(1) The increase in net premiums written and earned in 2004 as compared to 2003 is due to the fact that as of January 1, 2004 the Insurance Company placed the quota share agreement into runoff.
(3) Demutualization expenses include the cost of engaging external accounting, actuarial, legal and other consultants to advise the Company in the demutualization process.
(5) The increase in total investments from December 31, 2003 to 2004 is due to the Insurance Company investing cash on hand as of December 31, 2003 as well as cash provided by operations during 2004 into its investment portfolio during 2004. In addition, approximately $5.1 million was placed into the investment portfolio in 2004 from the proceeds of the Conversion. The increase in total investments from December 31, 2002 to December 31, 2003 is due primarily to cash flow provided by operations of approximately $11.4 million of which $10.4 million was invested in fixed maturity securities. Included in the 2003 cash flow provided by operations was the positive impact on cash of approximately $5.2 million related to the termination of the 2002 quota share contract.
(8) The net loss and loss adjustment expense ratio is the net loss and loss adjustment expenses in relation to net premium earned.
(11) The sum of the ratio of policy acquisition and other underwriting expenses divided by net premiums written, and the ratio of net losses and loss adjustment expenses divided by net premiums earned.
(13) Earnings per share data reflects only net income for the period from October 16, 2004 through December 31, 2004, the period after the Conversion. Net income during this period was $902,711.
Premiums. Direct written premium by major business segment for the years ended December 31 was as follows:
Direct written premiums for the personal segment increased 8.8% as a result of growth in the number of policies written and 5.3% as a result of rate changes. The increase was primarily driven by growth in the number of policies written in the homeowners and private passenger auto product lines of 3.3% and 30.2%, respectively. The commercial segment’s direct written premium decreased due to rate softening which is reflective of current market conditions and the non-renewal of larger commercial exposures that were deemed to be outside of the Insurance Company’s target market. Total commercial policies written during 2004 decreased 2.3% compared to 2003 while rate changes caused a decrease of 4.2% in written premiums in 2004. Direct written premiums for the farm segment increased 6.9% as a result of rate changes while the growth in the number of written policies increased 0.8% during 2004. The marine segment grew as a result of increased policies written of 4.6% in 2004 coupled with an increase 15.7% due to rate changes.
Net written premium for the year ended December 31, 2004 increased $17,613,000 or 93.2%. Approximately $14,925,000 of the increase is due to a reduction in written premium ceded under the quota share reinsurance contract which was placed into runoff on January 1, 2004. Further contributing to the increase is approximately $3,055,000 from overall premium volume growth offset by a net increase of approximately $367,000 in written premiums ceded under other reinsurance agreements.
Net premium earned by major business segment for the years ended December 31 was as follows:
Net premium earned for the year ended December 31, 2004 increased $9,097,000 or 50.3%. Approximately $6,024,000 of the increase is due to the decline in earned premium ceded to the reinsurer under the quota share reinsurance contract. Further contributing to the increase is approximately $3,406,000 from overall premium volume growth offset by a net increase of approximately $333,000 in earned premiums ceded under other reinsurance agreements.
The Insurance Company recorded a net realized investment gain of $277,000 for the year ended December 31, 2004, compared with a net realized investment loss of $32,000 for the year ended December 31, 2003. Gross realized gains on the sale of fixed maturity and equity investments were $484,000 and $297,000 for the years ending December 31, 2004 and 2003, respectively. The increase is due to management’s decision to shift the equity portfolio more towards mutual funds as opposed to common stocks which resulted in the sale of equity investment that generated realized gains. Gross realized losses on the sale of fixed maturity and equity investments were $207,000 and $329,000 for the years ending December 31, 2004 and 2003, respectively. Included in the gross realized loss for the year ended December 31, 2003 is an other than temporary impairment write-down on equity investments, which amounted to $182,000. There were no investments held by the Company during 2004 that were deemed to be other than temporarily impaired.
The decline in the commercial segment’s loss and LAE ratio is due to a decline in claim frequency and severity coupled with increased net earned premium. Commercial claim frequency decreased 20.9% in 2004 as compared to 2003 while the average net incurred loss and LAE per claim decreased 54.8%. The net incurred loss and LAE decreased during 2004 as a result of redundant reserve development and an increase in losses ceded to our reinsurers. During 2004 the commercial segment’s product lines of commercial multiple peril and workers compensation experienced favorable development of $1,076,000 primarily in accident years 2000, 2002 and 2003. Furthermore in 2004 commercial incurred losses ceded to our reinsurers as a percentage of direct incurred losses was 72% compared to 52% in 2003. The increase is due to the fact that the Company experienced an increase in the dollar amount of individual commercial claims which exceeded the retention level of $125,000 under the excess of loss reinsurance agreement. The commercial segment’s loss and LAE ratio was significantly higher during 2003 as a result of increased claim severity specifically in the commercial multiple peril product line. The increased severity in 2003 was partly attributable to the fact that the commercial multiple peril line includes larger liability exposures which have increased the dollar amount of individual claims not experienced by the Company in the past.
Premiums. Direct written premiums in 2003 were approximately $37,484,000, an increase of $3,373,000, or 9.9%, compared to $34,111,000 in 2002. Direct written premium by major business segment for the years ended December 31 was as follows:
Direct written premiums for the personal segment increased 8.8% primarily as a result of rate increases implemented during 2003. Actual policy count for the personal segment increased 0.7% over the prior year. Growth in direct written premiums for the commercial segment of 11.6% is attributable to both rate increases and growth in the number of policyholders. The commercial policy count increased 4.3% compared to the prior year. The farm segment grew 9.0% over the prior and was due to rate increases implemented during 2003. Actual policy count for the farm segment increased 0.2% over the prior year. The marine segment grew 20.1% which is due to rate increases during 2003 offset by a decline of 3.7% in the number of policyholders.
Investment Income. Net investment income, excluding net realized gains and losses, increased $166,000, or 25.5%, in 2003 to $815,000 from $649,000 in 2002. The rate of return on invested assets, including cash and cash equivalents, decreased to 2.8% in 2003 from 2.9% in 2002. Gross investment income before investment expenses increased approximately $363,000 or 35.8% which is due to an increase in invested assets during 2003. Cash and invested assets grew to $34,782,000 as of December 31, 2003, from $23,235,000 as of December 31, 2002, an increase of $11,547,000 or 49.7%. The growth in invested assets was primarily due to an increase in net cash flows provided from operating activities, which included $5.2 million of cash received as a result of the
Other Income, Net. Other income, net primarily includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income and expense items. Other income, net was approximately $208,000 in 2003 compared to $153,000 in 2002. Premium installment charges included in other income were $208,000 in 2003 compared to $198,000 in 2002, an increase of $10,000 or 4.8%. The increase is primarily driven by increased direct written premiums during 2003.
Loss and Loss Adjustment Expenses (LAE). The Insurance Company’s net loss and LAE by major business segment as well as the loss and LAE ratio’s are shown in the tables below:
history of producing profitable business for the Insurance Company. Despite the decline in direct written premium during 2002 and modest growth in 2003, primarily in the personal and farm segments, the Insurance Company has been able to underwrite more profitable business which is a significant factor driving the decline in loss and LAE and the related decline in the loss and LAE ratios noted in the table above. During 2003 the Insurance Company also experienced a decline in claim frequency which is evidence of management’s continued focus on its target market. The number of claims with activity during 2003 for the personal segment declined 20.8% while the farm segment experienced a decline of 37.7%.
The increase in the commercial segment’s loss and LAE is primarily attributable to variations from expected claim severity in the commercial line of business, specifically, commercial multiple peril. The commercial multiple peril line includes several newer and growing product lines for the Company and, as a result, the Company has not had an extensive history with respect to the nature of claims development in this line. Lack of a fully developed book of commercial multiple peril business has made our initial reserve estimates very difficult to predict. In addition, commercial liability claims are taking longer than anticipated to settle. Furthermore, upon re-estimation, management determined that claim severity (the average cost of a claim) in the commercial segment had increased more than expected. The average net incurred loss and LAE for the commercial segment was $5,969 in 2003 compared to $1,566 in 2002. The increase in claim severity is partly attributable to the fact that the commercial multiple peril line includes larger liability exposures which have increased the dollar amount of individual claims not experienced by the Company in the past. Based on the factors described above management strengthened the case base reserves during 2003. As a result, actuarial projections indicated higher ultimate losses on prior years and management increased its estimate of the reserve for incurred but not reported claims.
The decrease in the marine segment’s net loss and LAE and the related ratio was due to larger than normal losses in 2002 primarily attributable to a two-boat collision and a fire in a storage facility that contained two boats insured by the Insurance Company. Given the fact that marine is our smallest segment with 2002 net earned premiums of $485,000, these two losses during 2002 caused a significant increase in the net loss and LAE and the corresponding ratio. In addition, the marine segment also experienced a decline in claim frequency during 2003. The number of claims with activity during 2003 for the marine segment declined 14.0%
The loss and LAE reserves represent our best estimate of the ultimate cost of all losses incurred but unpaid and considers historical loss experience, loss trends, our loss retention levels and the expected frequency and severity of claims. The process of establishing reserves is a complex and uncertain process, requiring the use of informed estimates and judgments. Our estimates and judgments may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as the current legal environment affecting the settlement of our liability claims changes. Any changes could result in future revisions in the estimates of losses or reinsurance recoverables, and would be reflected in our results of operations for the most recent period being reported coinciding with when the change occurs. We believe our reserves for losses and LAE are adequate; however, given the inherent uncertainty in reserve estimates, there can be no assurance that the ultimate amount of actual losses will not exceed the related amounts currently estimated. Furthermore, any such difference could have a material effect on our results of operations and financial position.
increase is due to several factors. Contingent commission expense in 2003 increased approximately $259,000 over 2002 primarily due to continued improvement in profitable business written by the agency force as well as increased direct written premiums in 2003. In addition to contingent commissions the Insurance Company offered an incentive trip to eligible agents resulting in an increase to expense of approximately $178,000. Wages and benefits allocated to underwriting expense increased approximately $247,000 or 11.2%. Approximately $113,000 is due to an increase in employee profit sharing plan expense as a result of increased operating income during 2003. In addition, the net periodic benefit cost for the postretirement health benefit plan, allocated to underwriting expense increased approximately $72,000 with the remaining increase due primarily to annual compensation adjustments for employees. The Insurance Company participates in various associations within the State of Michigan designed to protect policyholders and claimants against losses due to insolvency of insurers. The assessments incurred during 2003 increased approximately $127,000 over the prior years. Other taxes increased approximately $155,000 primarily as a result of federal excise taxes incurred under the 2003 quota share reinsurance agreement. Offsetting the aforementioned items was a decrease of $156,000 in net amortization of deferred policy acquisition costs and the elimination of approximately $330,000 in expense incurred in 2002 related to the terminated defined benefit plan. The Insurance Company’s expense ratio, defined as policy acquisition and other underwriting expense as a percentage of net earned premiums, was 37.1% in 2003 compared to 37.9% in 2002. The decline in the expense ratio is due to primarily to the increase in net earned premium of 10.2% offset by the increase in policy acquisition and other underwriting expenses of 7.7% discussed above.
Interest Expense. Interest expense increased approximately $212,000 during 2003 compared to 2002. The increase is due to additional surplus note interest of $31,000 and interest expense of $181,000 related to the 2003 quota share reinsurance contract. The 2003 quota share reinsurance contract was structured on a funds withheld basis and required the Insurance Company to accrue interest at an annual rate of 2.5%.
Demutualization Expense. Demutualization expenses include the cost of engaging external accounting, actuarial, legal and other consultants to advise the Company in the demutualization process. Future demutualization expenses will also include the cost of printing and postage for communications with policyholders.
Effective November 30, 2001, we terminated the sponsored defined benefit plan. As of January 1, 2001, we had estimated that plan assets would exceed the projected benefit obligation as of the date of termination and a prepaid benefit cost was recorded. As a result of the termination of the plan during 2001, we recognized a curtailment gain of approximately $1,109,000 resulting in a prepaid benefit cost of $1,454,694 as of December 31, 2001. During 2002, we recorded net periodic benefit income of approximately $138,000 and a $424,808 settlement loss. After giving effect to the 2002 net periodic benefit income and settlement loss, the remaining prepaid benefit cost was liquidated in August of 2002. In accordance with the terms of the liquidation, we received approximately $701,000 upon settlement. In addition to the net periodic benefit income, we also contributed approximately $293,000 to our 401(k) plan and approximately $175,000 was paid in excise taxes as a result of the termination. The impact of the net periodic benefit income, 401(k) contribution and excise taxes recorded during 2002 which approximated $330,000, is reflected within policy acquisition and other underwriting expenses in the 2002 statement of operations.
The Company’s effective tax rate was 13.4% and 7.3% in 2003 and 2002, respectively. The primary factors which cause the difference between the expected tax rate of 34% and the effective tax rate in both years include the change in the Company’s deferred tax asset valuation allowance, the dividends received deduction and provision to return variances. The Company has recorded a deferred tax asset valuation allowance equal to 100% of the net deferred tax asset as of December 31, 2003 and 2002. Therefore, the net expense (benefit) as a result of the net decrease (increase) in the Company’s net deferred tax asset is entirely offset by a corresponding increase (decrease) in the valuation allowance.
Cash flow provided by operations was $6,953,000 in 2004 compared to $11,362,000 in 2003 a decrease of $4,409,000. During the year ended December 31, 2004 as compared to 2003 net premiums collected increased $14,133,000 due to policy growth and the quota share contract runoff, net loss and LAE paid increased $4,488,000 while policy acquisition and other underwriting expenses paid increased $5,671,000 due to the fact that the Company did not receive any ceding commission in 2004 as a result of the quota share contract runoff. During the year ended December 31, 2004, net cash used under the quota share funds withheld account was $5,599,000 while during the same period in 2003 net cash provided was $3,166,000, a change of $8,765,000. In 2003 the funds withheld account included both ceded written premiums retained by the Company as well as loss and LAE. Effective January 1, 2004 no new written premiums are ceded under the quota share reinsurance agreement however loss and LAE payments on policies in force at December 31, 2003 and covered by the quota share reinsurance agreement will continue to be paid out of the funds withheld account until all claims have been settled. Other cash provided by operational needs increased $382,000 during the year ended December 31, 2004 compared to 2003.
Cash flow provided by operations was $11,362,000 in 2003, compared to cash flow provided by operations of $974,000 in 2002. The increase in cash flow from operations was impacted by an increase of $799,000 in
As a result of the Holding Company’s acquisition of the stock of the Insurance Company a limitation on the ability to fully utilize the NOL occurred. Based on management’s best estimate, the amount of annual taxable income that can be offset each year by the NOL carryforward is approximately $400,000.
On October 12, 2004, FIC, formerly Fremont Mutual Insurance Company, converted from a mutual to a stock form of insurance company and subsequently on October 15, 2004, all of its outstanding capital stock was transferred to FMIC thereby becoming a wholly owned subsidiary of FMIC. Prior to the conversion and since 1876, Fremont Mutual Insurance Company conducted business as a Michigan domiciled mutual property and casualty insurer. FMIC was formed on November 18, 2003 for the purpose of acquiring all of the stock of FIC. On October 15, 2004 FMIC issued and sold 862,118 shares of its Common Stock at $10 per share (the “Conversion”). As part of the Conversion, surplus note holders converted approximately $2,498,000 of principal and accrued interest on surplus notes into common stock of FMIC. The following table presents (in thousands) the net value of the common stock issued as well as the net cash proceeds received as a result of the Conversion:
The accompanying consolidated financial statements which include the accounts of FMIC since the Conversion and its wholly-owned subsidiary, FIC, have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which vary in certain respects from statutory accounting practices followed in reporting to insurance regulatory authorities. See Note 12-Statutory Insurance Accounting Practices for additional information regarding statutory accounting practices. All significant intercompany transactions have been eliminated.
Additionally, the Company’s impairment evaluation and recognition for interests in mortgage-backed/asset-backed investments is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Under this guidance, impairment losses on investments must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. As a result of this re-evaluation process there were no impairment losses recorded during the years ended December 31, 2004, 2003 or 2002.
Insurance premium income is recognized on a daily pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in-force. Generally, premiums are collected in advance of providing risk coverage, minimizing the Company’s exposure to credit risk. Premiums due from policyholders are net of an allowance for doubtful accounts of $63,116 and $78,129 at December 31, 2004 and 2003, respectively.
The Company presents other comprehensive income or loss as a component of stockholders’ equity on the consolidated statements of stockholders’ equity and comprehensive income. For the years ended December 31 2004, 2003, and 2002, the unrealized gain and loss on investments included in other comprehensive income and loss consisted of the following:
Losses and loss adjustment expense (“LAE”) reserves represent the estimated liability for reported losses and loss adjustment expenses, and actuarial estimates for incurred but not reported losses and loss adjustment expenses based upon the Company’s actual experience, assumptions and projections as to claims frequency, severity, inflationary trends and settlement payments. The reserve for losses and loss adjustment expenses is intended to cover the ultimate net cost of all losses and loss adjustment expenses incurred but unsettled through the balance sheet date. The reserves are reported gross of any amounts recoverable from reinsurers and are reduced for anticipated salvage and subrogation. The methods of making estimates and establishing these reserves are reviewed regularly, and resulting adjustments are reflected in income currently. The liability for losses and loss adjustment expenses is necessarily an estimate and while it is believed to be adequate, the ultimate liability could exceed or be less than such estimate. Anticipated salvage and subrogation for the years ended December 31, 2004, 2003, and 2002 was approximately $473,000, $794,000 and $1,067,000, respectively.
Property and equipment is recorded at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method. Estimated useful lives are: building-35 years, data processing equipment including software-3 to 5 years and furniture, fixtures and equipment-5 to 7 years. Maintenance, repairs and minor renewals are charged to expense as incurred. Depreciation expense was $120,529, $130,947 and $140,580 for the years ended December 31, 2004, 2003, and 2002, respectively. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Upon sale or retirement, the cost and related accumulated depreciation of assets disposed of are removed from the accounts; any resulting gain or loss is reflected in income.
The Company accounts for stock-based compensation in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”. The Company values stock options issued based upon an option-pricing model and recognizes the fair value as an expense over the period in which the options vest.
effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.
The cost or amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value of investments at December 31, 2004 and 2003 are as follows:
Net investment income for the years ended December 31, 2004, 2003 and 2002 is summarized as follows:
Net realized gains (losses) on investments for the years ended December 31, 2004, 2003 and 2002 are summarized as follows:
During 2003, the Company engaged an investment management consultant for the fixed maturity portfolio. Under the guidelines provided to the investment management consultant the fixed maturity portfolio has experienced a rebalancing during 2004 and 2003. The focus of the Company’s rebalancing is to improve credit quality, liquidity and diversification within the portfolio, to create a more stable income stream and to enhance long-term total return. During 2004, special attention was given to portfolio duration in order to reduce market value fluctuations in a rising interest rate environment. Despite the Company’s intent and ability to hold fixed maturity investments until maturity, proceeds from the sale of fixed maturity investments increased during 2004 and 2003 as a result of rebalancing the portfolio.
The following tables shows the estimated fair value and gross unrealized losses, aggregated by investment category and length of time that individual investments have been in a continuous unrealized loss position at December 31, 2004 and 2003.
As of December 31, 2004, the portfolio included 39 fixed maturity investments and 2 equity investments in an unrealized loss position for less than 12 months and 15 fixed maturity investments in an unrealized loss position for more than 12 months, none of which were trading below 80% of cost or amortized cost. All of the fixed maturity investments in an unrealized loss position and assigned a rating by commercial credit rating companies are rated investment grade investments. While all of these investments are monitored for potential impairment, the Company’s experience indicates that they generally do not present as great a risk of impairment, as fair value often recovers over time. These investments have generally been adversely affected by the downturn in the financial markets and overall economic conditions. Management believes that the analysis of each of these investments support the view that these investments were not other-than-temporarily impaired.
At December 31, 2004, fixed maturities with a carrying value approximating $422,672 were on deposit with regulatory authorities, as required by law.
The carrying amount is a reasonable estimate of fair value due to the restrictive nature and limited marketability of the notes.
During 2004 and 2003 the property excess of loss coverage provided up to $2,375,000 over the $125,000 retention. The 2002 property excess of loss coverage provided up to $975,000 over the $125,000 retention.
During 2004, 2003 and 2002 casualty excess of loss coverage provided up to $4,875,000 over the $125,000 retention.
The Company had 3 layers of catastrophic excess of loss reinsurance providing coverage for up to $20,000,000 above a $1,000,000 retention for all three years. The Company had an automatic reinstatement provision after the first loss for each layer to provide coverage in the event of subsequent catastrophes during the year. Coverage would have lapsed after the second event, in which case the Company would have evaluated the need for a new contract for the remainder of a particular year. During 2004 and 2003 the first layer could be reinstated for a fee of 100% of the original premium and 125% of the original premium in 2002. The next two higher layers carried a 100% reinstatement fee for all three years.
In 2002, the Company ceded 70% of the premium and 70% of the first $1,000,000 in losses to reinsurers under the workers compensation quota share agreement. The Company received a 25% commission on the premium ceded.
The Company’s boiler and machinery quota share agreement is primarily an equipment breakdown endorsement to commercial policies. The agreement is a 100% quota share contract with Hartford Steam Boiler. The Company receives a 30% commission on the premium ceded.
During 2002, the Company’s multi line quota share agreement provided coverage for the remainder of the Company’s business. The Company ceded 45% of its premiums and losses to the reinsurers. The agreement contained a loss corridor between loss and LAE ratios of 60% and 71% in 2002. Loss reimbursement from the reinsurers stops when the loss ratio is in the corridor and resumes when the ratio exceeds the corridor. The Company received a 31.5% commission on the premium ceded in 2002. The effect of the features in these agreements is to limit the reinsurers’ aggregate exposure to loss and thereby reduce the ultimate cost to the Company as the ceding company. These features also have the effect of reducing the amount of protection relative to the quota share amount of premiums ceded by the Company. While the Company does not receive pro rata protection relative to the amount of premiums ceded, the amount of such protection is significant, as determined in accordance with guidance under GAAP.
Although reinsurance agreements contractually obligate the Company’s reinsurers to reimburse the Company for their share of losses, they do not discharge the primary liability of the Company. The Company remains liable for the ceded amount of reserves for unpaid losses and loss adjustment expenses and ceded unearned premiums in the event the assuming insurance organizations are unable to meet their contractual obligations. As a result, the Company is subject to credit risk with respect to the obligations of its reinsurers. In order to minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors the economic characteristics of the reinsurers on an ongoing basis. All reinsurers are rated A- or better by A. M. Best Company. Furthermore, the Company has not experienced a collectibility problem with any reinsurer.
The effect of reinsurance on premiums written and earned for the years ended December 31, 2004, 2003 and 2002, are as follows:
Losses and loss adjustment expenses reported on the statement of operations are net of ceded amounts of approximately $8,935,000, $11,190,000 and $6,742,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Actual federal income taxes vary from amounts computed by applying the current federal income tax rate of 34 percent to income or loss before federal income taxes. For the years ended December 31, 2004, 2003 and 2002, the reasons for these differences and the tax effects thereof, are as follows:
Amounts classified as ‘provision to return variance’ in 2004 and 2003 primarily reflect adjustments to prior period deferred tax items used in calculating the tax provision so they are consistent with the final amounts reflected on the Company’s income tax return. The amount in 2002 is due to the fact that the Company filed a request for refund in the amount of $45,396, relating to 1998 and 2000 federal income taxes paid, due to the suspension of the limitation on the use of AMT net operating losses for those years.
At December 31, 2004 and 2003, property and equipment consisted of the following:
During 2004 and 2003, the Company received a 36% ceding commission on the ceded premiums under the multi line quota share reinsurance agreement. During 2002, the Company received a 31.5% ceding commission on the ceded premiums under the multi line quota share reinsurance agreement.
During 2003, the Company recognized an increase of approximately $1,100,000 in the liability for loss and loss adjustment expenses related to prior years as a result of strengthening its reserves. The adverse development in 2003, which approximated 25.1% of the net liability for loss and loss adjustment expenses as of the beginning of the year, is primarily attributable to variations from expected claim severity in the commercial line of business, specifically, commercial multiple peril for the 2000, 2001 and 2002 accident years. The variation from initial reserve estimates is attributable to several factors. First, the commercial multiple peril line includes several newer and growing product lines for which the Company has not had a robust history with respect to the nature of claims development, particularly with ‘longer-tail’ liability claims. Lack of a fully developed book of commercial multiple peril business has made our initial reserve estimates very difficult to predict. As such, the claim development has been more volatile and immature in the early stages of development. For many years, the Company’s core business consisted primarily of homeowners’ policies which are typically ‘shorter-tail’ claims. Liability claims typically require more extended periods of investigation and at times protracted litigation before they are finally settled, and therefore tend to yield loss development and payment patterns that stretch over longer periods of time.
The outstanding balance at December 31, 2004 and 2003 included approximately $1,895,000 and $3,629,000, respectively of surplus notes held by related parties consisting of non-employee directors, agents, officers of the Company and an investment broker who provided services to the Company. Interest expense on surplus notes held by related parties was approximately $223,000 in 2004, $395,000 in 2003 and $365,000 in 2002.
The accrued benefit cost at December 31, 2004 and 2003, is included in accrued expenses and other liabilities in the accompanying balance sheets.
The Company uses a December 31 measurement date for its other postretirement plan. As this plan is not pre-funded, no contributions other than those necessary to cover benefit payments are anticipated. The Company expects to contribute approximately $51,000 to the plan in 2005 to cover anticipated benefit payments. At December 31, 2004, the Company’s expected future benefit payments are as follows:
For measurement purposes as of December 31, 2004, 2003 and 2002, the annual rate of increase in the per capita cost of covered health care benefits assumed for the subsequent year was 10%. Each year the rate was assumed to decrease by 0.5% per year until the ultimate rate of 5.5% was reached.
The Company provides vacation and sick pay benefits for all full-time employees. After one year of employment, any earned and unused vacation (up to 30 days) is payable as a post employment benefit. Prior to December 31, 2003, any earned and unused sick time (up to 30 days) was payable as a post employment benefit. Effective December 31, 2003, the Company reduced the maximum amount of earned and unused sick time that an employee can accumulate from 30 days to 6 days. The Company has accrued a liability for these post employment benefits in the amounts of approximately $183,000 and $202,000 at December 31, 2004 and 2003, respectively.
The Company leases various vehicles under non-cancelable operating lease agreements which begin to expire in 2006 and fully expire in 2007. Rental expense was approximately $57,000, $80,000 and $71,000 in 2004, 2003 and 2002, respectively.
Future minimum lease payments required under the vehicle leases as of December 31, 2004 are as follows:
As of December 31, 2004 and 2003, approximately $68,402,000 and $60,128,000, respectively, of consolidated assets represent assets of FIC that are subject to regulation and may not be transferred to FMIC in the form of dividends, loans or advances. Dividends paid by FIC are subject to limitations imposed by the Michigan Insurance Code (“Code”). Under the Code, FIC may pay dividends only from statutory earnings and capital and surplus. In addition, FIC may not declare an “extraordinary” dividend to its shareholders without the prior approval of the Michigan Office of Financial and Insurance Services (“OFIS”). An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of statutory capital and surplus as of December 31, of the preceding year or the statutory net income, excluding net realized investment gains, for the immediately preceding calendar year. Accordingly, FIC may pay dividends of approximately $2,027,000 in 2005 without prior approval. However, the OFIS has the authority to prohibit payment of any dividend.
Certain regulations that affect the insurance industry are promulgated by the National Association of Insurance Commissioners (“NAIC”), which is an association of state insurance commissioners, regulators and
Two nonemployee directors of the Company are also owners of independent insurance agencies. Both individuals are currently appointed as agents with and write insurance for the Company. The terms and conditions of the agency agreements between these agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays all agencies commissions on business produced. All agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. Total regular and profit sharing commissions earned by these two agencies approximated $410,000, $384,000 and $401,000 in 2004, 2003 and 2002, respectively. The commission rates, including profit sharing commission opportunity, are the same as other agents of the Company. Both agencies are independent agents and also write with regional and national insurers that may be competitors of the Company.
A nonemployee director of the Company is a partner in a law firm. The Company has retained this law firm for certain legal matters in the past and plans to continue to do so in the future. Legal fees paid by the Company to the law firm were approximately $261,000 in 2004, $121,000 in 2003 and $60,000 in 2002.
Non-employee directors of the Company also participated in the surplus note offerings and held surplus notes during 2004 through the Conversion date and at December 31, 2003, as disclosed in Note 9-Surplus Notes. For the years ending December 31, 2004, 2003 and 2002, non-employee directors holding surplus notes received directors’ fees of $47,100, $27,900 and $31,200, respectively.
The Company also paid investment commissions to a firm controlled by an individual who held surplus notes at December 31, 2004 and 2003. Total investment commissions paid during the years ending December 31, 2004, 2003 and 2002 were approximately $13,000, $114,000 and $81,000, respectively.
The Company defines its operations as property and casualty insurance operations. The Company writes four major insurance lines exclusively in the State of Michigan: Personal Lines, Commercial Lines, Farm and Marine. All revenues are generated from external customers and the Company does not have a significant reliance on any single major customer.
The Company evaluates product line profitability based on underwriting gain (loss). Certain expenses are allocated based on assumptions and estimates made by management. Underwriting gain (loss) by product line would change if different methods were applied.
Options to purchase 39,500 shares of common stock were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented.
2- Net income (loss) per share for the periods prior to October 16, 2004 is not applicable.