The Company leases approximately 23,000 square feet in an office building located in Hatboro, Pennsylvania. The office building also houses Penn Independent and certain of its subsidiaries. The Company leases the space from Mr. Irvin Saltzman, Chairman of the Board of Directors of the Company, pursuant to a lease agreement renewed June 30, 2000 that expires on June 30, 2005, and provides for an annual rental payment of $281,000. This amount is considered by the Company to be at fair market value.
(1) Cash flow provided by operations differs from net income (loss), due to the fact that net income (loss) includes accruals for non-cash items as required by GAAP and net realized investment gain (loss).
(4) The loss ratio is calculated by dividing losses and loss adjustment expenses by premiums earned.
(6) The combined ratio is the addition of the loss ratio and expense ratio.
Business. PAGI is a specialty property and casualty insurance holding company that markets and underwrites general liability, commercial property and multi-peril insurance for small businesses with average annual premiums of about $2,000. These small businesses are located primarily in small towns and rural areas in all fifty states and the District of Columbia. The small businesses Penn-America insures, such as restaurants, service contractors, retail stores and apartments, often cannot obtain insurance because of their rural locations, small premium size or non-standard risk characteristics. As a result, these small businesses must turn to companies like Penn-America, which operate in a small business niche of the secondary or residual market called the “excess and surplus lines” or “E&S” market. By operating in the E&S market, Penn-America is rewarded with higher prices than the standard lines market, more flexibility in excluding coverage for specific loss exposures and lower premium taxes and state guarantee fund assessments.
Key Financial Measures. The Company utilizes a number of financial measures to evaluate its operating performance and financial condition. The Company’s overall financial goal is to produce a 12 to 15 percent return on equity (“ROE”) over the long-term. The Company calculates ROE by dividing net income by average stockholders’ equity. The following table summarizes ROE for each year in the ten-year period ended December 31, 2003:
The remainder of the ROE generated by the Company is invested in growing the book value per share of the Company. Book value per share increased 10.9% in 2003 to $8.87 at December 31, 2003 from $8.00 at December 31, 2002 and 14.3% in 2002 from $7.00 per share at December 31, 2001. Book value per share is calculated by dividing stockholders’ equity by outstanding common shares.
Ceded written premiums, the portion of gross written premiums reinsured by unaffiliated insurers, increased 44.9% to $33.0 million for 2003 compared with $22.8 million for 2002. The increase in ceded written premiums was due primarily to growth in gross written premiums and an approximately 9% increase in reinsurance rates on the Company’s multiple-line excess of loss reinsurance treaty.
Losses and loss adjustment expenses increased 26.0% to $94.7 million for 2003 from $75.1 million for 2002. The loss ratio for 2003 was 61.4 compared with 65.3 for 2002. The loss ratio is calculated by dividing losses and loss adjustment expenses by premiums earned. This improvement in the loss ratio was
Other underwriting expenses increased 13.3% to $9.4 million for 2003 from $8.3 million for 2002. This increase was mainly attributable to increases in salary and benefit expenses associated with the hiring of additional underwriting and marketing personnel to support the growth in the insurance operations.
Income tax expense increased to $7.4 million for 2003 from $4.4 million for 2002. This increase was due primarily to improved underwriting profitability.
Net written premiums increased 54.6% for 2002 to $134.7 million compared with $87.1 million for 2001. The increase in net written premiums was consistent with the increase in gross written premiums, but was partially offset by higher reinsurance costs.
Net investment income increased to $11.8 million for 2002 compared with $11.3 million for 2001, primarily due to growth in average invested assets, partially offset by a decrease in the average yield on fixed maturity investments and lower interest rates on overnight cash balances.
Net realized investment gain was $1.3 million for 2002, compared to a $1.2 million net realized investment loss for 2001. The net realized investment gain for 2002 consisted mainly of realized gains on the sale of certain of the Company’s fixed-maturity investments of $2.9 million, offset by other-than-temporary impairment write-downs on certain of the Company’s investments in fixed maturity and equity securities of $1.3 million and realized losses of $0.3 million on sales of certain of the Company’s equity investments.
Underwriting income was $2.6 million for 2002 compared to an underwriting loss of $2.7 million for 2001. This improvement for 2002 was due primarily to the improved GAAP combined ratio which was 97.7 for 2003 compared with 103.1 for 2002.
Income tax expense increased to $4.4 million for 2002 from $1.8 million for 2001. This increase was due primarily to improved underwriting profitability.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
When a claim involving a probable loss is reported, the Company establishes a case reserve for the estimated amount of the Company’s ultimate loss. The estimate of the amount of the ultimate loss is based upon such factors as:
In addition to case reserves, management establishes reserves on an aggregate basis to provide for incurred but not reported losses and loss adjustment expenses, commonly referred to as “IBNR.” To establish reserves for IBNR the Company must estimate the ultimate liability based primarily on past
experience. The Company applies a variety of traditional actuarial techniques to determine its estimate of ultimate liability. The techniques recognize, among other factors:
In 2003, the Company increased incurred losses and loss adjustment expenses attributable to insured events of prior years by $5.5 million. This increase was primarily due to an increase of $3.6 million in the Company’s core commercial property and casualty lines of business. This increase consisted of a reduction in the Company’s estimate for the commercial property lines of business by $2.1 million relating primarily to the 2002 accident year, offset by an increase in the Company’s estimate for the commercial liability lines of business of $5.7 million due to the development of outstanding case reserves on claims occurring in various accident years. The remaining increase of $1.9 million in incurred losses and loss adjustment expenses was attributable to insured events of prior years related to the Company’s exited automobile lines of business. In 2003, the Company experienced an unanticipated increase in paid allocated loss adjustment expenses on its remaining open commercial automobile liability claims. Consequently, combined with the unanticipated activity in 2003 and review of open claims, the Company increased its estimates for loss and loss adjustment expense reserves.
The Company recorded a reinsurance recoverable of $5.0 million as of December 31, 2003 relating to a claim for an insured involving multiple policies written over multiple years beginning in 1998. The Company settled this claim in February 2004, but has not yet finalized the reinsurance recoverable with its reinsurer.
The Company’s change in estimates in 2002 for the commercial property lines resulted from lower costs per claim than expected for the 2001 accident year. As of December 31, 2001, the Company anticipated an increase in the average cost per claim of approximately 11% to $9,200 for the 2001 accident year as compared with $8,300 for the 2000 accident year. During 2002, the 2001 accident year developed more favorably than originally anticipated, as the average settlement per claim declined to approximately $8,000. Consequently, the Company reduced its estimates by $2.7 million in 2002.
In 2001, the Company increased incurred losses and loss adjustment expenses attributable to insured events of prior years by $36,000. This increase related entirely to the commercial automobile line of business. Additionally, the Company increased its estimate for loss and loss adjustment expense reserves by $1.8 million for commercial multi-peril liability and reduced its estimates by $1.4 million for non-standard personal automobile and $0.4 million for commercial multi-peril property.
The Company implemented several initiatives which have resulted in the improved loss ratios for accident years 2001, 2002 and 2003, compared with accident years 1994 through 2000. The initiatives included:
• implementing double-digit percentage premium price increases in 2001, 2002 and 2003, which resulted in an improvement in the commercial property loss ratio to 58.3 for accident years 2001 through 2003 compared with a 73.9 loss ratio for accident years 1994 through 2000;
In formulating its reinsurance programs, the Company is selective in its choice of reinsurers and considers numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize its exposure to the insolvency of its reinsurers, the Company evaluates the acceptability and reviews the financial condition of each reinsurer annually. The Company’s policy is to use only reinsurers that have an A.M. Best rating of “A” (Excellent) or better and that have at least $500 million in statutory surplus.
The Company’s reinsurance treaties include multiple-line excess of loss, umbrella quota share, property catastrophic loss and multiple-line quota share for certified acts of terrorism.
$1,700,000 per risk / $3,000,000 per occurrence in excess of $300,000 per risk
The Company’s combined retention for any one loss resulting from a common occurrence involving both the commercial property and commercial general liability coverage on a single risk is $500,000. The Company’s multiple-line excess of loss treaty also includes coverage for punitive damages and other extra-contractual obligations, losses in excess of policy limits, loss adjustment expenses and liability resulting from two or more of the Company’s insureds from the same occurrence.
For policies effective January 1, 2004, the Company increased its retention for commercial property to $500,000 per risk from $300,000 in 2003. Also, the Company increased its reinsurance coverage on commercial property to $4,500,000 per occurrence compared with $3,000,000 per occurrence in 2003. Additionally, the Company increased its reinsurance coverage for punitive damages and other extra-contractual obligations, losses in excess of policy limits, loss adjustment expenses and liability resulting from two or more of the Company’s insureds from the same occurrence to $10,000,000 per occurrence/aggregate.
Umbrella Quota Share. The Company offers umbrella liability policies up to $5.0 million per occurrence. For policies where the Company writes the primary general liability, 90% of policy limits up to $1.0 million per occurrence and 100% of policy limits up to $4.0 million in excess of $1.0 million per occurrence are reinsured with American Re. For policies where another insurer writes the primary general liability, 85% of policy limits up to $1.0 million per occurrence, 90% of policy limits up to $1 million in excess of $1 million per occurrence and 100% of policy limits up to $3.0 million in excess of $2.0 million per occurrence are reinsured with American Re.
Property Catastrophic Loss. The Company maintains a catastrophic loss reinsurance program. As of January 1, 2004, the terms of this program provide for 100% retention of the first $1.0 million per occurrence and reinsurance of 100% of $29.0 million per occurrence in excess of $1.0 million per occurrence.
The Act requires insurance carriers to offer coverage for certified acts of terrorism for all policies written after November 26, 2002. During 2003, the Company bound terrorism coverage on about 4% of its policies.
The Company maintains a multiple-line quota share reinsurance treaty with American Re that provides reinsurance protection for certified acts of terrorism relating to new and renewal policies effective January 1, 2003 or later. For 2003, the Company retained 20% of the first $5,000,000 per occurrence and ceded 80% of the first $5,000,000 per occurrence/aggregate to American Re. For 2004, the Company retains 30% of the first $10,000,000 per occurrence and cedes 70% of the first $10,000,000 per occurrence/aggregate to American Re.
The Company retains $8,260,000 per occurrence in excess of $10,000,000 per occurrence plus 10% of losses in excess of $18,260,000.
Other. For information regarding the amount of premiums written and ceded under reinsurance treaties, see Note 7 to the Consolidated Financial Statements beginning on page 57 of Item 8, “Financial Statements and Supplementary Data”, of this report on Form 10-K.
The following summarizes the classifications of the Company’s cash and investments at December 31, 2003:
The Company’s fixed-maturity portfolio of $323.5 million was 93.6% of the total cash and investments as of December 31, 2003. Of the fixed-maturity portfolio, 94.2% of the securities were rated “A” or better by Standard & Poor’s. Standard & Poor’s rates publicly traded securities in 20 categories ranging from AAA to CC. Securities with ratings from AAA to BBB- (the top ten categories) are commonly referred to as having an investment grade rating. Equity securities, which consist of preferred stocks and a mutual fund invested in adjustable rate mortgages, were $10.2 million or 2.9% of total cash and investments as of December 31, 2003.
The quality of the fixed-maturity portfolio at December 31, 2003 was as follows:
As of December 31, 2003, the investment portfolio contained $117.4 million of mortgage-backed, asset-backed and collateralized mortgage obligations. These securities are publicly traded, and have market values obtained from an independent pricing service. Changes in estimated cash flows due to changes in prepayment assumptions from the original purchase assumptions are revised based on current interest rates and the economic environment. The Company had no investments in real estate or mortgage loans in its investment portfolio as of December 31, 2003.
For information regarding net investment income results for the years ended December 31, 2003, 2002 and 2001, see Note 5 to the Consolidated Financial Statements beginning on page 54 of Item 8, “Financial Statements and Supplementary Data”, of this report on Form 10-K.
Junior subordinated debentures increased to $30.0 million at December 31, 2003, compared with $15.0 million at December 31, 2002. In May, 2003, Penn-America Statutory Trust II (“the Trust II”), a business trust subsidiary formed by PAGI, issued $15.0 million of floating rate trust preferred securities. These securities have a thirty-year maturity, with a provision that allows the Company to call these securities at par after five years from the date of issuance. Cash distributions will be paid quarterly in arrears at a rate of 410 basis points over three-month London Interbank Offered Rates. Distributions on these securities can be deferred for up to five years, but in the event of such deferral, the Company may not declare or pay cash dividends on its common stock. PAGI guarantees all obligations of the Trust II with respect to distributions and payments of these securities.
The Company continually evaluates the adequacy and mix of its capital resources. The Company’s strategy is to maintain capital at an adequate level to support its insurance operations, while achieving its 12% to 15% ROE financial goal over the long-term.
Penn-America Insurance Company’s principal sources of funds are underwriting operations, investment income and proceeds from sales and redemptions of investments. Funds are used by Penn-America Insurance Company and Penn-Star Insurance Company principally to pay claims and operating expenses, to purchase investments and to make dividend payments to PAGI. PAGI’s future liquidity is dependent on the ability of Penn-America Insurance Company to pay dividends to PAGI.
The Company’s insurance subsidiaries are restricted by statute as to the amount of dividends that they may pay without the prior approval of regulatory authorities. Penn-America Insurance Company may pay dividends to PAGI without advance regulatory approval only from unassigned surplus and only to the
Penn-America Insurance Company and Penn-Star Insurance Company are required by law to maintain a certain minimum level of statutory surplus. Statutory surplus is calculated by subtracting total liabilities from total assets. The National Association of Insurance Commissioners adopted risk-based capital standards designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2003, the statutory surplus of Penn-America Insurance Company and Penn-Star Insurance Company was in excess of the prescribed risk-based capital requirements. Penn-America Insurance Company’s statutory surplus at December 31, 2003 was $121,960,000 and its regulatory action level was $30,034,000. Penn-Star Insurance Company’s statutory surplus at December 31, 2003 was $42,232,000 and its regulatory action level was $11,256,000.
Net cash provided by operating activities increased to $57.3 million for 2003 from $45.1 million for 2002. This growth is due primarily to the increase of cash received from collections of premiums in excess of the increase of losses and loss adjustment expenses paid in 2003.
Net cash provided by financing activities was $13.2 million for 2003 as compared with $36.8 million for 2002. In 2003, the Company generated net proceeds of $14.5 million from its issuance of junior subordinated debentures and $1.4 from the issuance of common stock, partially offset by $2.7 million in dividends paid to PAGI’s shareholders. In 2002, the Company generated net proceeds of $24.2 million from the issuance of common stock and $14.5 million from its issuance of junior subordinated debentures, partially offset by $1.8 million in dividends paid to PAGI’s shareholders.
As a result of cash provided by operating and financing activities, cash used by investing activities was $68.3 million for 2003, compared with $85.2 million for 2002. For both 2003 and 2002, the Company invested these funds primarily in fixed-income securities classified as available for sale.
Another competitive factor is the rating assigned by independent rating organizations such as A.M. Best Company. Penn-America and Penn-Star currently have a pooled rating from A.M. Best of “A-” (Excellent). “A-” is the fourth highest of sixteen rating categories. These ratings are based upon factors, such as, capital adequacy, loss reserve adequacy and operating performance, of concern to policyholders and are not directed toward the protection of investors. The Company expects that it will at a minimum maintain its A.M. Best rating of “A-” based on the improved operating performance and capital adequacy of Penn-America Insurance Company and Penn-Star Insurance Company in 2003.
The Company believes that its distribution strategy, which is based on building and maintaining strong relationships with a small number of high quality general agents that are enabled with the latest technological innovation, provides a competitive advantage in the markets it targets. See the “Marketing and Distribution” section of Item 1, “Business”, of this report on Form 10-K which more fully describes the elements of the strategies which the Company believes provide this competitive advantage.
Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001.
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Penn-America Group, Inc. and its subsidiaries at December 31, 2003 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index as of and for the year ended December 31, 2003 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit. The financial statements of the Company as of December 31, 2002 and for each of the two years in the period then ended were audited by other auditors whose report dated January 17, 2003 expressed an unqualified opinion on those statements. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company markets and underwrites general liability, commercial property and multi-peril insurance for small businesses located primarily in small towns and rural areas. The Company is licensed to write business in all fifty states and the District of Columbia. The Company writes business on both an admitted and non-admitted basis in thirty-seven states, on only an admitted basis in one state and on only a non-admitted basis in twelve states and the District of Columbia.
Valuation of Premiums Receivable. The Company evaluates the collectibility of premiums receivable based on a combination of factors. In circumstances in which the Company is aware of a specific agent’s inability to meet its financial obligations to the Company, a specific reserve for bad debts against amounts due is recorded to reduce the net receivable to the amount reasonably believed to be collectible. No such instances occurred in 2003 and 2002. For all remaining balances, reserves are recognized for bad debts based on historical statistics of the length of time the receivables are past due.
Investments in fixed-maturity securities are adjusted for amortization of premium and accretion of discounts to maturity date using the constant yield method. Interest income is recognized on the accrual basis.
The amortized cost of mortgage-backed and asset-backed securities is calculated using the constant yield method including consideration of anticipated prepayments at the date of purchase. Significant changes in estimated cash flows from the original assumptions are accounted for using the retrospective method.
Realized gains or losses represent the difference between the book value of securities sold and the proceeds realized upon sale. The Company uses the specific identification method to determine the cost of securities sold. The cost of securities is adjusted where appropriate to include a provision for a decline in value that is considered to be other-than-temporary. The Company considers four factors in determining if an other-than-temporary decline exists: length of time and extent that a security has been in an unrealized loss position; the existence of an event that would impair the issuer’s future earnings potential; the near term prospects for recovery of the market value of a security; and the intent and ability of the Company to hold the security until the market value recovers. Realized gains or losses, including any provision for other-than-temporary declines in value, are included in the statement of operations.
Derivative Instruments. The Company accounts for derivative instruments under Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value.
As of December 31, 2003, the Company holds a single derivative instrument, an interest rate swap. In accordance with SFAS 133, the interest rate swap is designated as a cash flow hedge, and is recorded on the balance sheet at fair value. Changes in fair value are recorded in other comprehensive income (loss) and are reclassified to net income when impacted by the variability of the cash flow of the hedged item.
The primary objective of the Company’s interest rate swap was to hedge risk arising from interest rate volatility related to $15.0 million of the Company’s floating rate capital securities (“Trust Preferred Securities”) acquired by the Trust I. Pursuant to the Company’s adoption of the revised Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, in the fourth quarter of 2003, the Company re-designated the hedged item to $15.0 million of junior subordinated debentures issued by the Company to the Trust I. The junior subordinated debentures have the same terms with respect to maturity, payments and distributions as the Trust Preferred Securities that were previously assigned as the hedged item. The Company’s strategy is to convert distributions based on a floating rate on its junior subordinated debentures with the Trust I to a fixed-rate basis.
Capitalized Lease, Affiliate. The capitalized lease is carried at cost less accumulated amortization. Amortization is calculated using the interest method over 20 years, which represents the term of the mortgage on the office space that the Company rents from a related party.
Income Tax. Deferred income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in the period that includes the enactment date.
Comprehensive Income. Comprehensive income encompasses all changes in stockholders’ equity (except those arising from transactions with stockholders) and includes net income, change in net unrealized investment gain or loss on fixed-maturity investments classified as “available-for-sale” and equity securities, net of income tax and reclassification adjustment, and change in net unrealized gain or loss from the cash-flow hedging instrument, net of income tax.
Junior Subordinated Debentures. On July 1, 2003, the Company adopted SFAS No. 150 (“SFAS 150”), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. The Company’s junior subordinated debentures are classified as a liability on the Consolidated Balance Sheets and the related distributions are recorded as interest expense on the Consolidated Statements of Operations, which is in accordance with SFAS 150. Therefore, the adoption of SFAS 150 had no effect on the Company’s financial statements.
redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures” on its balance sheets. The impact of adopting FIN 46R was to increase junior subordinated debentures and reduce company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures by $30,000,000 at December 31, 2003 and $15,000,000 at December 31, 2002.
Penn-America was formed by Irvin Saltzman, chairman of PAGI’s Board of Directors and a director of Penn Independent. Jon S. Saltzman, Irvin Saltzman’s son, is President and Chief Executive Officer of PAGI and a director of Penn Independent. Penn Independent, which is owned 100% by the Saltzman family, owned approximately 31% of the outstanding common stock of PAGI at December 31, 2003.
At December 31, 2003, the future minimum lease payments for the capitalized lease obligation are $281,000 per year for 2004 through 2008 and the total minimum lease payments are $1,827,000. Interest expense incurred for the obligation under capital lease was $127,000, $139,000 and $160,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Penn Independent provides the Company with human resource management and other services. The Company paid $220,000, $230,000 and $212,000 in 2003, 2002 and 2001, respectively, for such services. Such amounts are based on allocations of estimated costs. All costs incurred by Penn Independent on
The Company uses the following methods and assumptions in estimating the fair value of each class of financial instrument.
Derivative: The fair value of the Company’s cash flow hedging instrument is based on external valuation.
The carrying amounts and fair values of the Company’s financial instruments at December 31, 2003 and 2002 were as follows:
Fixed-maturities at December 31, 2003, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or to prepay obligations with or without call or prepayment penalties.
Statutory Deposits: The amortized cost of fixed maturities on deposit with various regulatory authorities at December 31, 2003 and 2002 was $10,912,000 and $10,243,000, respectively.
In December 2002, the Company entered into an interest rate swap, its sole derivative instrument. The Company entered into the interest rate swap in order to hedge risk arising from interest rate volatility related to its floating rate junior subordinated debentures with the Trust I. The notional amount, which is the basis upon which pay or receive amounts are calculated, is $15.0 million and expires on December 4, 2007.
The Company recorded a reinsurance recoverable of $5,000,000 as of December 31, 2003 relating to a claim for an insured involving multiple policies written over multiple years beginning in 1998. The Company settled this claim in February 2004, but has not yet finalized the reinsurance recoverable with its reinsurer.
The Company’s change in estimates in 2002 for the commercial liability lines resulted primarily from an increase of $2,300,000 due to a lengthening of the selected development patterns on all accident years as closing patterns on claims closed in 2002 varied from the Company’s experience in previous years. The remainder of the change is due primarily to increases in estimates for claims expenses as paid development patterns during 2002 were in excess of expectations at December 31, 2001.
The Company has one reportable segment that consists of its commercial property and casualty lines of business. In 1999, the Company exited the non-standard personal automobile line of business and announced that it would run-off its remaining portfolio of such business. For the years ended December 31, 2003, 2002 and 2001, amounts relating to the non-standard personal automobile business were not material to the financial statements presented, and therefore, are not presented separately.
On December 4, 2002, the Trust I, a business trust subsidiary formed by PAGI, issued $15.0 million of floating rate Trust Preferred Securities. These securities have a thirty-year maturity, with a provision that allows the Company to call these securities at par after five years from the date of issuance. Cash distributions are paid quarterly in arrears at a rate of 400 basis points over three-month London Interbank Offered Rates. Distributions on these securities can be deferred for up to five years, but in the event of such deferral, the Company may not declare or pay cash dividends on its common stock. PAGI guarantees all obligations of the Trust I with respect to distributions and payments of these securities.
Proceeds from the sale of these securities by the Trust I were used to acquire $15.0 million of Floating Rate Junior Subordinated Deferrable Interest Rate Debentures issued by the Company. These junior subordinated debentures have the same terms with respect to maturity, payments, and distributions as the floating rate Trust Preferred Securities issued by the Trust I. In 2002, PAGI contributed net proceeds of $14.5 million from these junior subordinated debentures to Penn-America Insurance Company to support the business growth its insurance subsidiaries.
The Company participates in a profit-sharing and a 401(k) plan with Penn Independent that covers qualified employees. The Company’s contributions under the 401(k) plan were $192,000, $185,000 and $117,000 for the years ended December 31, 2003, 2002, and 2001, respectively. There were no profit-sharing distributions in 2003, 2002, and 2001.
Restricted Stock: The Company has awarded shares of restricted stock to certain employees. The Company issued 7,000 shares of restricted stock in 2003 and 17,500 shares of restricted stock in 2002. Such shares are held by the Company and released to each grantee at the rate of 20% per year provided that the grantee is still employed by the Company or its affiliates. Based on the fair value of the Company’s common stock on the date these awards were granted, the Company charged $57,000 in 2003, $79,000 in 2002 and $115,000 in 2001 to compensation expense relating to these awards. During 2003, 2002 and 2001, 6,500, 9,750 and 15,750 shares, respectively, of the restricted stock were released to the applicable employees as allowed by the provisions of the grant.
At December 31, 2003, the future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year were $532,000, $433,000, $195,000 and $194,000 for 2004, 2005, 2006 and 2007, respectively.
The Company’s other comprehensive income (loss) consists of net unrealized gain (loss) on investments and net unrealized gain (loss) on a single cash-flow hedging instrument for the year ended December 31, 2003, 2002 and 2001. The following table summarizes other comprehensive income (loss), related income tax effect, and comprehensive income (loss), net of tax: