We have limited historical experience in our excess policy business and therefore we perform a ground-up analysis of loss emergence patterns of the insured. The expected ultimate impact of these excess policies is based upon actual experience of the insureds’ and industry excess of loss factors which vary by state and hazard group. Gross losses were developed to ultimate and the portion of the losses expected to exceed our retention with respect to each insured was calculated. We reevaluated the loss ratios at December 31, 2009 and recognized favorable development for that year ended. The favorable development relates primarily to California accident years 2008 and 2006 for which actual results have been better than industry excess of loss factors.
These increases were offset by a $1.5 million decrease in management fee income in our fee-based management services segment resulting from lower premiums under management.
Total Expenses. Consolidated total expenses increased $25.2 million, or 21%, to $143.1million in 2008, from $117.9 in 2007. The increase was primarily attributable to
The underwriting expense ratio is calculated by dividing total of policy acquisition costs and selling, general and administrative expenses by the net premiums earned.
Majestic experienced $5.9 million of net unfavorable development on prior accident years in 2009, as compared to $3.7 of net favorable development on prior accident years in 2008. During 2009, Majestic experienced $6.5 million of unfavorable loss reserve development in its primary policy business. The adverse loss reserve development was primarily from accident year 2008 in California and New Jersey where our actual incurred and paid losses have developed higher than our initial actuarial projections. Losses in Majestic’s excess policy business experienced favorable development of $0.5 million where we experienced $0.7 million of favorable development in California, where losses above the self-insured retention have not emerged as expected. This was offset by $0.3 million of unfavorable development on excess policies issued in New York where claims have emerged higher than expected.
Despite the increase in premium volume, general corporate overhead expenses and an increase in our reserves for uncollectible receivables resulted in underwriting expense ratios of 34% and 28% for 2008 and 2007, respectively.
The loss and loss adjustment ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned.
Policy Acquisition Costs. Policy acquisition costs decreased $4.6 million, or 62%, to $2.8 million in 2009, from $7.4 million in 2008. The decrease was primarily due Twin Bridges’ reduction in net earned premiums as described above in “Reinsurance Segment Results of Operations 2009 Compared to 2008 - Net Premiums Earned.” Policy acquisition costs, as a percentage of net earned premiums, were unchanged year over year.
The recognition of $3.8 million of severance expense related to the March 2009 resignation of Mr. Hickey Jr., our former chairman and chief executive officer;
The amount of capital in our insurance and reinsurance subsidiaries is maintained relative to standardized capital adequacy measures. In the United States and Bermuda, insurers and reinsurers are required to maintain certain minimum levels of capital and risk-based capital, the calculation of which includes numerous factors specified by the respective insurance regulatory authorities and the related insurance regulations. Factors that affect capital requirements generally include premium volume, the extent and nature of loss and loss expense reserves, the type and form of insurance and reinsurance business underwritten and the availability of reinsurance protection on terms that are acceptable to us. Majestic is required to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The NAIC has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2009, the statutory surplus of Majestic was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action.
The Company is a sponsor that has a significant variable interest in CRM USA Holdings Trust I (“Trust”). The Trust was established for the sole purpose of issuing capital and common securities. On November 14, 2006, the trust issued $35.0 million of Trust capital securities and $1.1 million of Trust common securities and invested the proceeds in junior subordinated debt obligations (“Junior Debt”) issued by CRM USA Holdings in the aggregate principal amounts of $36.1 million. The Junior Debt is the sole asset of the Trust. Terms of the Junior Debt are described in Note 13. The capital and common securities of the Trust, representing the undivided beneficial ownership interests in the assets of the Trust, have no stated maturity and must be redeemed upon maturity of the Junior Debt securities. The Trust will make quarterly distributions on the capital and common securities at a fixed annual rate of 8.65% until December 15, 2011 and after such date at a fixed spread of 3.65% above 3-month London Interbank Offer Rate (“LIBOR”) per annum.
The Company and CRM USA Holdings have guaranteed the repayment of the capital securities which will remain in place until the full redemption of the capital securities. This guarantee does not represent a variable interest, as the Company is guaranteeing its own performance. Therefore, the Company is not the primary beneficiary and does not consolidate the Trust. Since CRM USA Holdings’ investment in the common securities of the Trust was financed directly by the Trust, CRM USA Holdings does not have any equity investment at risk, and, therefore, does not have exposure to loss from the trust.
CRM Holdings and Twin Bridges are Bermuda companies, and have received undertakings from the Bermuda Minister of Finance assuring it that if any legislation is enacted in Bermuda that would impose income or capital taxes, then the imposition of any such tax will not be applicable to CRM Holdings or Twin Bridges or any of its operations, shares, debentures or other obligations until March 28, 2016. The Company believes that CRM Holdings and Twin Bridges are not involved in the active conduct of a trade or business in the U.S. for U.S. tax purposes and as such has not provided for any federal or state and local income taxes for these entities.
Under the framework established in the fair value accounting guidance, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants at the measurement date.
Primary policies are issued through independent brokers to selected businesses. Coverage under these policies attaches typically at the first dollar of loss or in excess of policy deductibles. Excess insurance policies are issued through independent and related party brokers to self-insured groups or individual self-insured entities. Coverage under these policies attaches in excess of the group’s or individual’s self-insured retention, which range from $500 thousand to $1 million.
In 2007, Majestic completed an assignment, assumption and novation agreement (“Novation Agreement”) with NY Marine & General. Under the terms of the Novation Agreement, Majestic was substituted as the “fronting” company for almost all of the excess policies previously issued by NY Marine & General to certain of the self-insured groups managed by CRM CA and formerly managed by CRM. NY Marine & General transferred and assigned to Majestic all of its respective rights, duties and obligations under the excess workers’ compensation policies issued to certain self-insured groups during the policy years 2003 through 2006. In connection with this, NY Marine & General also transferred and assigned its rights, duties and obligations to Majestic under two quota share reinsurance treaties between NY Marine & General and Twin Bridges. Terms of the reinsurance agreements between NY Marine & General and Twin Bridges are described below with respect to the reinsurance segment. The Company has also guaranteed the performance of its subsidiaries in connection with this transaction. For the layers of coverage outside the Twin Bridges reinsurance agreements, NY Marine & General obtained consent agreements from each of its other reinsurers naming Majestic as an insured party on the reinsurance agreements.
Under Twin Bridges reinsurance agreements, Twin Bridges is required to provide security for any unpaid liabilities under those agreements. Twin Bridges has an informal secured letter of credit arrangement with Smith Barney Citigroup to obtain collateralized letters of credit. See Note 5 and Note 11 for balances of letters of credit issued pursuant to Twin Bridges credit facilities.
CRM USA Holdings has the option to defer payment of interest on its Junior Debt for up to twenty consecutive quarterly periods. CRM USA Holdings elected this option for its quarterly interest payment due December 15, 2009. Accrued interest payable on Junior Debt, includes $0.8 million of deferred payments and is included in other liabilities in the consolidated balance sheet at December 31, 2009.
The Company is involved in several pending litigation matters as described below. The Company intends to vigorously defend each of these matters and any claims that may be later asserted. Each of these matters is in a preliminary stage, and the Company cannot estimate what impact, if any, the litigation may have on its business reputation, results of operations, financial condition or cash flows; however, if any of these matters is decided adversely to the Company, it may result in a material adverse effect on its business, results of operations, financial conditions and cash flows.
70 Sheldon Inc., et al. v. Compensation Risk Managers, LLC. On August 20, 2009, 70 Sheldon, Inc., Advance Relocation Storage, Inc., All County Bus, LLC, Alpha Services of Westchester, Inc., A. T. & A. Trucking Corp., B. Pariso Transport, Inc., Carmen M. Pariso, Inc., Covered Wagon Train, Inc., Exclusive Ambulette Service, Inc. Ficel Transport, Inc., North Shore Ambulance and Oxygen Service, Inc., Rivlab Transportation Corp., Woodland Leasing Co., Inc., all of which were former members of the Transportation Industry Workers’ Compensation Trust (the “Transportation Trust”), on their own behalf and on behalf of all others similarly situated, sued CRM in New York State Supreme Court, Erie County. The lawsuit seeks class action certification and alleges that CRM: (1) breached its contract with the Transportation Trust; (2) breached its duty of good faith and fair dealing owed to the Transportation Trust; (3) breached its fiduciary duties owed to the Transportation Trust; (4) was negligent in administering the Transportation Trust; (5) engaged in deceptive business practices; (6) was unjustly enriched; and (7) should indemnify the plaintiffs for any assessments that they may incur. The plaintiffs are seeking damages (a) arising from the plaintiffs’ joint and several liability for the deficit of the Transportation Trust which, as of December 31, 2006, was estimated at $6.1 million, (b) from any unpaid claims of the plaintiffs’ injured employees in an amount presently undetermined, (c) from potentially being liable for the costs of liquidation charged or to be charged by the WCB, and (d) from fees paid by the plaintiffs and the Transportation Trust to CRM pursuant the service agreement between CRM and the Transportation Trust. On October 20, 2009, CRM filed a motion to dismiss the plaintiffs’ complaint. CRM has granted plaintiffs an extension of time to respond to CRM’s motion to dismiss until 20 days after entry of the court’s decision on CRM’s motion to dismiss in the FS Kids LLC, et al. v. Compensation Risk Managers, LLC lawsuit.
In December 2009, the New York State Workers’ Compensation Board commenced a lawsuit on its own behalf and in its capacity as successor in interest to seven of the eight workers’ compensation self-insured groups in New York previously managed by CRM. The New York State Workers’ Compensation Board’s lawsuit, brought in Supreme Court of the State of New York, Albany County, alleges that CRM, CRM Holdings, its subsidiaries and certain directors and officers breached fiduciary duties owed to the self-insured groups, breached contracts between CRM and the self-insured groups, breached duties of good faith and fair dealing owed to the self-insured groups, engaged in fraudulent activities in administering the self-insured groups, engaged in deceptive business practices and advertising, and were unjustly enriched. The complaint alleges that the New York Workers’ Compensation Board and the self-insured groups have suffered damages in an amount that is not currently ascertainable, but which is believed to exceed $405 million. To date, neither we nor any of our subsidiaries or directors or officers have been served with the lawsuit.
The following table sets forth the Company’s revenues, expenses, (loss) income before income taxes and total assets from continuing operations by business segment. Total assets exclude $3.5 million, $4.0 million and $8.1 million of assets from discontinued operations at December 31, 2009, 2008 and 2007, respectively.