Properties We own a 63,000 square foot building in Cleveland, Ohio. In addition, we lease an aggregate of approximately 265,000 square feet of office space in over twenty-five locations. See “Certain Relationships and Related Transactions.”
(3) Acquisition costs and other underwriting expenses include policy acquisition expenses include commissions paid directly to producers as well as premium taxes and assessments.
Reinsurance Agreement With Maiden During the third quarter of 2007, the Company and Maiden entered into master agreement, as amended, by which they caused the Company’s Bermuda affiliate, AmTrust International Insurance, Ltd. (“AII”) and Maiden Insurance to enter into a quota share reinsurance agreement (the “Reinsurance Agreement”) by which (a) AII retrocedes to Maiden Insurance an amount equal to 40% of the premium written by AmTrust’s U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated inuring reinsurance (and in the case of AmTrust’s U.K. insurance subsidiary IGI, net of commissions) and 40% of losses and (b) AII transferred to Maiden Insurance 40% of the AmTrust Ceding Insurer’s unearned premium reserves, effective as of July 1, 2007, with respect to current lines of business, excluding risks for which the AmTrust Ceding Insurers’ net retention exceeds $5 milion (“Covered Business”). AmTrust also has agreed to cause AII, subject to regulatory requirements, to reinsure any insurance company which writes Covered Business in which AmTrust acquires a majority interest to the extent required to enable AII to cede to Maiden Insurance 40% of the premiums and losses related to such Covered Business. The Agreement further provides that AII receives a ceding commission of 31% of ceded written premiums. The Reinsurance Agreement has an initial term of three years and will automatically renew for successive three year terms thereafter, unless either AII or Maiden Insurance notifies the other of its election not to renew not less than nine months prior to the end of any such three year term. In addition, either party is entitled to terminate on thirty day’s notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Insurance, run-off, or a reduction of 50% or more of the shareholders’ equity of Maiden Insurance or the combined shareholders’ equity of AII and the AmTrust Ceding Insurers. Effective June 1, 2008 the master agreement was amended such that AII agreed to cede and Maiden Insurance agreed to accept and reinsure Retail Commercial Package Business, which the Company, through Affiliates, commenced writing effective June 1, 2008, in connection with its acquisition of UBI. AII ceded 100% of the unearned premium related to in-force Retail Commercial Package Business and losses related thereto at the acquisition date and 40% the Company’s net written premium and losses on Retail Commercial Package Business written or renewed on or after the effective date. The $2 million maximum liability for a single loss provided in the Quota Share Reinsurance Agreement shall not be applicable to Retail Commercial Package Business. AmTrust receives a ceding commission of 34.375% for Retail Commercial Package Business. The Company recorded approximately $114 million and $59 million of ceding commission during 2008 and 2007, respectively, as a result of this transaction.
We utilize a combination of the Company’s incurred loss development factors and industry-wide incurred loss development factors. Our actuary generates a range within which it is reasonably likely that our ultimate loss and loss adjustment expenses will fall. The low end of the range is established by assigning a weight of 75% to our ultimate losses obtained by application of the Company’s own loss development factors and 25% to our ultimate losses developed through application of industry wide loss development factors. The high end is established by assigning a weight of 50% each to our ultimate losses as developed through application of Company and industry wide loss development factors. The determination to assign particular weights to ultimate losses developed through application of Company loss development factors and industry-wide loss development factors is made by our actuary and is a matter of actuarial judgment. In connection with the generation of the range, we have not made any shifts in the relative weights assigned to ultimate losses developed through application of Company and industry-wide loss development factors. However, in the selection of our reserves, the Company, based on the increasing amount of its own historical data to rely upon, has given greater consideration to the results attributable to its own loss development factors. Nevertheless, we continue to record our reserves at the higher end of the range, above the midpoint, which we believe to be prudent in light of the uncertainty inherent in estimating reserves.
Investments. The Company accounts for its investments in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), which requires that fixed-maturity and equity securities that have readily determined fair values be segregated into categories based upon the Company’s intention for those securities. In accordance with SFAS 115, the Company has classified certain of its fixed-maturity securities and certain of its fixed-maturities and equity securities as available-for-sale. The Company may sell its available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors.
Goodwill and Intangible Assets - The Company accounts for goodwill and intangible assets in accordance with SFAS 141, “Business Combinations.” A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset, and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statement of operations.
Ceding Commission. Ceding commission represents commission earned primarily through its quota share agreement with Maiden Insurance, whereby AmTrust receives between a 31% and 34% ceding commission on ceded written premiums to Maiden. The ceding commission earned in 2008 and 2007 was $115.6 million and $62.8 million, respectively. The increase related primarily to the Company reflecting an entire year of cessions in 2008 compared to six months of cessions in 2007.
million in the Company’s investment portfolio offset by growth in revenue combined with improvement in the both the loss ratio and the net expense ratio.
Interest Expense. Interest expense for the year ended December 31, 2008 was $16.4 million, compared to $10.1 million for the same period in 2007. The increase was attributable primarily to interest expense on collateral loans made by Maiden Insurance pursuant to the Reinsurance Agreement. Additionally, the Company incurred interest expense on its $40 million term loan and $30 million promissory note entered into during the second quarter of 2008.
Income Tax Expense (Benefit). Income tax expense for year ended December 31, 2007 was $36.7 million and resulted in an effective tax rate of 28.9%. Income tax expense for year ended December 31, 2006 was $17.8 million or an effective tax rate of 26.8%. The increase in the effective tax rate in 2007 resulted from non-recurring adjustments that decreased the 2006 effective rate. The Company believes the 2007 effective tax rate is more reflective of its future effective tax rate.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $13.5 million or 24.1% from $56.0 million to $69.5 million for the years ended December 31, 2007 and 2008, respectively. The loss ratio for the segment for the year ended December 31, 2008 increased to 62.0% from 61.9% for the year ended December 31, 2007. The Company’s actuarially projected ultimate losses remained consistent period over period.
Net Premiums Earned Less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income increased $5.0 million to $13.9 million for the year ended December 31, 2008 from $8.9 million for the year ended December 31, 2007. This increase is attributable to growth in revenue and improvement in the expense ratio.
Line of Credit The Company entered into an agreement for an unsecured line of credit on June 3, 2008 with JP Morgan Chase Bank, N.A. in the aggregate amount of $25 million. The line will be used for collateral for letters of credit. The agreement matures on June 30, 2009. Interest payments are required to be paid monthly on any unpaid principal and bears interest at LIBOR plus 150 basis points. As of December 31, 2008 there was no outstanding balance on the line of credit. The Company has an outstanding letter of credit in place at December 31, 2008 for $21.2 million that reduced the availability on the line of credit to $3.8 million as of December 31, 2008.