Unpaid loss and loss adjustment expenses comprised 44% of the Company’s liabilities at December 31, 2005. This obligation includes estimates for: 1) unpaid losses on claims reported prior to December 31, 2005, 2) development on those reported claims, 3) unpaid ultimate losses on claims incurred prior to December 31, 2005 but not yet reported to the Company and 4) unpaid loss adjustment expenses for reported and unreported claims incurred prior to December 31, 2005. Quantification of loss estimates for each of these components involves a significant degree of judgment and estimates may vary, materially, from period to period. Estimated unpaid losses on reported claims are developed based on historical experience with similar claims by the Company. Development on reported claims, estimates of unpaid ultimate losses on claims incurred prior to December 31, 2005 but not yet reported to the Company, and estimates of unpaid loss adjustment expenses are developed based on the Company’s historical experience, using actuarial methods to assist in the analysis. The Company’s actuarial staff develops ranges of estimated development on reported and unreported claims as well as loss adjustment expenses using various methods including the paid-loss development method, the reported-loss development method, the paid Bornhuetter-Ferguson method, the reported Bornhuetter-Ferguson method, the Berquist-Sherman method and a frequency-severity method. Any single method used to estimate ultimate losses has inherent advantages and disadvantages due to the trends and changes affecting the business environment and the Company’s administrative policies. Further, a variety of external factors, such as legislative changes, medical inflation, and others may directly or indirectly impact the relative adequacy of liabilities for unpaid losses and loss adjustment expenses. The Company’s approach is the selection of an estimate of ultimate losses based on comparing results of a variety of reserving methods, as opposed to total reliance on any single method. Unpaid loss and loss adjustment expenses are reviewed periodically for significant lines of business, and when current results differ from the original assumptions used to develop such estimates, the amount of the Company’s recorded liability for unpaid loss and loss adjustment expenses is adjusted. In the event the Company’s actual reported losses in any period are materially in excess of the previous estimated amounts, such losses, to the extent reinsurance coverage does not exist, would have a material adverse effect on the Company’s results of operations.
Future policy benefits comprised 14% of the Company’s total liabilities at December 31, 2005. These liabilities relate primarily to life insurance products and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Deferred income taxes comprised approximately 2% of the Company’s total assets at December 31, 2005. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for tax purposes. These deferred income taxes are measured by applying currently enacted tax laws and rates. Valuation allowances are recognized to reduce the deferred tax assets to the amount that is more likely than not to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income and tax planning strategies.
Net earned premiums increased $3.4 million, or 7.0%, during 2005 over 2004. American Southern increased its business writings in the general liability and surety lines of business in 2004 and such trends have continued in 2005.
Net earned premiums for 2004 increased $10.7 million, or 28.7%, over 2003. The increase during 2004 reflected increased earned premiums from new business written in the fourth quarter of 2003 and continuing in 2004. American Southern increased its business writings in the general liability and surety lines of business throughout 2004.
expense ratio for 2005 is a function of American Southern’s contractual arrangements, which compensate the company’s agents in relation to the loss ratios of the business they write. The majority of American Southern’s business is structured in such a way that the agents are rewarded or penalized based upon the loss ratio of the business they submit. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with American Southern. In addition, American Southern continued to experience increased acquisition costs associated with new programs and accounts underwritten. As a percentage of gross written premiums, net fixed commissions increased to 16.5% in 2005 from 16.3% in 2004. Total commissions (fixed plus variable) increased to 27.6% in 2005 from 26.3% in 2004.
The combined ratio for American Southern increased to 94.2% in 2004 from a combined ratio of 92.0% in 2003. The loss ratio decreased to 51.6% in 2004 from 56.2% in 2003. The decrease in the loss ratio during 2004 was primarily attributable to changes in American Southern’s book of business. The increased business writings in general liability and surety resulted in a decrease in the loss ratio due to positive loss experience in those lines of business during 2004. Further, the loss of American Southern’s largest account upon its contractual termination on April 30, 2003 contributed significantly to a decline in the loss ratio. That account had very low acquisition costs but disproportionately higher losses. The 2004 hurricane related losses in the state of Florida, which contributed $1.0 million to the hurricane related expenses within the property and casualty operations, partially offset the reported improvement in the loss ratio. The expense ratio for 2004 increased to 42.6% from 35.8% in 2003. The increase in the expense ratio for 2004 was primarily due to American Southern’s business structure, which compensates agents in relation to the profitability of business they write. Also, American Southern experienced increased acquisition costs associated with new programs and accounts the company had underwritten in 2004. As a percentage of gross written premiums, net fixed commissions increased to 16.3% in 2004 from 14.2% in 2003. Total commissions (fixed plus variable) increased to 26.3% in 2004 from 21.3% in 2003.
Written premiums assumed from Georgia Casualty under a quota share reinsurance agreement and eliminated in consolidation. This agreement was cancelled effective August 31, 2005.
Ceded premiums at Association Casualty increased $1.0 million, or 20.9%, during 2005 as compared to 2004. Excluding assumed written premiums of $0.7 million and $5.9 million in 2005 and 2004, respectively, that were not subject to reinsurance, premiums ceded as a percentage of direct written premiums increased to 22.7% in 2005 from 21.1% in 2004 primarily due to rate increases on certain reinsured loss layers as well as changes in retention rates and coverage limits.
Gross written premiums at Association Casualty increased $1.4 million, or 5.1%, during 2004 as compared to 2003. The increase in gross written premiums was due solely to the increased cession from Georgia Casualty, partially offset by a decrease in the amount of Texas direct written premiums that resulted from the continued evaluation of certain business and implementation of certain minimum account standards. Consequently, Association Casualty’s policy retention rates, specifically in the monoline workers’ compensation line of business, declined resulting in lower workers’ compensation premiums. Association Casualty increased its premium writings for general liability, property and automobile offsetting lower levels of workers’ compensation business.
Gross written premiums at Georgia Casualty decreased $17.0 million, or 25.9%, during 2005 as compared to 2004. The decrease in premiums was primarily attributable to the non-renewal of unprofitable accounts and reassessment of coastal property exposures. During 2005, accounts resulting in approximately $5.9 million in annualized gross written premiums were non-renewed as a result of these initiatives. Also, Georgia Casualty has experienced an increased level of price competition in the marketplace and ceased writing new property business in the state of Florida, both of which resulted in a decrease in 2005 business of approximately $4.0 million from 2004. Effective August 31, 2005, Georgia Casualty and Association Casualty terminated their quota share reinsurance agreement. In addition, effective September 1, 2005, Georgia Casualty no longer assumed business originated by Georgia Casualty and written by Association Casualty. During 2005, Georgia Casualty’s written premiums on behalf of Association Casualty and subsequently reinsured by Georgia Casualty were $16.2 million compared to $22.2 million in 2004, a decrease of $6.0 million. Since September 1, 2005, such business has remained with Association Casualty.
Ceded premiums at Georgia Casualty decreased $2.7 million, or 11.6%, during 2005 as compared to 2004. The decrease in ceded premiums was primarily due to the non-recurring accrual of an arbitration award described below of $3.1 million during 2004. Also contributing to the comparative reduction was the termination of the quota share agreement, discussed previously, and a negotiated rate adjustment to a broker’s commission, both of which resulted in a $5.8 million reduction in 2005 ceded premiums.
Ceded premiums at Georgia Casualty increased $5.3 million, or 29.4%, in 2004 as compared to 2003. The increase in ceded premiums was due to several factors. First, Georgia Casualty’s dispute with one of its reinsurers, PMA Re, was arbitrated and resulted in the award to PMA Re of $3.1 million. As a result of the award and in accordance with the arbitration agreement, Georgia Casualty accrued $3.1 million of additional ceded premiums in the fourth quarter of 2004. Also in 2004, Georgia Casualty accrued various hurricane related expenses, including $0.5 million in catastrophic reinstatement premiums and a $0.9 million reinsurance provisional rate adjustment. Such accruals were not necessary during the same period of 2003. These increases in ceded premiums were partially offset by the cession rate decrease in the quota share reinsurance agreement. During 2004, Georgia Casualty operated pursuant to a 15% quota share reinsurance agreement with Association Casualty. In 2003, the quota share cession rate was 20% (10% with Association Casualty and 10% with a third party reinsurer). The elimination of the third party reinsurer and a reduction in the aggregate quota share cession rate resulted in a decrease in total ceded premiums of approximately $2.5 million during 2004 as compared to 2003. Premiums ceded to Association Casualty increased $2.3 million, or 64.5%, in 2004 from 2003 due to its higher quota share participation.
Net earned premiums increased $4.6 million, or 13.3%, during 2005 as compared to 2004 primarily due to the non recurrence of the $3.1 million PMA Re arbitration award accrued as ceded premium in 2004. Also contributing to the increase was a higher level of premium volume written during 2004 which was reflected as earned in 2005. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2005 are related to premiums written during both 2004 and 2005.
2005, the company’s key states in terms of premium revenue were Georgia, Pennsylvania, Ohio, Utah and West Virginia, which collectively accounted for approximately 57% of total earned premium for 2005. The Medicare supplement line of business in these states increased approximately $0.5 million as compared to 2004. Significant rate increases on existing Medicare supplement business that were implemented in varying amounts by state and plan in 2004 resulted in increased revenues in 2005. In addition, during 2004, Bankers Fidelity purchased a block of Medicare supplement business with an estimated annualized premium of $4.5 million, which increased premium revenue during 2005. Partially offsetting the 2005 increase in Medicare supplement premium was a decline in new business levels and existing policies that resulted from increased competition. Premiums from the life insurance line of business decreased $1.3 million, or 10.3%, during 2005 due to the continued decline in sales related activities. In an effort to increase life insurance sales and further diversify its business, Bankers Fidelity plans to initiate several new programs in 2006.
Bankers Fidelity has been reasonably successful in controlling operating costs, while continuing to increase premium revenue. As a percentage of premiums, commissions and underwriting expenses were 29.8% in 2005 compared to 30.1% in 2004 and 30.6% in 2003.
The Company had net realized investment losses of $10.5 million in 2005 compared to net realized investment gains of $2.2 million and $0.4 million in 2004 and 2003, respectively. During the years ended December 31, 2005, 2004 and 2003, the Company recorded investment impairments due to other than temporary declines in values, which reduced reported realized investment gains, related to the following investments:
Interest expense of $3.6 million increased $0.5 million, or 17.6%, during 2005 as compared to 2004. The increase in interest expense during 2005 was due to an increase in interest rates. During 2005, the Company’s debt payable had a variable interest rate tied to three-month London Interbank Offerred Rate (“LIBOR”), which increased throughout 2005. In the third quarter of 2004 and during 2005, the Company repaid $4.8 million in principal on its term loan (as described below in “Liquidity and Capital Resources”) to Wachovia Bank, N.A. (“Wachovia”), which helped to offset the increase in interest expense by reducing the average debt level.
Interest expense of $3.1 million decreased 1.6%, during 2004 as compared to 2003. On June 30, 2004, the Company’s $15.0 million notional amount interest rate swap agreement with Wachovia matured. During the term of this agreement, the Company paid a fixed interest rate of 5.1% and received interest equal to the three-month LIBOR. Given the maturity of the interest rate swap and the decline in interest rates subsequent to the inception of the interest rate swap agreement in 2001, interest expense decreased by $0.2 million during 2004 as compared to 2003. Additionally, during 2004, the Company repaid $3.0 million in principal of its term loan to Wachovia, which also decreased interest expense. The increase in average debt levels resulting from a private placement offering of trust preferred securities by the Company in 2003, along with a higher variable rate of interest paid thereon, substantially offset the discussed decreases in interest expense during 2004.
Other expenses (commissions, underwriting expenses, and other expenses) increased $3.6 million, or 5.2%, in 2005 as compared to 2004. The increase in other expenses during 2005 was primarily attributable to increased acquisition costs at American Southern. Agents’ variable commissions at American Southern increased $0.8 million during 2005 due primarily to lower loss ratios. The majority of American Southern’s business is structured in a way that agents are rewarded or penalized based upon the loss ratio of the business they submit to the company. In periods where the loss ratio decreases, commissions and underwriting expenses will increase and conversely in periods where the loss ratio increases, commissions and underwriting expenses should decrease. Fixed commissions at American Southern also increased $0.4 million during 2005 primarily as a result of the increased surety bond business, which has a higher commission rate than other lines of business. In addition, the deferral of acquisition costs at American Southern in 2005 decreased $0.9 million from 2004 and, as a result, increased other expenses during 2005. The decrease in deferred acquisition costs at American Southern was primarily due to a significantly lower level of premium growth in 2005 than that which occurred in 2004. The Company has also experienced a significant increase in expenses related to Sarbanes-Oxley compliance work and audit fee accruals. These expenses increased $1.3 million, or 207.9%, in 2005 as compared to 2004. On a consolidated basis, as a percentage of earned premiums, other expenses increased to 41.3% in 2005 from 40.8% in 2004.
workers’ compensation business in the states of Florida and Georgia, which decreased underwriting expenses in 2003 and resulted in a comparative increase to other expenses in 2004. On a consolidated basis, as a percentage of earned premiums, other expenses increased to 40.8% in 2004 from 38.5% in 2003.
Dividend payments to the Parent by its insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries. At December 31, 2005, the Parent’s insurance subsidiaries had statutory surplus of $107.2 million.
The Company intends to pay its obligations under the term loans and the Junior Subordinated Debentures using dividend and tax sharing payments from its subsidiaries, or from potential future financing arrangements. In addition, the Company believes that, if necessary, at maturity, the term loans can be refinanced with the current lender, although there can be no assurance of the terms or conditions of such a refinancing, or its availability.
Net cash provided by operating activities totaled $11.3 million in 2005, $6.0 million in 2004, and $13.9 million in 2003. Increased operating cash flow in 2005 as compared to 2004 was attributable to more aggressive collection efforts related to reinsurance and other receivables. The decrease in operating cash flows during 2004 was primarily attributable to the collection of $7.6 million from a reinsurance contract termination that occurred in 2003 and did not reoccur during 2004. Also, the Company paid $1.2 million in federal income tax deposits in 2004 compared to $0.5 million during 2003. Cash and short-term investments increased from $41.0 million at December 31, 2004 to $41.8 million at December 31, 2005. During 2005, $1.8 million was used for debt reduction and $0.1 million was used for treasury share purchases, both of which were significantly lower than in 2004. During 2004, $3.0 million was used for debt reduction, $0.5 million was used for the redemption of the Company’s series C preferred stock, and $0.7 million was used for treasury share purchases. Offsetting these 2004 decreases in cash and short-term investments were net proceeds from the sale of equity securities which did not reoccur in 2005. Cash and short-term investments at December 31, 2005 of $41.8 million are believed to be sufficient to meet the Company’s near-term needs.
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections, a replacement of Accounting Principles Board (“APB”) Opinion No. 20 and SFAS No. 3”. SFAS 154 applies to all voluntary changes in accounting principles and changes the requirements of accounting for and reporting a change in accounting principle and is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless such application is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income, in the period of the change, the cumulative effect of change to the new accounting principle. The Company expects to adopt SFAS 154 on its effective date.
In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), “Share-Based Payment”, providing guidance on stock option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, and the disclosures in management’s discussion and analysis of financial condition and results of operations section of reports or registration statements subsequent to such adoption. The Company will provide SAB No. 107 required disclosures upon adoption of SFAS No. 123R on January 1, 2006.
Represents balances due for goods and/or services which have been contractually committed as of December 31, 2005. To the extent contracts provide for early termination with notice but without penalty, only the amounts contractually due during the notice period have been included.
Unearned premiums represent potential future revenue for the Company; however, under certain circumstances, such premiums may be refundable with cancellation of the underlying policy. Significantly all unearned premiums will be earned within the following twelve month period as the related future insurance protection is provided. Significantly all costs related to such unearned
premiums have already been incurred and paid and are included in deferred acquisition costs; however, future losses related to the unearned premiums have not been recorded. The contractual obligations related to unearned premiums reflected in the table represent the average loss ratio applied to the year end unearned premium balances, with loss payments projected in comparable proportions to the year end loss and claims reserves. Projecting future losses is subject to significant uncertainties and the projected payments will most likely vary materially from these estimates as a result of differences in future severity, frequency and other anticipated and unanticipated factors. Amounts reflected do not take into account reinsurance amounts which may be recoverable based on the level of ultimate sustained loss.
Certain of the statements contained herein are forward-looking statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to, among other things, economic, competitive and legislative developments. The forward-looking statements are subject to changes and uncertainties which are, in many instances, beyond the Company’s control and have been made based upon management’s current expectations and beliefs concerning future developments and their potential effect upon the Company. There can be no assurance that future developments will be in accordance with management’s expectations or that the effect of future developments on the Company will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of various factors. These factors include, among others, those discussed in the “Risk Factors” section and: unanticipated increases in the rate, number and amounts of claims outstanding; the possible occurrence of terrorist attacks; the level of performance of reinsurance companies under reinsurance contracts and the availability, pricing and adequacy of reinsurance to protect the Company against losses; changes in the stock markets, interest rates or other financial markets, including the potential effect on the Company’s statutory capital levels; the uncertain effect on the Company of regulatory and market-driven changes in practices relating to the payment of incentive compensation to brokers, agents and other producers; the incidence and severity of catastrophes, both natural and man-made; stronger than anticipated competitive activity; unfavorable judicial or legislative developments, including the possibility that the Terrorism Risk Insurance Act of 2002 is not ultimately extended; the potential effect of regulatory developments, including those which could increase the Company’s business costs and required capital levels; the possibility of general economic and business conditions that are less favorable than anticipated; the Company’s ability to distribute its products through distribution channels, both current and future; the uncertain effect of emerging claim and coverage issues; and the effect of assessments and other surcharges for guaranty funds and second-injury trust funds and other mandatory pooling arrangements. Many of such factors are beyond the Company’s ability to control or predict. As a result, the Company’s actual financial condition, results of operations and stock price could differ materially from those expressed in any forward-looking statements made by the Company. Undue reliance should not be placed upon forward-looking statements contained herein. The Company does not intend to publicly update any forward-looking statements that may be made from time to time by, or on behalf of, the Company.
We have audited the accompanying consolidated balance sheets of Atlantic American Corporation and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Atlantic American Corporation and subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
At December 31, 2005, the Parent had five insurance subsidiaries, Bankers Fidelity Life Insurance Company (“Bankers Fidelity”), American Southern Insurance Company and its wholly-owned subsidiary, American Safety Insurance Company (together known as “American Southern”), Association Casualty Insurance Company and Georgia Casualty & Surety Company (“Georgia Casualty”), in addition to two non-insurance subsidiaries, Association Risk Management General Agency, Inc., and Self-Insurance Administrators, Inc. (“SIA, Inc.”). Association Casualty Insurance Company and Association Risk Management General Agency, Inc. are together termed “Association Casualty.”
The Company’s investments in both fixed maturity securities, which include bonds and redeemable preferred stocks, and equity securities, which include common and non-redeemable preferred stocks, are classified as “available-for-sale” and, accordingly, are carried at fair value with the after-tax difference
Basic earnings per common share are based on the weighted average number of common shares outstanding during each period. Diluted earnings per common share are based on the weighted average number of common shares outstanding during each period, plus common shares calculated for stock options and share awards outstanding using the treasury stock method and assumed conversion of the Series B Preferred Stock, if dilutive. Unless otherwise indicated, earnings per common share amounts are presented on a diluted basis.
Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation, the Company’s net income (loss) and net income (loss) per share would have been as follows:
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123R requires all companies to recognize compensation costs for share-based payments to employees based on the grant-date fair value of the award for financial statements. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. The transition methods include both prospective and retrospective adoption options. The Company will adopt SFAS No. 123R during the first quarter of 2006 using the prospective method,
which requires that compensation expense be recorded for all unvested stock-based awards, including those granted prior to adoption of the fair value recognition provisions of SFAS No. 123, at the beginning of the first quarter of adoption of SFAS No. 123R. Currently, the Company does not expect the adoption of SFAS 123R to have a material impact on its financial condition or results of operations. The further effect of adoption of SFAS 123R on future operating results will depend on the levels of share-based payments granted in the future, the groups of employees to whom awards are granted, the terms of any future awards, as well as the final methods and assumptions used to determine the fair value of those share-base payments.
Market changes in interest rates and credit spreads result in changes in the fair values of investments and are accumulated and reported as unrealized gains and losses. The majority of the unrealized losses at both December 31, 2005 and 2004 were primarily attributable to increases in interest yields on comparable investments.
Includes automotive sector impairments of $10.7 million in 2005, primarily from holdings in General Motors and related entities.
As part of the Company’s ongoing investment review, the Company has reviewed its investment portfolio and concluded that there were no additional investments with other than temporary impairments as of December 31, 2005 or 2004. The evaluation for other than temporary impairments 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 changes in general economic conditions, the issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. Due to the issuers’ continued satisfaction of the investment obligations in accordance with their contractual terms, if applicable, and management’s expectation that they will continue to do so, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that unrealized losses on investments at December 31, 2005 and 2004 were temporary.
The amortized cost and carrying value of fixed maturities and short-term investments at December 31, 2005 by contractual maturity were as follows. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s investments in fixed maturity securities of General Motors and General Motors Acceptance Corporation exceeded 10% of shareholders’ equity at December 31, 2005. The carrying value of these fixed maturity investments at December 31, 2005 was $22,427 with an adjusted cost basis of $22,427.
Annualized premiums for accident and health insurance policies were $52,763 and $57,366 at December 31, 2005 and 2004, respectively.
During 2004, the Company purchased a block of Medicare supplement policies with estimated annualized premiums of approximately $4,500. Assets and liabilities acquired as of October 31, 2004, the effective date of the acquisition, were as follows:
In accordance with general practice in the insurance industry, portions of the life, property and casualty insurance written by the Company are reinsured; however, the Company remains liable with respect to reinsurance ceded should any reinsurer be unable to meet its obligations. Approximately 60% of the Company’s reinsurance receivables were due from seven reinsurers as of December 31, 2005. Reinsurance receivables of $861 were with General Reinsurance Corporation, rated “AAA” by Standard & Poor’s and “A++” (Superior) by A.M. Best, $14,633 were with GE Reinsurance Corporation, rated “A” by Standard & Poor’s and “A” (Excellent) by A.M. Best, $3,442 were with First Colony Life Insurance Company, rated “AA-” by Standard & Poor’s and “A+” (Superior) by A.M. Best, $4,257 were with PMA Capital Insurance Company, rated “B+” (Very Good) by A.M. Best, $1,891 were with GMAC Re, rated “A-” (Excellent) by A.M. Best, $1,755 were with PXRE Reinsurance Company, rated “BBB-” by Standard & Poor’s and “B+” (Very Good) by A.M. Best, and $8,635 were with Swiss Reinsurance Corporation, rated “AA” by Standard & Poor’s and “A+” (Superior) by A.M. Best. Allowances for uncollectible amounts are established against reinsurance receivables, if appropriate. Subsequent to December 31, 2005, the reinsurance contract with PXRE Reinsurance Company was commuted and recorded balances were collected.
A reconciliation of the differences between income taxes computed at the federal statutory income tax rate and the benefit for income taxes was as follows:
At December 31, 2005, the Company’s $10,250 of bank debt with Wachovia Bank, N.A. (“Wachovia”) consisted of a single term loan (the “Term Loan”). The Term Loan matures on June 30, 2008 and requires minimum annual payments as follows: 2006 - $1,750; 2007 - $1,750; 2008 - $6,750. The interest rate on the borrowing is London Interbank Offered Rate (“LIBOR”) plus a margin ranging between 1.75% and 2.50%. The applicable margin rate is determined based on the ratio of funded debt to consolidated total capitalization, each as defined. As of December 31, 2005, the stated interest rate on the Term Loan was LIBOR plus 2.00%, or 6.53%. The Term Loan requires the Company to comply with certain covenants including, among others, ratios that relate funded debt to capitalization and interest coverage, as well as the maintenance of minimum levels of tangible net worth. The Company also must comply with limitations on capital expenditures, additional debt obligations, equity repurchases and redemptions, as well as minimum risk-based capital levels. On February 28, 2006, the Company entered into a $3,000 credit agreement with Wachovia. This new credit agreement (the “Second Term Loan”), the proceeds of which were used for general corporate purposes, matures on April 1, 2007, has the same interest rate, covenants and collateral as the Term Loan. Effective December 31, 2005, and February 28, 2006, the Term Loan and the Second Term Loan, respectively, were amended. The amendments were necessitated by the recorded impairment charge taken on the Company’s automotive sector fixed maturity investments. Approximately $5,331 of the total $10,709 impairment charge was the result of an impairment in the value of the Company’s investment in General Motors bonds. The amendments to the Term Loan and Second Term Loan provide that the definition of consolidated net income, as calculated for the fourth quarter of 2005, excludes the $5,331 GM bond impairment. Further, the definition of consolidated tangible net worth was amended to exclude the after-tax impact of the same impairment. After giving effect to the amendment to the December 31, 2005 ratio of funded debt to EBITDA, both as defined, the Company was in compliance with the amended agreements. Various provisions contained in the amendments extend through 2006, and the Company believes it will be in compliance with all such provisions in future periods.
The financial structure of each of Atlantic American Statutory Trust I and II, as of December 31, 2005 and 2004, were as follows:
For each of the respective debentures, the Company has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters up to the debentures’ respective maturity dates. During any such period, interest will continue to accrue and the Company may not declare or pay any cash dividends or distributions on, or purchase, the Company’s common stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Junior Subordinated Debentures. The Company has the right at any time to dissolve each of the trusts and cause the Junior Subordinated Debentures to be distributed to the holders of the Trust Preferred Securities.
On February 21, 2006, the Company entered into a zero cost rate collar with Wachovia to hedge future interest payments on a portion of the Junior Subordinated Debentures. The notional amount of the collar was $18,042 with an effective date of March 6, 2006. The collar has a floor rate of 4.77% and a cap
From time to time, the Company is involved in various claims and lawsuits incidental to and in the ordinary course of its businesses. In the opinion of management, such claims are not expected to have a material effect on the business or financial condition of the Company.
In accordance with the Company’s 1992 Incentive Plan, the Board of Directors may grant up to 1,800,000 stock options or share awards. The Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company’s common stock and other stock unit awards; (e) deferred shares of common stock; or (f) all or any combination of the foregoing to officers and key employees. Stock options granted under this plan expire five or ten years from the date of grant, as specified in an award agreement. Vesting occurs at 50% upon issuance of an option, and the remaining portion vests in 25% increments in each of the following two years. In accordance with the Company’s 1996 Director Stock Option Plan, a maximum of 200,000 stock options may be granted that fully vest six months after the grant date. In accordance with the Company’s 2002 Incentive Plan (the “2002 Plan”), the Board of Directors may grant up to 2,000,000 stock options or share awards. Subject to adjustment as provided in the 2002 Plan, the Board of Directors may grant: (a) incentive stock options; (b) non-qualified stock options; (c) stock appreciation rights; (d) restricted shares; (e) deferred shares; and (f) performance shares and/or performance units. Further, the Board may authorize the granting to non-employee directors of stock options and/or restricted shares. A total of 21,923, 63,063 and 41,503 restricted shares were issued to the Company’s Board of Directors under the 2002 Plan in 2005, 2004 and 2003, respectively. As of December 31, 2005, an aggregate of forty-one employees, officers and directors held options under the three plans.
A summary of the status of the Company’s stock options at December 31, 2005, 2004 and 2003, is as follows:
Data on options outstanding and exercisable at December 31, 2005 is as follows:
The weighted average fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model and was $1.15 for grants in 2003. No options were granted in 2005 or 2004. Fair value determinations were based on expected dividend yields of zero, expected lives of 10 years, risk free interest rate of 4.21% and expected volatility of 60.08% for the year ended December 31, 2003. See Note 1.
The Company initiated an employees’ savings plan under Section 401(k) of the Internal Revenue Code in May 1995. The plan covers substantially all of the Company’s employees, except employees of American Southern. Under the plan, employees generally may elect to contribute up to 16% of their compensation to the plan. The Company makes a matching contribution on behalf of each employee in an amount equal to 50% of the first 6% of such contributions. The Company’s matching contribution is in Company common stock and had a value of approximately $269, $241, and $256 in 2005, 2004, and 2003, respectively.
The accumulated benefit obligation for all defined benefit plans at December 31, 2005 and 2004 was $4,578 and $4,088, respectively.
The weighted-average assumptions used to determine the benefit obligation at December 31, 2005 and 2004 were as follows:
Included in the above is one plan which is unfunded. The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for this plan were $1,803, $1,367, and $0, respectively, as of December 31, 2005 and $1,171, $946, and $0, respectively, as of December 31, 2004.
The weighted-average assumptions used to determine the net periodic benefit cost for the years ended December 31, 2005, 2004 and 2003 were as follows:
The qualified defined benefit plan assets were invested in the AIM Basic Balanced Fund (the “Fund”), the prospectus for which indicates an average annual return of approximately 7% since its inception; accordingly, a 7.00% rate of return was used to calculate the periodic benefit cost for 2005. The Fund normally invests at least 65% of its assets in equity securities and at least 30% of its assets in fixed income securities that are investment grade at the time of purchase. The remaining assets of the Fund are allocated to other investments at the Fund manager’s discretion, based upon current business, economic and market conditions.
In 1998, Georgia Casualty began directing certain workers’ compensation premiums to Delta Fire & Casualty Insurance Company (“Delta”) and fully reinsured such amounts. Delta is controlled by certain affiliates of the Company. Premiums assumed and commissions paid were $532 and $80 in 2005, respectively, $1,710 and $143 in 2004, respectively, and $1,817 and $168 in 2003, respectively.
In 1998, American Southern formed the American Auto Insurance Agency (the “Agency”) in a joint venture with Carolina Motor Club, Inc. to market personal automobile insurance to the members of the automobile club. American Southern at all times held a 50% interest in the joint venture, accounted for using the equity method and reflected as an operating activity, and underwrote a majority of the standard automobile business written by the Agency. This program, which began writing business in 1999, had gross written premiums of approximately $8,615, $8,517 and $8,311 in 2005, 2004, and 2003, respectively. The Company has, in the past funded its pro rata share of operations. Effective October 1, 2005, this joint venture was terminated due to unfavorable underwriting results.
The carrying amount is determined in accordance with methods prescribed by the NAIC, which do not differ materially from nationally quoted market prices. Certain non-redeemable preferred stocks that do not have quoted values are carried at estimated fair value as determined by management.
The fair value of investments in certain limited partnerships, which are included in other invested assets on the consolidated balance sheet, were determined by officers of those limited partnerships.
The fair value is estimated based on the quoted market prices for the same or similar issues or on the current rates offered for debt having the same or similar returns and remaining maturities.
The Company’s comprehensive income (loss) consists of net income (loss), unrealized gains and losses on securities available for sale, fair value adjustments to a previously existing interest rate swap and minimum additional pension liability, net of applicable income taxes. Other than net income (loss), the other components of comprehensive income (loss) for the years ended December 31, 2005, 2004 and 2003 were as follows:
The following table sets forth a summary of the quarterly unaudited results of operations for the two years in the period ended December 31, 2005: