The Company's California domiciled agency subsidiary leases approximately 1,900 square feet of office space in a suburb of Los Angeles, California. All West Coast operations are conducted from these facilities. The lease expires in May, 2007.
The primary sources of the Company's liquidity are (1) funds generated from insurance operations including net investment income, (2) proceeds from the sale of investments and (3) proceeds from maturing investments. The Company generally experiences positive cash flow from operations resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the insurance subsidiaries, other than loss and loss expense payments, generally average less than 30% of premiums earned on a consolidated basis and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, turn negative as loss settlements on claim reserves established in prior years exceed net premium revenue and receipts of investment income. During 2006, positive cash flow from operations totaled $17.2 million compared to $48.9 million in 2005. Approximately $11 million of this decrease in operating cash flow resulted from non-recurring refunds of premium related to retrospectively rated policies with the remainder due largely to the decline in premium volume during 2006.
The Company's assets at December 31, 2006 included $101.8 million in short-term and cash equivalent investments which are readily convertible to cash without market penalty and an additional $171.5 million of fixed maturity investments (at par) maturing in less than one year. The Company believes that these liquid investments, plus the expected cash flow from current operations, are more than sufficient to provide for projected claim payments and operating cost demands. In the event competitive conditions continue to produce inadequate premium rates and the Company chooses to further restrict volume, the liquidity of its investment portfolio would permit management to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, the Company's reinsurance program is structured to avoid serious cash drains that might accompany catastrophic losses.
Net premiums written by the Company's U.S. insurance subsidiaries for 2006 equaled approximately 38% of the combined statutory surplus of these subsidiaries. Premium writings of 200% to 300% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
As more fully discussed in Note F to the consolidated financial statements, at December 31, 2006, $70.0 million, or 21% of shareholders' equity, represented net assets of the Company's insurance subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company has no debt outstanding at December 31, 2006.
Direct premiums written for 2006 totaled $184.1 million, a decrease of $25.4 million (12%) from 2005. This decrease is primarily attributable to a decrease in fleet trucking liability premiums of $38.8 million (37%) from 2005 levels. Direct premium writings from the Company's private passenger automobile program also decreased by $4.5 million (12%). These decreases were partially offset by increases in the Company's independent contractor and small fleet trucking programs of $7.8 million (15%) and $10.5 million (67%), respectively. Large trucking fleet volume decreased as the result of ongoing rate competition, which resulted in the loss of business and the writing of lower limits for renewed accounts. Increased competitive pressures were also responsible for the decline in premium volume from the private passenger automobile program. The higher premium volume from the independent contractor program resulted from the addition of contractors by existing accounts and the increase in premium volume from the small fleet trucking program was due to geographic expansion, increased marketing efforts and slightly improved competitive conditions.
Premiums ceded to reinsurers decreased $14.8 million (37%) during 2006 to $24.8 million as the consolidated percentage of premiums ceded to direct premiums written decreased to 14% for 2006 from 19% for 2005. This decrease is reflective of the Company's increased retention under reinsurance treaties effective in 2004 through 2006 covering large fleet trucking risks. The Company's maximum retained loss under these treaties has increased over the last two years and, as a result, a lower percentage of the direct premiums are ceded to reinsurers. There were no other significant changes to reinsurance treaties during 2006.
After giving effect to changes in unearned premiums, net premiums earned decreased 9% to $169.8 million for 2006 from the record $186.2 million for 2005. Excluding inter-company reinsurance arrangements, net premiums earned from all trucking-related insurance products decreased by $9.6 million (7%). Net premiums earned from the Company's private passenger automobile and discontinued small business workers' compensation programs also decreased by $4.1 million (11%) and $2.7 million (99%), respectively. An increase in net premiums earned from non-affiliated reinsurance assumed of $1.2 million (10%) was offset by a $1.0 million (73%) decrease in premiums assumed from involuntary residual markets.
Pre-tax investment income increased 32% during 2006 to $19.5 million as yields were up 24% on average and invested assets increased by 5% despite lower cash flow from operations and the payment of over $38 million in cash dividends to shareholders during the year. This improvement followed similar increases in 2005. Short-term pre-tax rates increased most dramatically during 2006, averaging 55% higher than 2005. The after-tax investment income yield increased by 36% from 2005 as the movement of substantial portions of short-term
funds into short and moderate term municipal bonds enhanced after-tax yields by 29% compared to the prior year.
Net gains on investments totaled $17.1 million in 2006 compared to $23.0 million last year. These totals include gains from both direct securities trading and investments in limited partnerships. The decrease in gains in 2006 is attributable to lower direct investing activities and a $3.6 million decline in the earnings of limited partnership investments. The Company's investments in limited partnership ventures, consists primarily of securities trading and small venture capital activities and, to a lesser extent, real estate development. The estimated market value of these investments was $44.7 million at December 31, 2005 and the aggregate of the Company's share of earnings in these entities totaled approximately $11.2 million during 2006. While this lagged the $14.8 million of appreciation reported during 2005, it represented a return of over 25% for the year. The Company follows the equity method of accounting for its investments in limited partnerships. To the extent that the limited partnerships include realized and unrealized gains or losses in their net income, the Company's proportionate share of net income will include unrealized as well as realized gains or losses. The current year limited partnership total is composed of estimated realized income of $5.0 million and estimated unrealized income of $6.2 million, as reported to the Company by the general partners. Inception to date unrealized gains included in the December 31, 2006 asset valuation total $23.8 million. The final component of investment gains, consisting of adjustments attributable to "other-than-temporary impairment," was not significant during 2006 or 2005 and is more fully explained in Note B.
The Company produced an overall savings on the handling of prior year claims during 2006 of $16.9 million. This net savings is included in the computation of loss ratios shown in the table insert. Approximately $7.2 million of this savings relates to retrospectively-rated contracts whereby return premiums were recorded concurrently with the loss savings. The majority of the remaining $9.7 million in savings relates to the Company's large fleet trucking business, generally consistent with, but higher than, recent prior years. Because of the high limits provided by the Company to its large trucking fleet insureds, the length of time required to
Other operating expenses for 2006, before credits for allowances from reinsurers, increased $1.2 million (2.6%) to $48.7 million. This increase is due primarily to a $1.4 million increase in commission expense related to reinsurance assumed. A large portion of commission on reinsurance assumed is dependent on experience. During 2005, hurricane losses resulted in significant reductions to contingent commissions on this business. The favorable experience during 2006 returned commissions to normal levels in relation to premium volume. Offsetting much of the reinsurance assumed commission change was the recovery during 2006 of nearly $1 million previously written off related to bankrupt reinsurers. After consideration for these two items, expenses before ceding allowances increased $.7 million, or 1.7% from 2005. Because much of the Company's expense structure is fixed, expenses do not vary directly with revenue, which consists principally of net premiums earned from the insurance subsidiaries. In general, only commissions to independent agents, premium taxes and other acquisition costs vary directly with premium volume.
Substantially all fleet trucking business is produced by direct sales efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not incur commission expense on a consolidated basis. Instead, the expenses of the agency operations, including salaries and bonuses of salesmen, travel expenses, etc. are included in operating expenses. In general, commissions paid by the insurance subsidiaries to the parent company exceed related acquisition costs incurred in the production of fleet trucking business. The ratio of net operating expenses of the insurance subsidiaries to net premiums earned was 26.6% during 2006 compared to 22.0% for 2005. Including the agency operations, and after elimination of inter-company commissions, the ratio of other operating expenses to operating revenue (defined as total revenue less gains on investments) was 24.2% for 2006 compared with 19.0% for 2005, reflective of the loss of nearly 85% of ceding commissions from reinsurers, as discussed above.
Premiums assumed from other insurers and reinsurers totaled $11.5 million during 2005, an increase of $2.8 million (32%) from 2004, including $2.0 million of reinstatement premiums related to the 2005 hurricanes. Premium volume from reinsurance assumed will fluctuate depending on the favorability of pricing for the coverages provided. Further, premium volume for this segment is limited by the Company's self-imposed limitation to loss from a single catastrophic event.
The effective federal tax rate for consolidated operations for 2005 was 32.5%. This rate is lower than the statutory rate primarily because of tax-exempt investment income.
In determining if and when a decline in market value below cost is other-than-temporary, we first make an objective analysis of each individual security where current market value is less than cost. For any security where the unrealized loss exceeds 20% of original or adjusted cost, and where that decline has existed for a period of at least six months, the decline is treated as an other-than-temporary impairment, without any subjective evaluation as to possible future recovery. For individual issues where the decline in value is less than 20% but the amount of the decline is considered significant, we will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other-than-temporary. In those instances, the Company also considers its intent and ability to hold investments until recovery or maturity. For any decline which is considered to be other-than-temporary, we recognize an impairment loss in the current period earnings as an investment loss. Declines which are considered to be temporary are recorded as a reduction in shareholders' equity, net of related federal income tax credits.
It is important to note that all investments included in the Company's financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments does not change these valuations but, rather, determines when the decline in value will be recognized in the income statement (other-than-temporary decline) as opposed to a charge to shareholders' equity (temporary decline). Subsequent recoveries in value of investments which have incurred other-than-temporary impairment adjustments are accounted for as unrealized gains until the security is actually disposed of or sold. At December 31, 2006, unrealized gains include $6.4 million of appreciation on investments previously adjusted for other-than-temporary impairment, compared to $3.7 million of impairment write-downs at that date. See Note B to the consolidated financial statements for additional detail with respect to this process. This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors which relate to an industry, in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process which results in income statement recognition of any investment which, over a six month period, is unable to recover from a 20% decline in value from our cost basis. However, to the extent that certain declines in value are reported as unrealized at December 31, 2006, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2006, the total gross unrealized loss included in the Company's investment portfolio was less than $2.1 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2006, investment gains would have decreased by $.09 per share for the year, after tax. There would, however, have been no impact on total shareholders equity or book value per share since the decline in value of these securities was already recognized as a reduction to shareholders equity at December 31, 2006.
The Company's loss and loss expense reserves for each significant segment are shown in the following table for direct and assumed and on a net of reinsurance basis at December 31, 2006 and 2005. Those lines of business individually comprising less than three percent of the Company's total reserves are shown in the aggregate as "All other".
closed claims and study of current economic trends affecting loss settlement costs are used to estimate the loss adjustment reserve needs related to the established loss reserves. Each of these reserve categories contain elements of uncertainty which assure variability when compared to the ultimate costs to settle the underlying claims for which the reserves are established. The reserving process requires management to continuously monitor and evaluate the life cycle of claims based on the class of business and the nature of claims. Our claims range from the very routine private passenger automobile "fender bender" to the highly complex and costly third party bodily injury claim involving large tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in the Company's trucking liability policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. Note C to the consolidated financial statements includes additional information relating to loss and loss adjustment expense reserve development.
The reserving process requires management to continuously monitor and evaluate the life cycle of claims based on the class of business and the nature of claims. Our claims range from the very routine private passenger automobile "fender bender" to the highly complex and costly third party bodily injury claim involving large tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in the Company's trucking liability policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. Note C to the consolidated financial statements includes additional information relating to loss and loss adjustment expense reserve development.
SENSITIVITY ANALYSIS - POTENTIAL IMPACT ON RESERVE VOLATILITY FROM CHANGES IN - ----------------------------------------------------------------------------- KEY ASSUMPTIONS - ---------------
Management is aware of the potential for variation from the reserves established at any particular point in time. Redundancies or deficiencies could develop in future valuations of the currently established loss and loss expense reserve estimates under a variety of reasonably possible scenarios. The Company's reserve selections are developed to be a "best estimate" of unpaid loss at a point in time and, due to the unique nature of our exposures, particularly in the large fleet trucking excess product where insured's policies of insurance combine large self-insured retentions with high policy limits, ranges of reserve estimates are not established during the
reserving process. However, basic assumptions that could potentially impact future volatility of our valuations of current loss and loss expense reserve estimates include, but are not limited to, the following:
o Expected loss ratios for the current book of business, particularly the Company's large fleet excess product, where the number of accounts insured, selected self-insured retentions, policy limits and reinsurance structure may vary widely period to period
The liability method is used in accounting for federal income taxes. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for deferred federal income tax was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. Net deferred tax liabilities reported at December 31, 2006 and 2005 consisted of:
Deferred tax assets at December 31, 2006, include approximately $12,256 related to policy liability discounts required by the Internal Revenue Code which are perpetual in nature and, in the absence of the termination of business, will not reverse to a material degree in the foreseeable future. An additional $1,301 relates to impairment adjustments made to investments, as required by accounting regulations. The sizable unrealized gains in the Company's investment portfolios would allow for the recovery of this deferred tax at any time. The balance of deferred tax assets, approximately $1,248, consists of various normal operating expense accruals and is not considered to be material. As a result of its analysis, management does not consider any of these assets to be impaired at December 31, 2006.
The Company operates solely within the property and casualty insurance industry and, accordingly, has significant invested assets which are exposed to various market risks. These market risks relate to interest rate fluctuations, equities market prices and, to a far lesser extent, foreign currency rate fluctuations. All of the Company's invested assets, with the exception of investments in limited partnerships, are classified as available for sale and are listed as such in Note B to the consolidated financial statements.
Reference is made to the discussion of limited partnership investments in the Critical Accounting Policies portion of this report. All of the market risks, attendant to equity securities, apply to the underlying assets in these partnerships, and to a greater degree because of the generally more aggressive investment philosophies utilized by the partnerships. In addition, these investments are illiquid. There is no primary or secondary market on which these limited partnerships trade and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. Finally, through the application of the equity method of accounting, the Company's share of net income reported by the limited partnerships may include significant amounts of unrealized appreciation on the underlying investments. As such, the likelihood that reported income from limited partnership investments will be ultimately returned to the Company in the form of cash is markedly lower than the Company's other investments, where income is reported only when a security is actually sold.
The Company's fixed maturity portfolio totaled $338.5 million at December 31, 2006. Approximately 89% of this portfolio is made up of U. S. Government and government agency obligations and state and municipal debt securities; 84% of the portfolio matures within 5 years; and the average life of the Company's fixed maturity investments is approximately 3.0 years. Although the Company is exposed to interest rate risk on its fixed maturity investments, given the anticipated duration of the Company's liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, even a 100 to 200 basis point increase in interest rates would not have even a moderate impact on the Company's ability to conduct daily operations or to meet its obligations.
We estimate that a 100 basis point increase in market interest rates would have resulted in a pre-tax loss in the fair value of fixed maturity investments of approximately $5.0 million at December 31, 2006. Similarly, a 100 basis point decrease in market interest rates would have resulted in an estimated pre-tax gain in the fair value of these instruments of approximately $5.4 million at December 31, 2006. Note, however, that the hypothetical loss mentioned above would only be realized if the Company was obligated to sell bonds prior to maturity, which is extremely unlikely. The aggregate value of money market and short-term investments, bonds maturing within twelve months and expected positive cash flow from operations for 2007 is equal to more than 100% of net loss and loss expense reserves at December 31, 2006.
We have audited the accompanying consolidated balance sheets of Baldwin & Lyons, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in equity other than capital, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Baldwin & Lyons, Inc.'s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2007 expressed an unqualified opinion thereon.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Baldwin & Lyons, Inc. and Subsidiaries (DOLLARS IN THOUSANDS)
RECOGNITION OF REVENUE AND COSTS: Premiums are earned over the period for which insurance protection is provided. A reserve for unearned premiums, computed by the daily pro-rata method, is established to reflect amounts applicable to subsequent accounting periods. Commissions to unaffiliated companies and premium taxes applicable to unearned premiums are deferred and expensed as the related premiums are earned. The Company does not defer acquisition costs which are not directly variable with the production of premium and are not refundable in the event of policy cancellation. If it is determined that expected losses and deferred expenses will exceed the related unearned premiums, the asset representing deferred policy acquisition costs is reduced and an expense is charged against current operations to reflect any such premium deficiency. In the event that the expected premium deficiency exceeds deferred policy acquisition costs, an additional liability would be recorded with a corresponding expense to current operations for the amount of the excess premium deficiency. Anticipated investment income is considered in determining recoverability of deferred acquisition costs.
In the ordinary course of business, our federal income tax returns are audited by the Internal Revenue Service. We establish additional tax liabilities when, despite our belief that our tax positions are fully supportable, it is probable that the taxes ultimately payable will exceed the amounts reflected in our filed tax returns. Changes in the estimate of these matters will impact the provision for income taxes in the period in which such determination is made.
SHARE-BASED PAYMENTS: The Company uses a "Black-Scholes-Merton" option pricing model to value options granted to employees and non-employee directors in accordance with Statement of Financial Accounting Standards No. 123R, SHARE-BASED PAYMENT, adopted January 1, 2006 with no material effect. Compensation costs for all share-based awards to employees and non-employee directors are measured based on the grant date fair value of the award and are recognized over the period(s) during which the employee or non-employee director is required to perform service in exchange for the award (the vesting period).
NOTE B - INVESTMENTS The following is a summary of investments at December 31:
NOTE B - INVESTMENTS (CONTINUED) The following table summarizes, for fixed maturity and equity security investments in an unrealized loss position at December 31, the aggregate fair value and gross unrealized loss categorized by the duration those securities have been continuously in an unrealized loss position.
The fair value and the cost or amortized cost of fixed maturity investments, at December 31, 2006, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. The Company's fixed maturity investment portfolio is sensitive to interest rate fluctuations, which impact the fair value of individual securities. Accordingly, unrealized losses on fixed maturity securities reported above were generally caused by the effect of a rising interest rate environment on certain securities with stated interest rates currently below market rates. The Company has the ability and intent to hold these fixed maturity securities until their full cost can be recovered. Therefore, the Company does not believe the unrealized losses represent an other-than-temporary impairment as of December 31, 2006.
NOTE B - INVESTMENTS (CONTINUED) Gains and losses on investments, including equity method earnings from limited partnerships, for the years ended December 31 are summarized below:
The 2006 net gains from limited partnerships, as shown in the above table, include approximately $6.2 million of unrealized gains as reported in the net income of the various partnerships. Shareholders' equity includes approximately $15.5 million, net of deferred federal income taxes, of earnings yet undistributed by limited partnerships as of December 31, 2006.
performance-based fees of $1,587 and $1,687, respectively, to these organizations for management of these limited partnerships. Fees paid in 2004 for management of a single limited partnership were $21. The Company has been informed that the fee rates applied to its investments in these limited partnerships are the same as, or lower than, the fee rates charged to unaffiliated customers for similar investments.
The Company utilized the services of a broker-dealer firm of which a director of the Company is an executive officer and owner. This broker-dealer serves as agent for purchases and sales of securities and manages an equity securities portfolio and fixed maturity portfolio with market values of approximately $3,854 and $16,052, respectively, at December 31, 2006. The Company has been informed that commission and management rates charged by this broker-dealer to the Company are commensurate with rates charged to non-affiliated customers for similar investments. Total commissions and fees earned by the broker-dealer and affiliates on these transactions and for advice and consulting were approximately $148, $279 and $151 during 2006, 2005 and 2004, respectively. The Company had previously entered into an agreement with an associate of this broker-dealer for management of a portion of its equity securities portfolio. That agreement was terminated during 2005. That associate earned performance-based compensation and management services fees and expense reimbursements totaling approximately $90 and $307 during 2005 and 2004, respectively. The Company has been informed that the broker-dealer retained none of this compensation for its own account.
Short-term investments at December 31, 2006 include $7.3 million in foreign time certificates of deposit.
Favorable loss development is influenced by the Company's long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Reserve savings developed related to retrospectively-rated accident and health business resulted in the concurrent recording of return premiums of approximately $4,738, $4,484 and $2,700 for the years ended December 31, 2006, 2005 and 2004, respectively. As more fully discussed in Note D, the Company has increased it's per occurrence retention of risk related to trucking liability business over the past several years. The increased net retention per occurrence is reflected in the favorable developments during 2006, 2005 and 2004. These trends were considered in the establishment of the Company's reserves at December 31, 2006 and 2005.
Loss reserves have been reduced by estimated salvage and subrogation recoverable of approximately $3,845 and $3,374 at December 31, 2006 and 2005, respectively.
operation of these assigned risk pools have resulted in net losses allocated to the Company although such losses have generally not been material in relation to the Company's direct and voluntary assumed operations.
Net losses and loss expenses incurred for 2006, 2005 and 2004 have been reduced by ceded reinsurance recoveries of approximately $14,026, $39,389 and $103,579, respectively. Ceded reinsurance premiums and loss recoveries for catastrophe reinsurance contracts were not material.
NOTE F - SHAREHOLDERS' EQUITY Changes in common stock outstanding and additional paid-in capital are as follows.
The Company maintains a defined contribution 401(k) Employee Savings and Profit Sharing Plan ("the Plan") which covers all employees who have completed one year of service. The Company's contributions to the Plan for 2006, 2005 and 2004 were $1,137, $1,093 and $1,053, respectively.
In accordance with the terms of the 1981 Stock Purchase Plan (1981 Plan), the Company is obligated to repurchase shares issued under the 1981 Plan, at a price equal to 90% of the book value of the shares at the end of the quarter immediately preceding the date of repurchase. No shares have ever been repurchased under the 1981 Plan. At December 31, 2006 there were 158,503 shares (Class A) and 438,583 shares (Class B) outstanding which are eligible for repurchase by the Company.
Under the Director Option Plan (the Director Plan), which is shareholder approved, the Company has reserved 300,000 shares of Class B common stock for the granting of discounted and market value options to non-employee directors. Approximately 167,000 shares of Class B common stock are available for future grants. No options were granted to directors during 2006 and all discounted options outstanding at December 31, 2005 were exercised during 2006. Prior to May, 2005, discounted options were granted to non-employee directors in lieu of cash directors' fees. In addition, during 2005 and 2004, non-employee directors were each granted 1,500 options at market value on the date of grant as part of their regular annual directors' fees. During 2006, all market value options were terminated, without compensation to the directors, and all subsequent directors' fees have been paid in cash. The Director Plan provides that options granted to non-employee directors are not exercisable for one year from the date of grant. Discounted options expire ten years from the date of grant while market value options expire seven years from the date of grant.
A summary of option activity under the Director Plan as of December 31, 2006, and changes during the year then ended, is presented below:
The weighted-average grant-date fair value of options granted during 2005 and 2004 at prices below market value were $25.10 and $25.71, respectively. The weighted-average grant-date fair value of options granted during 2005 and 2004, at market, were $5.33 and $4.70, respectively. The total intrinsic value of options exercised during 2006, 2005 and 2004 was $484, $27, and $1,641, respectively.
The total intrinsic value of options exercised during 2006, 2005 and 2004 was $1,684, $420, and $328, respectively.
Options to purchase 35,422 shares of the Company's Class B common stock were excluded in 2005 from the above reconciliation in that inclusion would have an anti-dilutive effect.
The Company writes policies of excess insurance attaching above a self-insured retention ("SIR") and also writes policies that contain large, per-claim deductibles. Those losses and claims that fall within the SIR or deductible are obligations of the insured. The Company also writes surety bonds in favor of various regulatory agencies guaranteeing the insured's payment of claims within the SIR. Losses and claims under a large deductible policy are payable by the Company with reimbursement due the Company from the insured. The Company requires collateral from its insureds to serve as a source of reimbursement if the Company is obligated to pay claims within the SIR by reason of an insured's default or if the insured fails to reimburse the Company for deductible amounts paid by the Company.
Acceptable collateral may be provided in the form of letters of credit on Company approved banks, Company approved marketable securities or cash. At December 31, 2006, the Company held collateral in the aggregate amount of $251,624.
In addition, the Company's balance sheet includes paid and unpaid amounts recoverable from reinsurers under various agreements totaling $163,426 at December 31, 2006, as more fully discussed in Note D - Reinsurance. With minor exception, these recoverables are uncollateralized. The largest estimated amount due from a single reinsurer totaled $19,859 at December 31, 2006. Included in the total recoverable amount are case basis and estimated IBNR losses of approximately $14.3 million due from Converium Insurance (North America) Inc. and $2.7 million due from PMA Re., each of which have reported substantial reserve strengthening and/or impairment of assets which have negatively affected their reported financial positions. All amounts due from these reinsurers on paid claims as of December 31, 2006 are current and the Company has no information at this time to indicate that all obligations of these reinsurers will not be met.
Investments in limited partnerships include an aggregate of $39,203 invested in three related partnerships, New Vernon India Fund, New Vernon Global Opportunity Fund and New Vernon North American Opportunity Fund.
In September 2005, the American Institute of Certified Public Accountants ("AICPA") released Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 requires identification of transactions that result in a substantial change in an insurance contract. If it is determined that a substantial change to an insurance contract has occurred, the related unamortized deferred policy acquisition costs, unearned premiums and other related balances must be written off. SOP 05-1 is effective on January 1, 2007 and it is expected that SOP 05-1 will not have a material effect on the Company's consolidated financial condition or results of operations.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109" ("FIN 48"), which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized only if it is "more likely than not" that the position is sustainable based on its technical merits. FIN 48 is effective on January 1, 2007 and it is expected that FIN 48 will not have a material effect on the Company's consolidated financial condition or results of operations.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements" ("SFAS No. 157"), which provides a common definition of fair value and establishes a framework to make the measurement of fair value more consistent and comparable. SFAS No. 157 also requires expanded disclosures about (1) the extent to which companies measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair value and (3) the effect of fair value measures on earnings. SFAS No. 157 is effective on January 1, 2008 and it is expected that SFAS No. 157 will not have a material effect on the Company's consolidated financial condition or results of operations.