Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operation and should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. The MD&A is divided into subsections entitled “Business Overview,” “Critical Accounting Policies,” “Results of Operations,” “Liquidity and Capital Resources” and “Losses and Loss Adjustment Expenses.”
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A “Risk Factors” of this Form 10-K for a discussion of factors that could cause our actual results to differ materially from those in the forward-looking statements. However, the risk factors listed in Item 1A “Risk Factors” or discussed in this Form 10-K should not be construed as exhaustive and should be read in
AmerInst has two operating segments: 1) reinsurance activity and 2) RINITS™, its insurance financing product, which is in the marketing phase of development. See Note 11, Segment Information, of the notes to the consolidated financial statements contained in Item 8 of this annual report on Form 10-K for financial information concerning these segments.
AmerInst has filed an application for a U.S. patent on a unique financing concept that it has developed to securitize insurance and reinsurance risk, involving property, casualty, life and health. Such securitization would be by equity and debt financing of Bermuda special purpose companies licensed as reinsurers. It is AmerInst’s intention to grant patent licenses to the special purpose companies and investment banking organizations which
will market the securities. In addition to the license royalties, AmerInst would manage the special purpose companies for a fee, and at its option could invest in them as well. However, AmerInst may not be issued a patent, and even if so, may not be able to license such patent.
Our results of operations for the years ended December 31, 2008 and December 31, 2007 are discussed below.
We operate our business with no long-term debt, no capital or operating lease obligations, no purchase obligations, and no off-balance sheet arrangements required to be disclosed under applicable rules of the SEC. AmerInst’s access to operating cash flows of its subsidiaries is from the payment of dividends.
Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include the Company’s intent and ability to hold the security, changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. AmerInst’s accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
We recorded a net loss of $633,783 in 2008, compared to net income of $3,057,600 in 2007.
Net premiums written in 2008 were $8,393,705, an increase of $711,845 from $7,681,860 in 2007. The increase in net premiums written was primarily attributable to an adjustment in 2007 for premiums over ceded to AmerInst in prior years offset by rate decreases under the current AICPA Professional Liability Plan treaty. We continue to look for ways in which it may be advantageous to expand our business to include the reinsurance of lines of coverage other than accountants’ professional liability.
Net realized loss increased by $5,479,280 in 2008 to $4,558,251 from a net realized gain of $921,029 in 2007. The increase in net realized loss was due to other than temporary impairment charges of $5,271,859 in 2008.
Invested assets, including investments, cash and cash equivalents and restricted cash and cash equivalents, decreased by $9,001,556 or 16.0%, to $47,238,872 in 2008 compared to $56,240,428 in 2007. The decrease was primarily due to a decrease in fair value of the investment portfolio. Investment yield of net investment income and net realized gains and losses in 2008 as of December 31 was (5.9%) as compared to 4.5% in 2007, due to the increase in realized loss on investments in 2008. The investment yield of net investment income was 2.9% in 2008 and in 2007, respectively.
Unrealized gain on investments was $2,731,362 at December 31, 2008 compared to $7,628,904 at December 31, 2007. We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at fair value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The 64.2% decrease in unrealized gain on investments was due primarily to a decline in the value of the Company’s equity portfolio. Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary
The following table shows the fair value of the Company’s investments and where in the Financial Accounting Standard No. 157 “Fair Value Measurements” (“FAS 157”) fair value hierarchy the fair value measurements are included as of December 31, 2008.
The following is a reconciliation of the beginning and ending balance of investments using significant unobservable inputs (Level 3) for the quarter ended December 31, 2008.
Under existing accounting principles generally accepted in the United States, we are required to recognize certain assets at their fair value in our consolidated balance sheets. This includes our fixed maturity investments and equity securities. Fair value, as defined in FAS 157 is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FAS 157 established a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
At each measurement date, we estimate the fair value of the financial instruments using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our investments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of investments. The following describes the valuation techniques we used to determine the fair value of investments held as of December 31, 2008 and what level within the FAS 157 fair value hierarchy the valuation technique resides.
Obligations of state and political subdivisions: Comprised of fixed income obligations of state and local governmental municipalities. The fair values of these securities are based on quotes and current market spread relationship, and are included in the Level 2 fair value hierarchy. AmerInst considers that there is a liquid market for the types of securities held. Broker quotes are not used for fair value pricing.
Equity securities, at fair value: Comprised primarily of investments in the common stock of publicly traded companies. All of the Company’s equities are included in the Level 1 fair value hierarchy. The Company receives prices based on closing exchange prices from independent pricing sources to measure fair values for the equities.
trading becomes less frequent. As such, valuations may include assumptions or estimates that may have significant period-to-period changes that could have a material adverse effect on our results of operations or financial condition.
The Company’s investment portfolio includes U.S. mortgage/asset-backed securities, which comprised approximately 17% of our total investments at December 31, 2008. These securities generally have a low risk of default as they are backed by an agency of the U.S. government, which enforces standards on the mortgages before accepting them into the program. They are considered prime mortgages and the primary risk is uncertainty of the timing of pre-payments. While these securities do not carry a formal rating, they are generally considered to have a credit quality equivalent to or greater than AAA. While there have been recent market concerns regarding sub-prime mortgages, asset-backed home equity loans, commercial mortgages, and adjustable rate mortgages, the Company believes it did not have material exposure to these types of securities in its own portfolio at December 31, 2008.
Assumed reinsurance premiums receivable represent current assumed premiums receivable less commissions payable to the fronting carriers. This balance was $352,085 at December 31, 2008 and $605,756 at December 31, 2007. This balance fluctuates due to the timing of renewal premiums written.
Prepaid expenses and other assets were $228,435 at December 31, 2008, a decrease of 3.0% from 2007. These expenses relate to prepaid directors and officers’ liability insurance costs, director’s retainer, and management fees.
Two semi-annual dividends of $0.47 per share were paid during 2008 and two semi-annual dividends of $0.45 per share were paid during 2007, and a special dividend of $0.70 per share was paid in the first quarter of 2007. During 2008, the dividend amount was reduced by $29,080, which represents a write-off of uncashed dividends issued prior to the year 2001 to shareholders that we have been unable to locate. Since AmerInst began paying consecutive dividends in 1995, our original shareholders have received approximately $16.02 in cumulative dividends per share, which when measured by a total rate of return calculation has resulted in an effective annual rate of return of approximately 9.89% from the inception of the Company, based on a per share purchase price of $8.33 paid by the original shareholders, and using a book value of $27.85 per share as of December 31, 2008.
The Bermuda Monetary Authority has authorized Investco to purchase up to 20% of the Company’s common shares from shareholders who have died or retired from the practice of public accounting and on a negotiated case-by-case basis. From January 1, 2000 through March 1, 2009 Investco had purchased 84,886 common shares from shareholders who had died or retired for a total purchase price of $1,746,151. In addition, from January 1, 2000 through March 1, 2009, Investco had purchased in negotiated transactions at various prices 66,303 common shares for a total purchase price of $869,027.
An actuarial review and projection is performed for us by our independent actuary as of June 30 and December 31 of each year. We review the actuarial estimates throughout the year for the possible impact on our financial position. As noted in our discussion of our results of operations, based on the analysis by the Company’s actuaries, a reduction of $4.6 million from unpaid losses and loss adjustment reserves occurred in the fourth quarter of 2008. This reduction was the result of the completion of the December 31 actuarial review, which indicated positive loss development in policy years 1994 to 2004. This positive loss development in 2008 reflected the recognition of better than expected loss emergence in the 1994 to 2004 policy years rather than explicit changes to our actuarial assumptions.
The traditional loss development method separately forecasts ultimate loss and allocated loss adjustment expense for each year on the basis of historical emergence patterns found in incurred and paid loss and allocated loss adjustment expense data. The claim count-based Cape Cod method treats ultimate claim counts as the exposure base, and uses a claim severity index to reflect changes in expected losses per claim over time. In effect, the Cape Cod method combines a loss development approach (which forecasts future emergence of loss and allocated loss adjustment expense based on past emergence patterns) with an expected pure premium approach (which assumes that future expected emergence can be projected based on historical pure premiums). The claim severity index assumed a 4.0% claim severity trend, based on recent professional liability severity trend indications and judgment.
For premier plan and value plan business, many policies provide allocated loss adjustment expense coverage in addition to the standard $1 million per claim indemnity limit. The effect of a provision for allocated loss adjustment expense in addition to limits was estimated by performing incurred and paid loss and allocated loss adjustment expense Bornhuetter-Ferguson (BF) calculations on the incurred and paid loss and allocated loss adjustment expense in addition to the limits. The BF method essentially blends together an expected loss result and a loss development result. The expected losses used in the BF calculation were selected by multiplying expected claim counts by average excess of $1 million frequency and severity amounts. Based on historical allocated loss adjustment expenses data, the actuary selected a 1.39% claim frequency provision and a $910,000 claim severity provision for 2008, respectively, for allocated loss adjustment expense in addition to limits. Claim severities for earlier years were obtained by de-trending the selected 2008 claim severity using a 5.0% severity trend assumption.
The projected allocated loss adjustment expense in addition to limit amounts were then added to projected ultimate losses and allocated loss adjustment expense derived from the historical data (which exclude allocated loss adjustment expense above the $1 million limit) to obtain the selected ultimate loss and allocated loss adjustment expense amounts including allocated loss adjustment expense in addition to limits.
The CAMICO Mutual Insurance Company was a new program for the Company in 2005. An estimated loss and allocated loss adjustment expense ratio of 70% has been selected annually for this business.
The “cumulative redundancy (deficiency)” represents the aggregate change in the estimates over all prior years. For example, the 1998 liability has developed a $10,335,000 redundancy which has been reflected in income in subsequent years as the reserves were re-estimated.
The lower section of the table shows the cumulative amount paid in respect of the previously recorded liability as of the end of each succeeding year. For example, the 1998 year end liability was originally $20,842,000. As of December 31, 2008, we had paid $9,032,000 of the currently estimated $10,507,000 of losses and LAE that had been incurred for 1998 and prior years through the end of 2008; thus an estimated $1,475,000 in losses incurred through 1998 remain unpaid as of the current financial statement date.
The following table provides an analysis of our contractual obligations at December 31, 2008:
We have audited the accompanying consolidated balance sheets of AmerInst Insurance Group, Ltd. and subsidiaries (the “Company”) as at December 31, 2008 and 2007, and the related consolidated statements of operations and other comprehensive (loss) income, changes in shareholders’ equity and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index and included in Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AmerInst Insurance Group, Ltd. and subsidiaries as at December 31, 2008 and 2007 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We adopted FAS 157, Fair Value Measurements (“FAS 157”), effective January 1, 2008. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants at the measurement date.
In determining fair value, we use the market approach which makes use of prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. FAS 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
The adoption of FAS 157 did not result in any cumulative-effective adjustment to our beginning retained earnings at January 1, 2008, or any material impact on our results of operations, financial position or liquidity. In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157 (“FSP FAS 157-2), which permits a one-year deferral of the application of FAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Accordingly, we have also adopted FSP FAS 157-2 effective January 1, 2008, for non-financial assets and non-financial liabilities. We are currently considering the impact of adopting FAS 157 for non-financial assets and non-financial liabilities with effect from January 1, 2009. We, however, do not anticipate that this adoption will have a material impact on our results of operations, financial position or liquidity.
The gross unrealized loss on investments at December 31, 2008 and 2007 are categorized as follows:
As of December 31, 2008, there were approximately 9 securities in an unrealized loss position with an estimated fair value of $2,759,187. Of these securities, there is 1 security that has been in an unrealized loss position for 12 months or greater with an estimated fair value of $105,959. As of December 31, 2008, none of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The cost or amortized cost and estimated fair value of fixed maturity investments at December 31, 2008 by contractual maturity are shown below. Expected maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations without penalties.
As a result of the change in estimates of insured events in prior years, the provision for losses and loss expenses decreased by $4,553,000 and $2,790,997 in 2008 and 2007, respectively. The 2008 decrease related mainly to positive loss development in the policy years 1994 to 2004. The positive loss development in both 2008 and 2007 reflected the recognition of better than expected loss emergence in the prior policy years noted rather than explicit changes to our actuarial assumptions. The 2007 decrease related mainly to positive loss development in the policy years 1994 to 2002.
Notwithstanding the absence of a public market for our common shares, we have a policy of having Investco, which holds our investment portfolio, purchase shares owned by our shareholders who have retired from the practice of accounting or have died. We are currently prepared to repurchase those shares at a price equal to the greater of the last year-end net book value per share or $27.85 per share.
The combined total net (loss) income for both segments is as follows:
On January 5, 2009, AMIC Ltd. received written notice from CNA that CNA does not intend to renew the reinsurance program encompassed by the AICPA Plan and the Value Plan Policies Accountants Professional Liability Quota Share Treaty effective January 1, 2010. AmerInst’s underwriting profitability is substantially dependent upon the policy pricing, risk selection and claims administration functions exclusively controlled and performed by CNA, the officially sponsored insurer for the AICPA Plan. Neither AmerInst nor any of its subsidiaries has any contractual right to act as a reinsurer or in any other capacity incident to the AICPA Plan. The business relationship with CNA currently accounts for over 95% of AmerInst’s operating revenue.