Reflects the participation rights of our convertible preferred stock. See Note 12 to our audited financial statements.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Item 1A of this report. These factors could cause our actual results in 2006 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements.
We actively market our insurance in 27 states and the District of Columbia through independent agencies, as well as through our wholly owned insurance agency subsidiary. We are also licensed in an additional 18 states and the U.S. Virgin Islands.
Investment income is an important part of our business. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in many other lines of business. From December 31, 2001 to December 31, 2005, our investment portfolio, including cash and cash equivalents, increased from $192.6 million to $582.9 million and produced net investment income of $16.9 million in 2005, $12.2 million in 2004 and $10.1 million in 2003. In the third quarter of 2005, we received $61.3 million from one of our reinsurers pursuant to a commutation agreement. In the fourth quarter of 2005 we completed our initial public offering, and we retained approximately $53.0 million of the net proceeds from the offering. These funds were contributed to our investment portfolio in 2005.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2006 includes eleven reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Under our reinsurance program, we pay our reinsurers a percentage of our gross premiums earned and, in turn, the reinsurers assume an allocated portion of losses for the accident year. Our 2006 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $30.0 million, subject to applicable deductibles and retentions. However, for any loss
With limited exceptions, we historically have retained a significant amount of losses under our reinsurance programs. From 1998 through 2000, we substantially lowered our retention to approximately $18,000 per loss occurrence, which means that we ceded a greater portion of our premiums to our reinsurers. The effect of these lower retention levels was a significant increase in the amount of estimated losses assumed by our reinsurers. In addition, our amounts recoverable from reinsurers increased, reaching a high of $360.9 million at April 30, 2001. In 2001 and 2002, we increased our retention level to $500,000. In 2003, we increased our retention to $500,000 plus 20% of each loss occurrence between $500,000 and $5.0 million. In 2004, we further increased our retention level to $1.0 million. In addition, for losses between $1.0 million and $2.0 million, we had an annual aggregate deductible of approximately $300,000 and, after we satisfied the deductible, retained 10% of each loss occurrence. For losses between $2.0 million and $5.0 million, we had an annual aggregate deductible of approximately $1.3 million and, after we satisfied the deductible, retained 20% of each loss occurrence. In 2005, we continued to retain the first $1.0 million of each loss occurrence. However, for losses between $1.0 million and $5.0 million, we increased our annual aggregate deductible to approximately $5.6 million and, after we satisfied the deductible, retained 10% of each loss occurrence. As described below under “-Liquidity and Capital Resources,” effective as of June 30, 2005, we entered into a commutation agreement with one of our reinsurers. Pursuant to this agreement, we released this reinsurer from all liabilities to us under certain reinsurance agreements in exchange for a cash payment of $61.3 million. As a result of increases in our retention levels, the commutation agreement and collections from our reinsurers in the normal course of business, our amounts recoverable from reinsurers decreased from $199.0 million at December 31, 2004 to $122.6 million at December 31 2005.
Net Premiums Earned. Net premiums earned is the earned portion of our net premiums written. Net premiums written is equal to gross premiums written less premiums ceded to reinsurers. Gross premiums written includes the estimated annual premiums from each insurance policy we write in our voluntary and assigned risk businesses during a reporting period based on the policy effective date or the date the policy is bound, whichever is later, as well as premiums from mandatory pooling arrangements.
Premiums are earned on a daily pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2005 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2005 and the other half in 2006.
Interest Expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rate.
In establishing these estimates, we make various assumptions regarding a number of factors, including frequency and severity of claims, length of time to achieve ultimate settlement of claims, projected inflation of medical costs and wages, insurance policy coverage interpretations and judicial determinations. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may be different from our original estimates. On a quarterly basis, we review our reserves for loss and loss adjustment expenses to determine whether further adjustments are required. Any resulting adjustments are included in the current period’s results. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Additional information regarding our reserves for loss and loss adjustment expenses can be found under the caption “Business-Loss Reserves” in Item 1 of this report.
on our estimates of the underlying loss and loss adjustment expenses, as well as the terms and conditions of our reinsurance contracts, which could be subject to interpretation. In addition, we bear credit risk with respect to our reinsurers, which can be significant because some of the unpaid loss and loss adjustment expenses for which we have reinsurance coverage remain outstanding for extended periods of time.
Assessments. We are subject to various assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and second injury funds. Assessments based on premiums are generally paid one year after the calendar year in which the policies are written. Assessments based on losses are generally paid within one year of when claims are paid by us. State guaranty fund assessments are used by state insurance oversight agencies to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. Second injury funds are used by states to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments and premium surcharges may be partially recovered through a reduction in future premium taxes.
Share-Based Compensation. As of January 1, 2005 we adopted Statement of Financial Accounting Standards (SFAS) No. 123(R) - Share-Based Payment. In accordance with SFAS No. 123(R) we are using the “modified prospective” method to record prospectively compensation costs for new and modified stock option awards over the applicable vesting periods.
Net Premiums Written. Net premiums written in 2005 were $269.4 million, compared to $243.0 million in 2004, an increase of 10.8%. The increase was attributable to growth in gross premiums written and a small decrease in premiums ceded to reinsurers, $21.5 million in 2005 compared to $22.0 million in 2004. As a percentage of gross premiums written, ceded premiums were 7.4% in 2005 compared to 8.3% in 2004.
Net Premiums Earned. Net premiums earned in 2005 were $256.6 million, compared to $234.7 million in 2004, an increase of 9.3%. This increase was primarily the result of an increase in premiums written during 2004 compared to 2003, which resulted in higher premiums earned in 2005 compared to 2004.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits in 2005 were $63.4 million, compared to $58.2 million in 2004, an increase of 8.9%. This increase was primarily due to a $2.1 million increase in agent commissions, a $1.8 million increase in loss-based assessments and a $2.4 million decrease in ceding commissions. This increase was partially offset by an $884,000 decrease in salaries. In 2005, we transferred our employee agents from our insurance company subsidiary to our insurance agency subsidiary, which resulted in a change in their compensation expense from salary to commission expense. The increase in our loss-based assessments resulted primarily from state second injury funds. Ceding commissions, which are commissions we receive from reinsurers, reduce our total underwriting expenses. Ceding commissions decreased in 2005 compared to 2004 as a result of changes in our reinsurance program for that year.
Gross Premiums Written. Gross premiums written in 2004 were $265.0 million, compared to $223.6 million in 2003, an increase of 18.5%. The increase was attributable primarily to a $26.9 million increase in annual premiums on policies written during the period, a $10.6 million increase in premiums resulting from payroll audits and related premium adjustments and a $3.5 million increase in assumed premiums from mandatory pooling arrangements.
Net Premiums Earned. Net premiums earned in 2004 were $234.7 million, compared to $179.8 million for the same period in 2003, an increase of 30.5%. The increase was attributable to the growth in net premiums written and an increase in the amount of premiums written in the first half of 2004 as compared to the first half of 2003.
Net Realized Gains on Investments. Net realized gains on investments in 2004 totaled $1.4 million, compared to $316,000 in 2003. The increase was due to $1.2 million in gains from the sale of equity securities in our investment portfolio.
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred increased to $174.2 million in 2004 from $129.3 million in 2003, an increase of 34.8%. The increase resulted from a growth in net premiums earned of 30.5%, and an increase in loss and loss adjustment expenses incurred of $13.4 million for prior accident years. The increase for prior accident years related primarily to the 2002 accident year, which increased by $9.4 million. The unfavorable development in 2002 was the result of adverse development in certain existing claims and increased estimates in our reserves for that accident year. Our net loss ratio was 74.2% in 2004 compared to 71.9% in 2003.
Interest Expense. Interest expense in 2004 was $1.8 million, compared to $203,000 in 2003. Our weighted average borrowings increased to $31.1 million in 2004 from $7.1 million in 2003 as a result of the issuance of $25.8 million of subordinated notes in April 2004, offset by the repayment of $6.0 million of a note payable. Our weighted average interest rate increased to 4.9% per annum in 2004 from 2.9% per annum in 2003 as a result of the higher weighted average interest rate on our subordinated notes as compared to our note payable.
Gross Premiums Written. Gross premiums written in 2003 were $223.6 million, compared to $185.1 million in 2002, an increase of 20.8%. The increase was attributable primarily to a $28.9 million increase in annual premiums on policies written during the period, an $8.2 million increase in premiums resulting from payroll audits and related premium adjustments and a $0.9 million increase in assumed premiums from mandatory pooling arrangements.
Net Premiums Earned. Net premiums earned in 2003 were $179.8 million, compared to $163.3 million in 2002, an increase of 10.2%. The increase was attributable to the growth in net premiums written, offset by an increase in premiums ceded to reinsurers and a decrease in the amount of premiums written in the first half of 2003 as compared to the first half of 2002.
As discussed above under “-Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2006 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
Net cash provided by operating activities was $142.0 million in 2005, as compared to $91.9 million in 2004 and $50.4 million in 2003. Major components of cash provided by operating activities in 2005 were net premiums collected of $260.1 million and amounts recovered from reinsurers of $85.0 million, offset by claim payments of $161.7 million and operating expenditures of $41.4 million. Major components of cash provided by operating activities in 2004 were net premiums collected of $237.8 million and amounts recovered from reinsurers of $54.1 million, offset by claim payments of $160.6 million and operating expenditures of $39.4 million. Major components of cash provided by operating activities in 2003 were net premiums collected of $183.2 million and amounts recovered from reinsurers of $61.0 million, offset by claim payments of $159.6 million and operating expenditures of $34.2 million.
Interest on the outstanding subordinated notes accrues at a floating rate equal to the three-month LIBOR plus a marginal rate. Our $10.3 million issuance of subordinated notes due 2034 has a marginal rate of 4.1%, and, as of December 31, 2005, had an effective rate of 8.25%. These notes are prepayable at par beginning in January 2009. Our $25.8 million issuance of subordinated notes due 2034 has a marginal rate of 3.8% and, as of December 31, 2005, had an effective rate of 8.13%. These notes are prepayable at par beginning in April 2009.
During 2004, Converium Reinsurance (North America), one of our reinsurers, reported a significant loss, resulting in a downgrade in its A.M. Best rating. Although Converium continued to reimburse us under the terms of our reinsurance agreements, we initiated discussions with Converium to seek to reduce the credit risk associated with the amounts due to us. Effective June 30, 2005, we entered into a commutation agreement with Converium. In the third quarter of 2005, Converium paid us $61.3 million pursuant to this agreement in exchange for a termination and full release of three of our five reinsurance agreements with Converium. Under the commutation agreement, all liabilities reinsured with Converium under these three reinsurance agreements have reverted back to us. We recorded a pre-tax loss of $13.2 million related to this commutation agreement. Converium remains obligated to us under the remaining two agreements. At December 31, 2005, the amounts recoverable from Converium under the remaining two reinsurance agreements was $6.6 million. The $61.3 million we received in connection with the commutation with Converium was contributed to our investment portfolio.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate, Silver Oak Casualty and American Interstate of Texas. AMERISAFE’s primary assets are the capital stock of these operating subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. See “Business-Regulation-Dividend Limitations” in Item 1 of this report. Based on reported capital and surplus at December 31, 2005, American Interstate is permitted under Louisiana insurance law to pay dividends to AMERISAFE in 2006 in an amount up to $3.9 million without approval by the Louisiana Department of Insurance.
Under Louisiana and Texas law, as applicable, each of American Interstate, Silver Oak Casualty and American Interstate of Texas is required to invest only in securities that are either interest-bearing or eligible for dividends, and must limit its investment in the securities of any single issuer to five percent of the insurance company’s assets. As of December 31, 2005, we were in compliance with these requirements.
As of December 31, 2005, there were no other-than-temporary declines in the fair values of the securities held in our investment portfolio.
Rental expense was approximately $924,000 in 2005, $956,000 in 2004 and $1.1 million in 2003.
Audited Financial Statements as of December 31, 2005 and 2004 and for the three years in the period ended December 31, 2005:
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AMERISAFE, 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.
AMERISAFE, Inc. (“Amerisafe”), is an insurance holding company incorporated in the state of Texas. Based on voting shares, Amerisafe is 40.7% owned by Welsh, Carson, Anderson and Stowe VII L.P. and its affiliate WCAS Healthcare Partners, L.P. (“Welsh Carson”). The accompanying consolidated financial statements include the accounts of Amerisafe and its subsidiaries: American Interstate Insurance Company (“AIIC”) and its insurance subsidiaries, Silver Oak Casualty, Inc. (“SOCI”) and American Interstate Insurance Company of Texas (“AIIC-TX”), Amerisafe Risk Services, Inc. (“RISK”) and Amerisafe General Agency, Inc. (“AGAI”). AIIC and SOCI are property and casualty insurance companies, domiciled in the state of Louisiana. AIIC-TX is a property and casualty insurance company organized under the laws of the state of Texas, was incorporated on December 20, 2004, and commenced business on January 1, 2005. RISK, a wholly-owned subsidiary of Amerisafe, is a claims and safety service company servicing only affiliate insurance companies. AGAI, a wholly owned subsidiary of Amerisafe, is a general agent for the Company. AGAI sells insurance, which is underwritten by AIIC, SOCI and AIIC-TX, as well as by nonaffiliated insurance carriers. The assets and operations of AGAI are not significant to that of the consolidated entity.
Amerisafe and its subsidiaries are collectively referred to herein as the “Company.”
The Company provides workers’ compensation and general liability insurance for companies primarily in special trade groups, including construction, trucking and logging. Assets and revenues of AIIC represent approximately 99% of comparable consolidated amounts of the Company for each of 2005, 2004 and 2003.
On November 23, 2005, the Company completed the initial public offering of its common stock with the sale of 8,000,000 shares at $9.00 per share. Prior to that time, there was no public market for the Company’s common stock. The shares were registered under the Securities Act of 1933 under a Registration Statement on Form S-1 that was declared effective by the Securities and Exchange Commission on November 17, 2005. The Registration Statement also covered additional shares of common stock made available for sale by certain of the Company’s shareholders pursuant to an option granted to the underwriters of the offering. On December 9, 2005, the underwriters exercised the option to purchase 485,750 shares of common stock from the selling shareholders. The sale of these shares closed on December 14, 2005. The Company did not receive any of the proceeds from the sale of shares by the selling shareholders.
The Company’s net proceeds from the initial public offering were approximately $63.2 million, after deducting approximately $5.0 million in underwriting discounts and commissions and approximately $3.7 million in other expenses related to the offering. Approximately $10.2 million of net proceeds were used by the Company to redeem shares of Series A preferred stock and Series E preferred stock. The Company retained approximately $53.0 million of the net proceeds from the offering. Of this amount, the Company contributed $45 million to its insurance company subsidiaries. The remaining $8.0 million will be used to make additional capital contributions to the Company’s insurance company subsidiaries as necessary to support anticipated growth and for general corporate purposes, including to pay interest on the Company’s outstanding subordinated notes and to fund other holding company operations.
On October 27, 2005, the Company effected a 72-for-one reverse stock split. All amounts included in these financial statements have been restated to give effect to the reverse stock split.
Investment income is recognized as it is earned. The discount or premium on fixed maturities is amortized using the scientific “constant yield” method. Anticipated prepayments, where applicable, are considered when determining the amortization of premiums or discounts. Realized investment gains and losses are determined using the specific identification method.
Premiums receivable consist primarily of premium-related balances due from policyholders. The Company considers premiums receivable as past due based on the payment terms of the underlying policy. The balance is shown net of the allowance for doubtful accounts. Receivables due from insureds are charged off when a determination has been made that a specific balance will not be collected based upon the collection efforts of Company personnel. An estimate of amounts that are likely to be charged off is established as an allowance for doubtful accounts as of the balance sheet date. The estimate is primarily comprised of specific balances that are considered probable to be charged off after all collection efforts have ceased, as well as historical trends and an analysis of the aging of the receivables.
Reserves for loss and loss adjustment expenses represent the estimated ultimate cost of all reported and unreported losses incurred through December 31. The Company does not discount loss and loss adjustment expense reserves. The Company uses a consulting actuary to assist in the evaluation of the adequacy of the reserves for loss and loss adjustment expenses. The reserves for loss and loss adjustment expenses are estimated using individual case-basis valuations, statistical analyses and estimates based upon experience for unreported claims and their associated loss and loss adjustment expenses. Such estimates may be more or less than the amounts ultimately paid when the claims are settled. The estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in these estimates, management believes that the reserves for loss and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any adjustments are included in current operations.
Amounts recoverable from reinsurers include balances currently owed to the Company for losses and allocated loss adjustment expenses that have been paid to policyholders, as well as amounts that are currently reserved for and will be recoverable once the related expense has been paid.
Ceding commissions are earned from certain reinsurance companies and are intended to reimburse the Company for costs related to acquiring policies. Ceding commission income is recognized over the effective period of the related insurance policies in proportion to premium revenue earned and is reflected as a reduction in underwriting and other operating costs.
Contingent commissions are earned from certain reinsurance companies based on the financial results of the applicable risks underwritten by the Company. Contingent commission revenue on reinsurance contracts is recognized during the related reinsurance treaty period and is based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations. Contingent commissions recognized increased underwriting and other operating costs by $251,000 in 2005, and reduced costs by $200,000 in 2004 and $10,000 in 2003.
All advertising expenditures incurred by the Company are charged to expense in the period to which they relate and are included in underwriting and other operating costs in the consolidated statements of income. Total advertising expenses incurred were $382,000, $412,000 and $506,000 during 2005, 2004 and 2003, respectively.
The Company considers deferred tax assets to be recoverable if it is probable that the related tax losses can be offset by future taxable income. The Company includes reversal of existing temporary differences, tax planning strategies available and future operating income in this assessment. To the extent the deferred tax assets exceed the amount expected to be recovered in future years, the Company records a valuation allowance for the amount determined unrecoverable. The Company has not recorded a valuation allowance, since the recorded deferred tax asset is expected to be fully realized.
Insurance-related assessments are accrued in the period in which they have been incurred. The Company is subject to a variety of assessments related to insurance commerce, including those by state guaranty funds and workers’ compensation second-injury funds. State guaranty fund assessments are used by state insurance oversight agencies to cover losses of policyholders of insolvent or rehabilitated insurance companies and for the operating expenses of such agencies. These mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. Assessments related to premiums are generally paid one year after the calendar year in which the premium is written, while assessments related to losses are generally paid within one year of when the loss is paid.
The Company writes certain policies for which the policyholder may participate in favorable claims experience through a dividend. An estimated provision for workers’ compensation policyholders’ dividends is accrued as the related premiums are earned. Dividends do not become a fixed liability unless and until declared by the respective Boards of Directors of Amerisafe’s insurance subsidiaries. The dividend to which a policyholder may be entitled is set forth in the policy and is related to the amount of losses sustained under the policy. Dividends are calculated after the policy expiration. The Company is able to estimate the policyholder dividend liability because the Company has information regarding the underlying loss experience of the policies written with dividend provisions and can estimate future dividend payments from the policy terms.
On December 16, 2004, FASB issued FASB Statement No. 123(R) (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement No. 123(R) supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement No. 123(R) is similar to the approach described in Statement No. 123. However, Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an option.
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as held-to-maturity at December 31, 2005 are summarized as follows:
The amortized cost for the fixed maturity securities classified as held-to-maturity includes an unamortized gain of $6,325,000. This gain resulted in 2004 from the difference between each security’s par value and fair value at the date of transfer from available-to-sale to held-to-maturity and is being amortized as a yield adjustment over the respective security’s life.
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as available-for-sale at December 31, 2005 are summarized as follows:
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as held-to-maturity at December 31, 2004 are summarized as follows:
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as available-for-sale at December 31, 2004 are summarized as follows:
A summary of the cost or amortized cost and fair value of investments in fixed maturity securities at December 31, 2005, by contractual maturity, is as follows:
A summary of the Company’s realized gains and losses on sales, calls or redemptions of investments for 2005, 2004 and 2003 is as follows:
At December 31, 2005, furniture and equipment included property under capital leases of $90,000 and software included property under capital leases of $1,242,000. Accumulated depreciation includes $391,000 that is related to these properties. At December 31, 2004, furniture and equipment included property under capital leases of $20,000 and software included property under capital leases of $1,110,000. There was no accumulated depreciation related to capital leases at December 31, 2004. The capital lease obligations related to this property are included in accounts payable and other liabilities.
Future minimum lease payments related to the capital lease obligations are detailed below (in thousands):
The Company cedes certain premiums and losses to various reinsurers under quota share and excess-of-loss treaties. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer
insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers. The effect of reinsurance on premiums written and earned in 2005, 2004 and 2003 was as follows:
The Company received reinsurance recoveries of approximately $85,025,000 in 2005, $54,144,000 in 2004 and $60,960,000 in 2003.
The following table provides a reconciliation of the beginning and ending reserve balances, net of related amounts recoverable from reinsurers, for 2005, 2004 and 2003:
The total payment from Converium was $61.3 million, of which $56.1 million was for ceded reserves and $5.2 million was for paid recoverables as of June 30, 2005.
The Company’s reserves for loss and loss adjustment expenses, net of amounts recoverable from reinsurers, at December 31, 2004, 2003 and 2002, were increased during the subsequent year by $21,108,000, $13,139,000 and $973,000, respectively. Over 75% of the 2005 prior year development occurred in accident years 1999 through 2002. The unfavorable development was the result of settlements above the established case reserves or upward revisions to the estimated settlements on an individual case basis, totaling $7.9 million, and the commutation with our largest reinsurer, Converium Reinsurance North America (“Converium”), as discussed in the following paragraph. The revisions to the Company’s case reserves reflect new information gained by claims adjusters in the normal course of adjusting claims and then reflected in the financial statements when the information becomes available. It is typical for more serious claims to take several years to settle and the Company continually revises estimates as more information about claimants’ medical conditions and potential disability becomes known and the claims get closer to being settled.
Reliance Insurance Company (“Reliance”), one of the Company’s reinsurers, was placed into liquidation in October 2001. As a result of adverse development in the policy years covered by the Reliance reinsurance, the Company incurred an additional $770,000, $260,000 and $1,300,000 of loss and allocated loss adjustment expense related to additional impaired amounts recoverable from Reliance during 2005, 2004 and 2003, respectively.
Property and casualty insurance companies are subject to certain risk-based capital (“RBC”) requirements specified by the National Association of Insurance Commissioners. Under these requirements, a target minimum amount of capital and surplus maintained by a property/casualty insurance company is determined based on the various risk factors related to it. At December 31, 2005, the capital and surplus of AIIC and its subsidiaries exceeded the minimum RBC requirement.
Pursuant to regulatory requirements, AIIC cannot pay dividends to Amerisafe in excess of the lesser of 10% of statutory surplus, or statutory net income, excluding realized investment gains, for the preceding 12-month period, without the prior approval of the Louisiana Commissioner of Insurance. However, for purposes of this dividend calculation, net income from the previous two calendar years may be carried forward to the extent that it has not already been paid out as dividends. No such dividends were paid to Amerisafe in 2005, 2004 or 2003. Based upon the above described calculation, AIIC could pay to Amerisafe dividends up to $3,946,000 in 2006 without seeking regulatory approval.
Additionally, 2,429,541 shares of common stock were issuable upon conversion of all outstanding shares of Series C and Series D convertible preferred stock at December 31, 2005, based on the conversion price on that date of $20.58.
All 862,924 shares of Series A preferred stock redeemed or exchanged were canceled and retired and cannot be reissued.
Prior to the completion of the Company’s initial public offering in November 2005, holders of the Convertible Preferred Stock were entitled to cumulative dividends at the rate of $7 per year payable quarterly in shares of Series E preferred stock. Under the terms of the Company’s articles of incorporation, holders of the Convertible Preferred Stock are no longer entitled to receive these pay-in-kind dividends as a result of the redemption and exchange of all outstanding shares of Series A preferred stock. However, if holders of two-thirds of the outstanding shares of Convertible Preferred Stock consent to the payment of a dividend by the Company to the holders of common stock or non-voting common stock, holders of Convertible Preferred Stock will receive (on an as-converted to common stock or non-voting common stock basis) a dividend equal to the dividend paid to holders of common stock and non-voting common stock.
Prior to the completion of the Company’s initial public offering in November 2005, holders of Series E preferred stock were entitled to cumulative dividends at the rate of $7 per year payable quarterly in shares of Series E preferred stock. In connection with the offering and in accordance with the terms of its articles of incorporation, the Company used approximately $5.1 million of the proceeds from the offering to redeem all then-outstanding shares of Series E preferred stock, at the Redemption Price. The Company made cash redemptions of Series E preferred stock on May 28, 2004, June 8, 2004 and June 30, 2004. An aggregate of 317,744 shares of Series E preferred stock have been redeemed by the Company. These shares were canceled and retired and cannot be reissued.
There were no outstanding shares of Series E preferred stock as of December 31, 2005.
In the event of any liquidation or dissolution of Amerisafe, the holders of Convertible Preferred Stock will receive $100 for each outstanding share before any distributions are made to holders of any other then-outstanding series of preferred stock, junior preferred stock, common stock or non-voting common stock. Any remaining net assets will be distributed first to holders of common stock and non-voting common stock, subject to any other preferential amounts payable to holders of any then-outstanding series of preferred stock or junior preferred stock.
The 2005 Incentive Plan is administered by the Compensation Committee of the Board and is designed to provide incentive compensation to executive officers and other key management personnel. The 2005 Incentive Plan permits awards in the form of incentive stock options, as defined in Section 422(b) of the Internal Revenue Code of 1986, non-qualified stock options, restricted shares of common stock and restricted stock units. The maximum number of shares of common stock that may be issued pursuant to option grants and restricted stock and restricted stock unit awards under the 2005 Incentive Plan is 1,900,000 shares, subject to the authority of the Board to adjust this amount in the event of a merger, consolidation, reorganization, stock dividend, stock split, combination of shares, recapitalization or similar transaction affecting the common stock. Officers, other key employees, consultants and other persons performing services for the Company that are equivalent to those typically provided by Company employees are eligible to participate in the 2005 Incentive Plan. However, only employees (including Company officers) can receive grants of incentive stock options.
Stock options granted under the 2005 Incentive Plan have an exercise price of not less than 100% of the fair value of the common stock on the date of grant. However, any stock options granted to holders of more than 10% of the Company’s voting stock will have an exercise price of not less than 110% of the fair value of the common stock on the date of grant. Stock option grants are exercisable, subject to vesting requirements determined by the Compensation Committee, for periods of up to ten years from the date of grant, except for any grants to holders of more than 10% of the Company’s voting stock, which will have exercise periods limited to a maximum of five years. Stock options generally expire 90 days after the cessation of an optionee’s service as an employee. However, in the case of an optionee’s death or disability, the unexercised portion of a stock option remains exercisable for up to one year after the optionee’s death or disability. Stock options granted under the 2005 Incentive Plan are not transferable, except by will or the laws of descent and distribution.
Subject to completion of the initial public offering, the Board approved grants of options to officers and employees to purchase an aggregate of 1,548,500 shares of common stock. These options have an exercise price equal to the initial public offering price of $9.00 and are subject to pro rata vesting over a five-year period.
The following table summarizes information about the stock options outstanding under the 2005 Incentive Plan at December 31, 2005:
The Company recognized $53,000 in compensation expense in 2005 related to the 2005 Incentive Plan.
Upon completion of the initial public offering, each non-employee Director received a pro-rated award of 833 shares of restricted stock. As of December 31, 2005, there were 3,332 shares of restricted stock outstanding, all of which will vest on the date of the annual meeting of shareholders in 2006.
The Amerisafe 1998 Amended and Restated Stock Option and Restricted Stock Purchase Plan (the “1998 Plan”) was terminated on June 20, 2005. The 1998 Plan was administered by the Board of Directors and provided for grants of incentive stock options, nonqualified stock options, or restricted stock to selected employees, officers and directors. Each option granted under the 1998 Plan was exercisable for one share of common stock. Options could have been granted under the 1998 Plan for a number of shares not to exceed, in the aggregate, 2,500,000 shares of common stock.
Exercise prices for the incentive stock options could be no less than 100% of the fair value of a share of common stock on the date the option was granted. If the option was granted to any owner of 10% or more of the total combined voting power of the Company, the exercise price was to be at least 110% of the fair value of a share of common stock on the date the option was granted. Exercise prices for the nonqualified stock options could be no less than 100% of the fair value of a share of common stock on the date the option was granted. Each option vested ratably over a period of five years and was exercisable during a period not to exceed ten years from the date such option was granted. Exercise prices for non-employee Director stock options could be no less than 100% of the fair value of a share of common stock on the date the option was granted.
A summary of the Company’s 1998 Plan as of December 31, 2005, 2004 and 2003, and changes during each of the years then ended is as follows:
The calculation of basic and diluted EPS for the years ended December 31, 2005, 2004 and 2003 are presented below.
Computed under the two-class method by dividing the weighted-average common shares outstanding (225 at December 31, 2004) by the sum of the weighted-average common shares outstanding and shares issuable upon conversion of all convertible participating securities, calculated on the if-converted method (such additional shares totaled 96 at December 31, 2004). In computing basic EPS using the two-class method, the Company has not allocated the loss available to common shareholders for the years ended December 31, 2005 and 2003 between common shareholders and participating security holders as the participating holders do not have a contractual obligation to share in the loss.
Each of the life insurance companies from which the Company purchases annuities, or the entity guaranteeing the life insurance company, has an A.M. Best Company rating “A-” (Excellent) or better.
Rental expense was approximately $924,000 in 2005, $956,000 in 2004 and $1,074,000 in 2003.