Countervailing to some extent the recent trend in primary insurers’ new business production are developments that have provided growth opportunities for us in our financial guaranty reinsurance business. Underwriting capacity for reinsurance, meaning the U.S. based statutory capital available for financial guaranty reinsurance, is more limited now than it was in years prior to 2003, primarily because the large multi-line insurance
In January and February of 2005, the SEC discussed with financial guaranty industry participants the diversity in practice with respect to their accounting policies for loss reserves. In June 2005, the FASB added a project to its agenda to consider the accounting by financial guaranty insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed and final documents are expected to be issued during 2007. When the FASB issues authoritative guidance on this matter, we and the rest of the financial guaranty industry may be required to change some aspects of our loss reserving policies, premium recognition and acquisition cost recognition. Until the authoritative guidance is issued, RAM Re intends to continue to apply its existing policies with respect to its accounting for the establishment of both case and unallocated reserves as well as for premium recognition and deferred acquisition costs.
advance through refunding, any remaining unearned premium is earned at that time, since there is no longer any risk outstanding in connection with the issue. Refunding levels vary depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. Installment premiums are received in accordance with contractual terms over the life of an issue, recorded as written at each installment due date and earned over the installment period which corresponds to the expiration of risk. Structured finance premiums are customarily paid in installments and earned over installment periods that generally range from three months to one year in duration. We do not record a provision for doubtful accounts because historically we have not experienced any material issues related to the collectibility of assumed premiums.
Net Income. Net income was $41.1 million in 2006, $19.6 million in 2005, and $24.7 million in 2004. The increase in net income of $21.5 million, or 109.7%, in 2006 relative to 2005 is primarily the result of a year over year decrease of $10.0 million in losses and loss adjustment expenses, realized investment losses of $1.0 million in 2006 compared to realized losses of $1.6 million in 2005, and immaterial unrealized losses on credit derivatives in 2006 compared to $2.5 million of unrealized losses during 2005, an increase in net earned premium of $6.2 million and in investment income of $6.0 million. Net income of $19.6 million in 2005, a decrease of $5.1 million, or 20.6%, in 2005 relative to 2004 is primarily the result of a year over year increase of $3.6 million in losses and loss adjustment expenses, realized investment losses of $1.6 million in 2005 compared to realized investment gains of $0.5 million in 2004, and unrealized losses on credit derivatives of $2.5 million in 2005 versus unrealized gains of $2.8 million during 2004, partially offset by 2005 increases in earned premium of $7.9 million and in investment income of $1.4 million.
General Expenses. General or operating expenses were $13.4 million in 2006, an increase of $1.9 million or 16.5% above $11.5 million in 2005, which were $0.5 million or 4.5% higher than $11.0 million of operating expenses in 2004. The majority of the increase of operating expenses in 2006 includes $2.3 million in non-recurring costs related to the IPO. Expenses connected to the IPO have been expensed as incurred in proportion to the shares sold in the IPO by the selling shareholders, with $0.3 million of IPO expenses relating to the issuance of new shares allocated against the proceeds. Operating expenses in 2005 included $2.5 million of non-recurring compensation expense associated with a termination feature of a stock option plan, while 2004 operating costs included $2.7 million of non-recurring items comprised of $0.9 million in compensation expenses related to settlement of an employment matter, $1.5 million in legal expenses and $0.3 million in consulting fees. Operating expenses as a percentage of earned premiums were 27.4% in 2006, 27.1% in 2005, and 31.8% in 2004.
On May 2, 2006, the Company completed an initial public offering (“IPO”) of 10,820,816 common shares (including 1,411,411 over-allotment option shares). The offering raised approximately $131.2 million of proceeds, net of underwriters’ discount and commission, of which the company received $16.4 million and the selling shareholders received $114.8 million. The Company contributed substantially all of the net proceeds of the offering to RAM Re to increase its capital and surplus in order to increase its underwriting capacity.
Our finance personnel monitor the portfolio on for performance and adherence to policies, including market valuation, credit quality, portfolio duration and liquidity. We have a formal review process for all securities in our investment portfolio, including a review for impairment losses based on the factors described above under “Critical Accounting Policies - Valuation of Investment Portfolio.” We have not recognized any impairments at either December 31, 2006 or at December 31, 2005.
On May 1, 2006, the board of directors and shareholders approved a 10 for 1 stock split of the common shares of the Company and, in addition, issued bonus shares on a 0.3 for 1 basis, effectively resulting in a 13:1 stock split. As a result of this action 23,893,620 additional shares were issued and the par value of all shares became $0.10 per share. Prior to this the par value of the common shares was $1.00 per share. As a result of the bonus shares, $597,341 was transferred from additional paid in capital to common shares. All references to number of common shares and per common share amounts including the reference in Note 14 have been restated to reflect the retroactive effect of the effective 13:1 stock split for all periods presented.
The Company reviews the portfolio on a continuous basis to identify problem credits. Quarterly, the Management Committee formally reviews case and the unallocated reserves. Management establishes reserves that it believes are adequate to cover the present value of the ultimate liability for claims. The reserves are necessarily based on estimates and are substantially dependent on the surveillance activities and reserving policies of our ceding companies and may vary materially from actual results. Adjustments based on actual loss experience will be recorded in the periods in which they become known.
The Company has one reportable segment, financial guaranty reinsurance, which provides financial guaranty reinsurance for public finance, structured finance and other obligations.
The Company’s liability for losses and loss adjustment expenses consists of case basis loss reserves and an unallocated reserve. Movement in the provision for losses and loss adjustment expenses is summarized as follows:
Statutory financial statements prepared under the Act differ from financial statements prepared in accordance with US GAAP due to the exclusion of non-admitted assets such as deferred policy acquisition costs, prepaid expenses and the fair value adjustment of derivative instruments.