that combine property, liability, business interruption, crime coverage, workers’ compensation, commercial automobile, and umbrella liability coverage for small and middle market businesses. The types of businesses this segment targets include retail, service, hospitality, wholesalers, light manufacturers, and printers. Both the commercial and agribusiness lines are marketed primarily through independent producers. The “other” segment includes the runoff of discontinued lines of insurance business and the results of mandatory assigned risk reinsurance programs that the Company must participate in as a condition of doing business in the states in which it operates.
The Company owned Eastern Insurance Group (EIG), an insurance agency that placed business with both PMIC and unaffiliated insurance companies. In 2008, the Company committed to a plan to sell EIG’s business; and therefore, the assets and liabilities were classified as held-for-sale with the results of operations reported as discontinued operations in the accompanying consolidated financial statements. The Company sold substantially all of the assets of EIG in February 2009 (see note 18).
The Company owned Penn Software & Technology Services Inc. (PSTS) which provided both hardware and computer programming services to its clients. In 2007, management made a decision to sell PSTS; and as such, reported the assets and liabilities of PSTS as held-for-sale with the results of its operations as discontinued operations in the accompanying consolidated financial statements. The Company sold substantially all of the assets of PSTS in July 2008 (see note 18).
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and include the accounts and operations of the Company and its subsidiary. All material intercompany balances and accounts have been eliminated in consolidation. The consolidated financial statements, along with related notes, reflect the reclassification of EIG and PSTS as assets and liabilities held-for-sale and discontinued operations. See note 18 for additional disclosure related to discontinued operations.
The Company’s business is subject to concentration of risk with respect to geographic concentration. Although the Company’s operating subsidiaries are licensed collectively in 33 states, direct premiums written for two states, New Jersey and Pennsylvania, accounted for more than 22% of the Company’s direct premium writings for 2009. Consequently, changes in the New Jersey or Pennsylvania legal, regulatory, or economic environment could adversely affect the Company.
The Company classifies all of its fixed maturity securities as available for sale. Fixed maturities classified as available for sale are carried at fair value. Short-term investments are recorded at cost, which approximates fair value. The fair value of level 1 and level 2 fixed maturities is based upon data supplied by an independent pricing service. The fair value of level 3 fixed maturity securities is based on cash flow analysis and other valuation techniques.
Premiums and discounts on fixed maturity securities are amortized or accreted using the interest method. Mortgage-backed securities are amortized over a period based on estimated future principal payments, including prepayments. Prepayment assumptions are reviewed periodically and adjusted as necessary to reflect actual prepayments and changes in expectations. Adjustments related to changes in prepayment assumptions are recognized on a retrospective basis. Dividends and interest on securities are recognized in operations when declared and earned, respectively. Accrual of income is suspended on fixed maturities or mortgage-backed securities that are in default, or on which it is likely that future payments will not be made as scheduled. Interest income on investments in default is recognized after principal is paid and when payments are received. There are no investments included in the consolidated balance sheets that were not income-producing for the preceding 12 months.
The fair value of investments is reported in note 4. The fair value of other financial instruments, principally receivables, accounts payable and accrued expenses, and debt approximates their December 31, 2009 and 2008 carrying values.
The Company tests for impairment of property, plant, and equipment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. As of December 31, 2009, an impairment is not considered necessary.
The Company and its subsidiary file a consolidated federal income tax return. Income taxes are allocated to each legal entity based on income before income tax expense. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using tax rates and laws that are expected to be in effect when the differences reverse. The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the character of such income and the expected timing of the reversals of existing temporary differences. A valuation reserve is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2009, the Company had no material unrecognized tax benefits or accrued interest and penalties.
In accordance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) Topic 5A, Expenses of Offering, the Company had deferred offering costs consisting principally of legal, underwriting, and audit fees incurred through the completion of the offering, on October 16, 2009. On that date, $3,867 of offering costs were netted against the offering proceeds in equity.
As of September 30, 2008, the Company determined that the carrying amount of the EIG reporting unit exceeded its fair value. The Company had not completed the second step of the goodwill impairment test, as of September 30, 2008. However, as a goodwill impairment loss was probable and could be reasonably estimated, the Company recognized its best estimate of that loss as of September 30, 2008. The Company estimated that EIG goodwill of $4,747 was impaired by $2,435. Management estimated the fair value of the reporting unit at September 30, 2008, based on various offers obtained during their process of selling EIG. The estimate was consistent with offers received subsequent to the end of the third quarter 2008.
The Company completed the sale of substantially all of EIG’s assets and liabilities on February 2, 2009 and received proceeds of $3,109 less estimated costs to sell of $248. In the first quarter of 2009, the Company recorded a pretax loss on sale of $6. The Company has recognized approximately $862 of capital income tax expense.
The liability for unpaid losses and loss adjustment expenses represents the estimated liability for claims reported to the Company plus claims incurred but not yet reported and the related estimated adjustment expenses. The liability for losses and related loss adjustment expenses is determined using case basis evaluations and statistical analyses. Although considerable variability is inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are reasonable. These estimates are periodically reviewed and adjusted as necessary and such adjustments are reflected in current operations.
The Company’s estimated liability for asbestos and environmental claims is $2,397 and $2,502 at December 31, 2009 and 2008, respectively, a substantial portion of which results from the Company’s participation in assumed reinsurance pools. The Company estimates this liability based on its pro rata share of asbestos and environmental case reserves reported by the pools and an additional estimate of incurred but not reported losses and loss adjustment expenses based on actuarial analysis of the historical development patterns. The estimation of the ultimate liability for these claims is difficult due to outstanding issues such as whether coverage exists, the definition of an occurrence, the determination of ultimate damages, and the allocation of such damages to financially responsible parties. Therefore, any estimation of these liabilities is subject to significantly greater than normal variation and uncertainty.
The Company records annual amounts relating to its defined benefit pension plan and nonqualified Supplemental Executive Retirement Plan (SERP) based on calculations that include various actuarial assumptions, such as discount rates, mortality, rates of return, and compensation increases. These estimates are highly susceptible to change from period to period based on the performance of plan assets, demographic changes, and market conditions. The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. The Company believes that the assumptions used in recording its defined benefit pension plan and SERP obligations are reasonable based on its experience, market conditions, and input from its actuaries and investment advisors.
The Company recognizes compensation expense related to its ESOP equal to the product of the number of shares earned, or committed to be released during the period, and the average price of the Company’s common stock during the period. The estimated fair value of unearned ESOP shares is equal to the fair market value of the Company’s common stock at the end of the period. For purposes of calculating earnings per share, the Company includes the weighted average of ESOP shares committed to be released for the period.
In 2005 the Company entered into an interest rate swap agreement in an effort to manage interest rate risk associated with its variable rate debt. The Company’s derivative instrument was executed with a financial institution (counterparty) and was subject to counterparty credit risk. Counterparty credit risk is the risk that the counterparty is unable to perform under the terms of the derivative instrument upon settlement of the derivative instrument.
The derivative was recorded in accounts payable and accrued expenses in the consolidated balance sheets at fair value with the associated gain/loss included in the consolidated statements of operations. On August 3, 2009 the variable rate debt was paid off and the interest rate swap terminated.
In May 2009, additional new authoritative accounting guidance (Accounting Standards Update No. 2009-5) under ASC 820 was issued. This update provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of ASC 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The adoption of this guidance in the third quarter of 2009 did not have an impact on the Company’s results of operations or financial position.
All other standards and updates of those standards issued during the twelve months ended December 31, 2009 either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company or (iv) are not expected to have a significant impact on the Company.
As described in note 1, the Offering resulted in the issuance of common shares of the Company on October 16, 2009. Basic earnings per share are computed by dividing net income for the period subsequent from October 16, 2009 to December 31, 2009 by the weighted average number of common shares outstanding for the period of 4,820,280. There were no dilutive potential common shares outstanding during this period. Consolidated net income for the period from October 17, 2009 to December 31, 2009 was $929, resulting in basic earnings per share of $0.19.
The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008:
Should the independent pricing service be unable to provide a fair value estimate, the Company would attempt to obtain a non-binding fair value estimate from a number of broker-dealers and review this estimate in conjunction with a fair value estimate reported by an independent business news service or other sources. In instances where only one broker-dealer provides a fair value for a fixed maturity security, the Company uses that estimate. In instances where the Company is able to obtain fair value estimates from more than one broker-dealer, the Company would review the range of estimates and would select the most appropriate value based on the facts and circumstances. Should neither the independent pricing service nor a broker-dealer provide a fair value estimate, the Company would develop a fair value estimate based on cash flow analyses and other valuation techniques that utilize certain unobservable inputs. Accordingly, the Company would classify such a security as a Level 3 investment.
Included in accounts payable and accrued expenses at December 31, 2008 is an interest rate swap agreement (see note 5). Management estimated the fair value of the interest rate swap based on information obtained from a third-party financial institution counterparty. Management also considered the prevailing interest rate environment as a key input into the valuation of the swap.
The amortized cost and estimated fair value of fixed maturity securities at December 31, 2009, by contractual maturity, are shown below:
At December 31, 2009 and 2008, investments with a fair value of $4,358 and $4,543, respectively, were on deposit with regulatory authorities, as required by law.
The fair value and unrealized losses for securities temporarily impaired as of December 31, 2009 and 2008 are as follows:
Accumulated other comprehensive income (loss) at December 31, 2009 and 2008 consisted of the following amounts (all amounts net of taxes):
Property and equipment consisted of land and buildings with a cost of $5,746 and $5,677 and equipment, capitalized software costs, and other items with a cost of $9,177 and $9,064 at December 31, 2009 and 2008, respectively. Accumulated depreciation related to such assets was $11,154 and $10,510 at December 31, 2009 and 2008, respectively.
Rental expense under leases for continuing operations amounted to $100, $140, and $245 for 2009, 2008, and 2007, respectively.
On August 3, 2009, $1,800 from this new line of credit and cash from operations of $1,134 was used to pay off the long-term debt amount of $1,251 of principal and interest due at the settlement date, and the two then-existing lines of credit, at an aggregate amount of principal and interest of $1,683. The interest rate swap tied to the long-term debt was also terminated. On December 1, 2009, the Company paid the balance of $1,800 in full and closed the line of credit.
Long-term debt related to continuing operations at December 31, 2009 and 2008 consisted of the following:
On August 1, 2009, upon approval by the board of directors, the Company’s administrator amended the plan, whereby all participants’ accrued benefits under the plan were frozen as of October 31, 2009. The Company recognized a curtailment benefit of $1,659 for the year ended December 31, 2009, which has been reflected in accumulated other comprehensive income (loss) in equity. Due to a decline in interest rates, this benefit has been partially offset by an actuarial loss of $717.
In 2008, as a result of the probable sale of EIG, the Company recognized a curtailment of its defined benefit pension plan. The recognized curtailment loss represents the balance of unrecognized prior service cost associated with the EIG employees, in the amount of $222. A reduction in projected benefit obligation of $123 was recognized at the same time.
The accumulated benefit obligation and projected benefit obligation of the SERP were $1,294 and $1,679, respectively, at December 31, 2009 and $1,024 and $1,353, respectively, at December 31, 2008.
Weighted average assumptions used to determine benefit obligations at December 31, 2009 and 2008 are as follows:
Weighted average assumptions used to determine net periodic benefit cost for the years ended December 31, 2009 and 2008 are as follows:
For a discussion of the methods employed by the Company to measure the fair value of invested assets, see note 4. The following discussion of fair value measurements applies exclusively to the Company's pension plan assets.
The following table presents the level within the fair value hierarchy at which the financial assets of the Company’s pension plan are measured on a recurring basis at December 31, 2009.
As a result of the defined benefit pension plan freeze, the Company's minimum required contribution in 2010 is expected to be $0. However, the Company expects to make a contribution of at least $500 in order to improve the adequacy of the funding position and take advantage of the tax benefits associated with making such a contribution.
The Company has a defined contribution benefit plan sponsored by PMIC covering all employees who have attained age 21. Eligible employees may contribute up to 30% of their salary to the plan, subject to statutory limits. The Company matches 50% of employee contributions up to 3% of employee compensation. Amounts charged to operations were $175, $225, and $242 for 2009, 2008, and 2007, respectively.
The Company sponsors an ESOP, which became effective on October 16, 2009. Eligible employees generally include those employees who have completed six months of service. All employees who had completed six months of service with the Company, prior to the effective date of the plan, were determined to have met the eligibility requirements on that date. ESOP shares are allocated to participants based on the ratio of their individual compensation during the plan year multiplied by a factor that corresponds with their combined age and years of service. A final allocation percentage is then determined by calculating the ratio of an individual’s initial compensation allocation percentage to the total of all eligible participants’ initial compensation allocation percentages.
The Company issued 539,999 shares of its common stock to the ESOP on October 16, 2009. The ESOP is funded entirely by an employer loan in the amount of $5,400, which will be repaid in ten equal installments. These shares held by the ESOP will be allocated over the same 10-year period to eligible employees. Shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid.
Suspense shares, allocated shares, shares committed to be released, average price per share and stock compensation expense as of December 31, 2009, or for the period October 17, 2009 through December 31, 2009, are as follows (in thousands, except for share data):
Components of the provision for income tax (benefit) expense from continuing operations for the years ended December 31, 2009, 2008, and 2007 are as follows:
The Company’s net (refunds) payments for income taxes in 2009, 2008, and 2007 were $(907), $23, and $1,963, respectively.
A reconciliation of the expected and actual federal income tax (benefit) expense from continuing operations for the years ended December 31, 2009, 2008, and 2007 is as follows:
The Company has recorded income tax expense of $879 on discontinued operations, which relates primarily to the tax expense recorded on the sale of the assets of Eastern Insurance Group (EIG), whose book basis exceeded their tax basis. The Company has reviewed the potential of a tax position regarding a worthless stock deduction for its investment in EIG. The Company determined that the more-likely-than not recognition threshold would not be met. Therefore, if the Company were to conclude to take a tax return position on the 2009 Federal Income Tax Return, the benefit would need to be recorded as an uncertain tax position, with no current benefit recognized. The maximum favorable impact of this deduction is estimated to be $900, with reasonable possibility that the tax return position will not be taken.
As of December 31, 2009, the Company had no material unrecognized tax benefits or accrued interest and penalties. The Company’s policy is to account for interest as a component of interest expense and penalties as a component of other expense. Federal tax years 2006 through 2009 were open for examination as of December 31, 2009.
Effective January 1, 2009, the Company modified its reinsurance program in which the Company lowered its participation in the per-risk reinsurance treaty. Losses between $500 and $1,000 are retained at 52.5% in 2009 versus a 75% retention rate in 2008. Losses between $1,000 and $5,000 are retained at 0% in 2009 versus 25% in 2008.
The Company continues to maintain a whole account, accident year aggregate excess of loss (aggregate stop loss) contract. This contract covers the 2008 and 2009 accident years and provides reinsurance coverage for loss and allocated loss adjustment expense (ALAE) from all lines of business, in excess of a 72% loss and ALAE ratio. The reinsurance coverage has a limit of 20% of subject net earned premiums. In 2009, the Company experienced favorable development on accident year 2008 loss reserves subject to the treaty. In addition, accident year 2009 resulted in a loss ratio subject to the treaty for the twelve months ended December 31, 2009 of approximately 66%. As a result of this favorable development on the 2008 accident year and the lower 2009 accident year loss ratio, the benefit recognized under the stop loss as of December 31, 2008 has reversed.
The development in 2008 is primarily attributable to favorable development in the fire and allied line of business of $2,229, the workers’ compensation line of business of $1,652, and the commercial auto liability line of business of $1,124. The fire and allied lines development was the result of prior years’ claims settling for less than originally estimated. The development in the workers’ compensation and commercial auto lines was due to the general observation of declines in claims severity on prior accident years.
The development in 2007 is primarily attributable to the workers’ compensation line of business of $2,757, the commercial auto liability line of business of $2,525, and fire and allied line of business of $1,064. The Company broadly observed some decreasing frequency and severity in the commercial auto liability line and decreasing severity in the workers’ compensation line. The fire and allied lines development was attributable to claims settling for less than originally reserved.
This development for 2007 was partly offset by $1,493 of unfavorable development in the commercial multi-peril line and reserve strengthening of $374 related to asbestos claims assumed from a terminated reinsurance pool. The commercial multi-peril line experienced an increase in newly reported claims for the 2005 accident year.
The Company records its estimated future payment related to guaranty fund assessments and its estimated ultimate exposure related to other insurance-related assessments. Estimates are based on historical assessment and payment patterns, the Company’s historical premium volume, and known industry developments that affect these assessments, such as insurance company insolvencies and industry loss and pricing trends. The Company’s net accrued liability for guaranty fund and other insurance related assessments is $1,397 and $1,528 at December 31, 2009 and 2008, respectively. The accrual is expected to be paid as assessments are made over the next several years.
The above statutory basis net income (loss) and capital and surplus amounts relate to the Company’s insurance subsidiaries, PMIC and AMIC.
In July 2008, the Company entered into an asset purchase agreement and sold the assets of PSTS for $150. The Company recorded a pre-tax loss on sale of $117. In September 2009, the Company received $52 for the contingent portion of the sale price, which was recognized at that time.
At September 30, 2008, the Company tested the goodwill carrying value of EIG for impairment. The possibility of impairment was evident based on information obtained in the selling process and the deterioration of local and national economic conditions. As a result of the impairment test, the Company recognized an impairment to goodwill of $2,435 within discontinued operations at September 30, 2008 (unaudited), which represented its best estimate, as discussed in note 2. The Company completed the sale of EIG on February 2, 2009. Pursuant to the asset purchase agreement, the Company sold substantially all of EIG’s assets and liabilities for proceeds of $3,109, less estimated costs to sell of $248. Based on the fair value determined by the final terms of the sale and finalization of step 2 of the goodwill impairment test, the Company recorded an additional write down of goodwill at December 31, 2008 of $165. In the first quarter of 2009, the Company recorded a pretax loss on sale of $6.
The Company completed the sale of EIG on February 2, 2009 recording a pre-tax loss on sale in the first quarter 2009. A portion of the proceeds of the sale was used to pay off $285 of acquisition payables in liabilities held-for-sale.
The results of operations for EIG were reported within discontinued operations in the accompanying consolidated statements of operations for all periods presented.
Operating results from total discontinued operations for the years ended December 31, 2009, 2008, and 2007 are as follows:
EIG is the only segment with reportable activity in assets and liabilities held-for-sale as of December 31, 2008.
The Company’s unaudited quarterly financial information for continuing operations is as follows:
During the preparation of the second quarter 2009 financial statements, the Company discovered an error in the accrual of ceded premium for the 2009 accident year under the aggregate stop loss contract in effect for 2008 and 2009. Pursuant to SAB No. 108, Quantifying Financial Statement Misstatements, it was determined the misstatements were not material. An adjustment of ($166) to net income is reflected in the first quarter financial information above.
For the Period from October 17, 2009 to December 31, 2009
See note 16 of the notes to the consolidated financial statements.