Net premiums written by the Company's U.S. insurance subsidiaries for 2005 equaled approximately 43% of the combined statutory surplus of these subsidiaries. Premium writings of 200% to 300% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company has no debt outstanding at December 31, 2005.
Direct premiums written for 2005 totaled $209.5 million, a decrease of $27.6 million (12%) from 2004. This decrease is primarily attributable to a decrease in fleet trucking liability premiums of $21.2 million (17%) from 2004 levels. Direct premium writings from the Company's private passenger automobile program also decreased by $2.5 million (6%). Discontinued in 2004, direct premium writings from the Company's small business workers' compensation program decreased by $8.9 million (98%). These decreases were partially offset by increases in the Company's independent contractor and small fleet trucking programs of $4.0 million (9%) and $.9 million (6%), respectively. Large trucking fleet volume decreased as the result of increased rate competition, principally in the layers of coverage above $5 million per occurrence, which resulted in the loss of business and the writing of lower limits for renewed accounts. Increased competitive pressures were also responsible for the decline in premium volume from the private passenger automobile program. The higher premium volume from the independent contractor program resulted from the addition of contractors by existing accounts and the increase in premium volume from the small fleet trucking program was due to geographic expansion.
After giving effect to changes in unearned premiums, net premiums earned increased 8% to $186.2 million for 2005 from $172.1 million for 2004. Excluding inter-company reinsurance arrangements, net premiums earned from all trucking-related insurance products increased by $18.8 million (17%). Net premiums earned from non-affiliated reinsurance assumed also increased by $2.1 million (22%). These increases were partially offset by decreases in net premiums earned from the Company's small business workers' compensation and private passenger automobile programs of $5.3 million (66%) and $1.9 million (5%), respectively.
pronounced, with a 35% increase in pre-tax investment income compared to 2004. The average pre-tax yield on invested assets increased to 3.3% from 2.9% during 2004 (13%) and the after-tax yield of 2.4% compares to 2.2% in 2004. In addition to higher yields, average invested assets increased over 5% during the year.
Losses and loss expenses incurred during 2005 increased $14.3 million (11%) to $140.6 million. The increase in losses incurred is due primarily to losses from hurricanes (Katrina, Rita, and Wilma) during 2005 of $17.6 million compared to $5.0 million of losses attributable to the Florida hurricanes during September, 2004. The 2005 consolidated loss and loss expense ratio was 75.5% compared to 73.4% for 2004. The Company's loss and loss expense ratios for individual product lines are summarized in following the table.
The Company produced an overall savings on the handling of prior year claims during 2005 of $13.7 million. This net savings is included in the computation of loss ratios shown in the table insert. Approximately $8.0 million of this savings relates to retrospectively-rated contracts whereby return premiums were recorded concurrently with the loss savings. The majority of the remaining $5.7 million in savings relates to the Company's large fleet trucking business, generally consistent with, but less than, recent prior years. Because of the high limits provided by the Company to its large trucking fleet insureds, the length of time required to settle larger, more complex claims and the volatility of the trucking liability insurance business, the Company believes it is important to have a high degree of conservatism in its reserving process. As claims are settled in
years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. The Company believes that favorable loss developments are attributable to the Company's long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Changes in both gross premium volumes and the Company's reinsurance structure for its large trucking fleets can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.
Other operating expenses for 2005, before credits for allowances from reinsurers, decreased $4.1 million (8%) to $47.4 million. Gross expenses decreased at a lower rate than the increase in premium volume because much of the Company's expense structure is fixed and does not vary directly with volume. In general, only commissions to independent agents, premium taxes and other acquisition costs vary directly with premium volume. Direct commission expense decreased $2.3 million (18%) due to a decline in business produced by outside agents, predominantly from the discontinued small business workers' compensation product. Resulting primarily from the decrease in direct premium writings, taxes other than federal income and salary-related taxes decreased $1.3 million (18%) from 2004, Most other expense categories were level or down from the prior year as the investment in automation during the past several years has allowed for the handling of higher premium volume without the addition of employees.
Direct premiums written for 2004 totaled $237.1 million, an increase of $21.5 million (10%) from 2003. This increase is primarily attributable to an increase in fleet trucking liability premiums of $16.7 million (15%) from 2003 levels. Direct premium writings from the Company's independent contractor program also increased by $7.2 million (18%). These increases were partially offset by decreases in the Company's private passenger automobile, small business workers' compensation and small fleet trucking programs of $1.4 million (3%), $.6 million (6%) and $.4 million (3%), respectively. Large trucking fleet volume increased primarily from the addition of new accounts during 2004, increased revenues from renewal accounts and, to a lesser degree, premium rate increases. The higher premium volume from the independent contractor program resulted from
Premiums ceded to reinsurers increased $5.1 million (7%) during 2004 to $78.6 million. However, the consolidated percentage of premiums ceded to direct premiums written decreased to 33% for 2004 from 34% for 2003. This decrease is reflective of the Company's increased exposure under reinsurance treaties effective in 2003 and 2004 covering large fleet trucking risks. The Company's maximum retained loss under these treaties has increased over the last two years and, as a result, a lower percentage of the direct premiums are ceded to reinsurers. There were no other significant changes to reinsurance treaties during 2004.
Investment gains were $9.8 million in 2004 compared to gains of $10.0 million for 2003. The current year's net gain consisted of gains on equity securities of $8.5 million, gains on fixed maturities of $1.9 million, and losses on other investments of $.6 million. Net gains for the current year include a net gain of $1.2 million attributable to the process of accounting for "other than temporary impairment" in the investment portfolio. The net gain includes $2.4 million representing subsequent appreciation on previously written down securities disposed of during 2004 offset by additional write downs during the year.
Losses and loss expenses incurred during 2004 increased $30.6 million (32%) to $126.3 million. The increase in losses incurred is reflective of the 18% increase in net premiums earned, and primarily the 24% increase in premiums from trucking-related products, as previously discussed, and from $5.0 million of losses attributable to the Florida hurricanes during September, 2004. The 2004 consolidated loss and loss expense ratio was 73.4% compared to 65.5% for 2003. The loss and loss expense ratio for fleet trucking products for 2004 reflects an increase in severity of accidents, particularly in the large fleet excess product. While overall frequency in the trucking lines has not increased significantly, the frequency of severe losses was higher in 2004. Part of the increase in severity is attributable to social inflation factors which result in higher jury awards and settlements on serious accidents. The Company's higher retention under recent reinsurance treaty renewals also allows for more net volatility in this line of business. The loss and loss expense ratio for reinsurance assumed increased by 8 percentage points, and relates primarily to hurricane losses in 2004. The small business
workers' compensation program continued to perform poorly. This continued unsatisfactory performance prompted management to discontinue this product in the current year fourth quarter.
Other operating expenses for 2004, before credits for allowances from reinsurers, increased $.9 million (2%) to $51.5 million. Gross expenses increased at a lower rate than the increase in premium volume because much of the Company's expense structure is fixed and does not vary directly with volume. Direct commission expense increased $.8 million (7%) due to growth in business produced by outside agents. Resulting primarily from the increase in premium earned, taxes other than federal income and salary-related taxes increased $.7 million (12%) from 2003. Most other expense categories were level or down from the prior year.
As a result of the factors mentioned above, net income for 2004 was $30.3 million compared to $33.1 million for 2003. Diluted earnings per share decreased to $2.05 in 2004 from $2.25 in 2003. Earnings per share from operations, before gains on investments, was $1.62 in 2004 compared to $1.81 in 2003.
The Company's significant accounting policies are discussed in Note A to the consolidated financial statements. The following discussion is provided to highlight areas of the Company's accounting policies which are material and/or subject to significant degrees of judgment.
Approximately 72% of the Company's assets are composed of investments at December 31, 2005. Approximately 93% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 7% of investments are composed of minority interests in thirteen limited partnerships. These limited partnerships are engaged in the trading of public and non-public equity securities and debt, hedging transactions, real estate development and venture capital investment. These partnerships, themselves, do not have readily-determinable market values. Rather, the fair values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the partnerships. While the majority of the underlying assets at December 31, 2005 are publicly-traded securities, a significant minority have been valued by the partnerships using their experience and judgment. In addition, approximately
In determining if and when a decline in market value below cost is other than temporary, we first make an objective analysis of each individual security where current market value is less than cost. For any security where the unrealized loss exceeds 20% of original or adjusted cost, and where that decline has existed for a period of at least six months, the decline is treated as an other than temporary impairment, without any subjective evaluation as to possible future recovery, except where substantial recovery to cost has actually occurred prior to the issuance of the financial statements. For individual issues where the decline in value is less than 20% but the amount of the decline is considered significant, we will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other than temporary. In those instances, the Company also considers its intent and ability to hold investments until recovery or maturity. For any decline which is considered to be other than temporary, we recognize an impairment loss in the current period earnings as an investment loss. Declines which are considered to be temporary are recorded as a reduction in shareholders' equity, net of related federal income tax credits.
combination of quota-share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by the Company's insurance policies for trucking liability and workers' compensation, provide more variability in the estimation process than lines of business with lower coverage limits.
tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in the Company's trucking liability policies provide for greater volatility in the reserving process for more serious claims. Court rulings, tort reform (or lack thereof) and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. Note C to the consolidated financial statements includes additional information relating to loss and loss adjustment expense reserve development.
The liability method is used in accounting for federal income taxes. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for deferred federal income tax was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. Net deferred tax liabilities reported at December 31, 2005 and 2004 consisted of:
Deferred tax assets at December 31, 2005, include approximately $12,176 related to policy liability discounts required by the Internal Revenue Code which are perpetual in nature and, in the absence of the termination of business, will not reverse to a material degree in the foreseeable future. An additional $1,775 relates to impairment adjustments made to investments, as required by accounting regulations. The sizable unrealized gains in the Company's investment portfolios would allow for the recovery of this deferred tax at any time. The balance of deferred tax assets, approximately $1,104, consists of various normal operating expense accruals and is not considered to be material. As a result of its analysis, management does not believe that any of these assets are impaired at December 31, 2005.
The Company's fixed maturity portfolio totaled $265.4 million at December 31, 2005. Approximately 80% of this portfolio is made up of U. S. Government and government agency obligations and state and municipal debt securities; 84% of the portfolio matures within 5 years; and the average life of the Company's fixed maturity investments is approximately 2.4 years. Although the Company is exposed to interest rate risk on its fixed maturity investments, given the anticipated duration of the Company's liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, even a 100 to 200 basis point increase in interest rates would not have even a moderate impact on the Company's ability to conduct daily operations or to meet its obligations.
We estimate that a 100 basis point increase in market interest rates would have resulted in a pre-tax loss in the fair value of fixed maturity investments of approximately $4.2 million at December 31, 2005. Similarly, a 100 basis point decrease in market interest rates would have resulted in an estimated pre-tax gain in the fair value of these instruments of approximately $4.0 million at December 31, 2005. Note, however, that the hypothetical loss mentioned above would only be realized if the Company was obligated to sell bonds prior to maturity, which is extremely unlikely. The aggregate value of money market and short-term investments, bonds maturing within twelve months and expected positive cash flow from operations for 2006 is equal to more than 100% of net loss and loss expense reserves at December 31, 2005.
The Company's loss and loss expense reserves do not have contractual maturity dates and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, we have included an estimate of when we might expect our direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid in the preceding table. Timing of the collection of the related reinsurance recoverable, estimated to be $186.1 million at December 31, 2005, would approximate that of the above projected direct reserve payout.
The investment commitments in the above table relate to maximum unfunded capital obligations for limited partnership investments the Company owned at December 31, 2005.
We have audited the accompanying consolidated balance sheets of Baldwin & Lyons, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in equity other than capital, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
REINSURANCE: Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other insurers have been reported as a reduction of premium earned. Amounts applicable to reinsurance ceded for unearned premium and claim loss reserves have been reported as reinsurance recoverable assets. Certain reinsurance contracts provide for additional or return premiums and commissions based upon profits or losses to the reinsurer over prescribed periods. Estimates of additional or return premiums and commissions are adjusted quarterly to recognize actual loss experience to date as well as projected loss experience applicable to the various contract periods. Estimates of reinstatement premiums on reinsurance assumed contracts covering catastrophic events are recorded concurrently with the related loss.
The Company accounts for foreign reinsurance assumed using the periodic method. Under the periodic method, premiums from foreign reinsurance assumed are recognized as revenue over the contract term, and claims, including an estimate of claims incurred but not reported, are recognized as they occur.
The fair value and the cost or amortized cost of fixed maturity investments at December 31, 2005, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties.
Gain and loss activity for fixed maturity and equity security investments, as shown in the above table, include adjustments for other than temporary impairment for the years ended December 31 and is summarized as follows:
The Company has invested a total of $24,000 in three limited partnerships managed by organizations in which two directors of the Company are executive officers, directors and owners. The Company's ownership interest in these limited partnerships ranges from 6% to 31%. These limited partnerships have an aggregate market value of $31,292 at December 31, 2005 and contributed $7,145 to equity method earnings in 2005. During 2005, the Company has recorded $481 in management fees and $1,687 in performance-based fees to these organizations for management of these limited partnerships. Fees paid in 2004 and 2003, for management of only one limited partnership, were $21 and $46, respectively. The Company has been informed that the fee rates applied to its investments in these limited partnerships are the same as, or lower than, the fee rates charged to unaffiliated customers for similar investments.
The reserves for losses and loss expenses, net of related reinsurance recoverables, at December 31, 2004, 2003 and 2002 were decreased by $13,692, $14,956 and $13,586, respectively, for claims that had occurred on or prior to those dates. These decreases are the result of the settlement of claims at amounts lower than previously reserved and changes in estimates of losses incurred but not reported as part of the normal reserving process.
The major components of the developments shown above are as follows:
Favorable loss development is influenced by the Company's long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Reserve savings developed related to retrospectively-rated accident and health business resulted in the concurrent recording of return premiums of approximately $4,484, $2,700 and $1,512 for the years ended December 31, 2005, 2004 and 2003, respectively. As more fully discussed in Note E, the Company has increased it's per occurrence retention of risk related to trucking liability business over the past several years. The increased net retention per occurrence is reflected in the favorable developments during 2005 and 2004. These trends were considered in the establishment of the Company's reserves at December 31, 2005.
The Company has not changed its original estimate for the loss sustained as a result of the terrorist attacks of September 11, 2001. Therefore, there is no impact on the loss developments shown in the above table except for payments against the original established reserves. The Company has paid $11.1 million to date and carries a remaining reserve of $8.9 million at December 31, 2005.
Cash flows related to federal income taxes paid, net of refunds received, for 2005, 2004 and 2003 were $12,147, $14,865 and $14,100, respectively.
Detail with respect to direct premiums and premiums assumed from and ceded to other insurers and reinsurers is as follows:
Net losses and loss expenses incurred for 2005, 2004 and 2003 have been reduced by ceded reinsurance recoveries of approximately $39,389, $103,579 and $96,592, respectively. Ceded reinsurance premiums and loss recoveries for catastrophe reinsurance contracts were not material.
NOTE G - SHAREHOLDERS' EQUITY Changes in common stock outstanding and additional paid-in capital are as follows
In accordance with the terms of the 1981 Stock Purchase Plan (1981 Plan), the Company is obligated to repurchase shares issued under the 1981 Plan, at a price equal to 90% of the book value of the shares at the end of the quarter immediately preceding the date of repurchase. No shares have ever been repurchased under the 1981 Plan. At December 31, 2005 there were 158,503 shares (Class A) and 438,583 shares (Class B) outstanding which are eligible for repurchase by the Company.
Exercise prices for 20,134 options outstanding as of December 31, 2005 were either $.80 or $1.00 and averaged $.93 with a weighted-average remaining contractual life of 7.0 years. Exercise prices for 466,750 ranged from $20.60 to $26.00 and averaged $20.94 with a weighted average remaining contractual life of 2.3 years. The weighted average exercise price for 15,392 options exercisable at either $.80 or $1.00 at December 31, 2005 was $.91. The weighted average exercise price for 451,750 options exercisable at either $20.60 or $26.00 at December 31, 2005 was $20.78.
During 2002 and 2001, the Company offered loans to certain employees for the sole purpose of purchasing the Company's Class B common stock in the open market. $2,339 and $2,514 of such loans were issued and outstanding at December 31, 2005 and 2004, respectively, and carry interest rates ranging from 4.75% to 6%, payable annually on the loan anniversary date. The underlying securities, with value in excess of the related debt, serve as collateral for these full-recourse loans, which must be repaid no later than 10 years from the date of issue. This loan program was terminated in 2002.
The Company and its consolidated subsidiaries market and underwrite casualty insurance in four major specialty areas (reportable segments): (1) fleet trucking, (2) nonstandard private passenger automobile, (3) small fleet trucking and (4) the assumption of reinsurance. A fifth segment, small business workers' compensation, was placed in runoff status effective during the fourth quarter of 2004 and is shown in the following table only for comparative purposes. The fleet trucking segment provides multiple line insurance coverage to large trucking fleets which generally retain substantial amounts of self-insurance and to medium-sized trucking fleets on a first dollar or small deductible basis. The nonstandard private passenger automobile segment provides motor vehicle liability and physical damage coverages to individuals. The small fleet trucking segment provides commercial automobile coverages to small trucking fleets and owner/operators. The reinsurance assumed segment accepts retrocessions from selected reinsurance companies, principally reinsuring against catastrophes. The small business workers' compensation segment formerly provided workers' compensation coverages to small businesses and other entities.
For 2005, 2004 and 2003, the above amounts for voluntary reinsurance assumed include certain intersegment reinsurance agreements. Intersegment premiums earned during 2005, 2004 and 2003 were $1,570, $1,609 and $1,239, respectively. Intersegment losses and loss expenses incurred during 2005, 2004 and 2003 were $1,595, $1,270 and $1,357, respectively.
One customer of the fleet trucking segment represents approximately $62,570, $57,767 and $47,693 of the Company's consolidated direct and assumed premium written in 2005, 2004 and 2003, respectively.
Cash and cash equivalents includes $88,351 invested in the Northern Funds Money Market Fund which approximates 1% of the fund's net assets.
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123 (revised 2004), SHARE- BASED PAYMENT ("SFAS No. 123R"), which is a revision of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS No. 123") and supersedes APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Pro forma disclosure is no longer an alternative.