inflation trends, the expected consistency in the frequency and severity of claims incurred but not yet reported, changes in the timing of claims submission patterns from providers, changes in our speed of processing claims, and expected costs to settle unpaid claims.
Goodwill and Other Intangible Assets. Goodwill represents the excess of purchase price over the fair value of tangible and identifiable intangible net assets acquired. At December 31, 2004, goodwill was $10.7 million and represented approximately 1.4% of our total assets. Additionally, other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination
a higher level of severity in the December 31, 2001 claim inventory adversely impacted 2002 loss ratios.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
The accompanying audited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which differ from accounting practices prescribed or permitted by the various state departments of insurance in which the insurance subsidiaries are domiciled. See Note Q. Statutory Financial Information for further information.
The FASB staff also issued Emerging Issues Task Force, or EITF D-100: Clarification of Paragraph 61(b) of FASB Statement No. 141 and Paragraph 49(b) of FASB No. 142, which further clarified what the FASB staff believed was the Board’s intent for reclassifying an intangible asset out of goodwill of a previously acquired intangible asset.
Claim liabilities with a long pay out period, such as disability income and long-term care claims, are discounted at interest rates of 4.5% and 6.125%-6.5%, respectively. Although considerable variability is inherent in such computations, management believes that the liabilities for unpaid life and accident and health claims are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known with such adjustments included in current operations.
disclose the pro forma effect of stock-based compensation on net income (loss) and earnings (loss) per share. Upon adoption, pro forma disclosure will no longer be an alternative. The new statement may be adopted in one of three ways - the modified prospective transition method, a variation of the modified prospective transition method, or the modified retrospective method. We are currently evaluating the method of adoption and the effect that the adoption of SFAS 123R will have on our consolidated results of operations, cash flows and financial position.
If management believes a decline in the value of a particular investment is temporary, the decline is reported as an unrealized capital loss, net of deferred federal income taxes, in Stockholders’ Equity. If the decline is expected to be other-than-temporary, the carrying value of the investment is written down and a realized capital loss is reported in our Consolidated Statements of Operations. In June 2003, we wrote down our holdings in American Airlines and Coastal Corp. to their then fair market value, recording a total realized pre-tax loss of $0.3 million. None of the fixed investments above are delinquent or in default and there are no conditions present that indicate a high probability that all amounts will not be collected. Based on evaluation by both internal management along with external investment managers, including our ability to sell or hold the investments and the length of time and magnitude of the unrealized loss, management has determined that at December 31, 2004, none of the above fixed maturity investment values represent an other-than-temporary impairment.
Prior to 1984, the Life Insurance Company Income Tax Act of 1959, as amended by the Deficit Reduction Act of 1984 (DRA), permitted the deferral from taxation of a portion of statutory income under certain circumstances. In these situations, the deferred income was accumulated in the Policyholders’ Surplus Account (PSA). On January 1, 1984 the balance of the PSA account was fixed and only subject to taxation in the event amounts in the PSA account were distributed to shareholders, or if the balance of the account exceeded certain limitations prescribed by the IRS. On October 22, 2004, President Bush signed into law the America Jobs Creation Act of 2004. Included among the various provision of the Act was a two-year suspension of the taxation on distributions of amounts from a company’s PSA and reordering rules for current distributions providing that distributions are deemed to reduce the existing PSA balance before reducing amounts available to shareholders. At December 31, 2004, our accumulated untaxed PSA balance was $2.9 million.
In December 1997, Central Reserve entered into a retroactive reinsurance treaty (the 1997 Treaty) with Hannover. The quota share treaty was effective January 1, 1997, and covered certain group accident and health policies in force and written during 1997. Under the provisions of the 1997 Treaty, Central Reserve ceded 50% of the premiums of the eligible policies, and in return received reimbursement for 50% of the claims paid, plus a commission and expense allowance. In connection with the 1997 Treaty, Central Reserve transferred $24.5 million of reserves to Hannover, and received an initial ceding allowance of $10.0 million, resulting in a net cash transfer of $14.5 million to Hannover. The initial ceding allowance was reported as a deferred reinsurance gain, and is being amortized into income over the duration of the underlying block of business.
In December 2001, Continental General entered into a reinsurance transaction with London Life International Reinsurance Corporation, or London, for a 75% quota share of certain health policies issued after February 1, 1999. Under the provisions of the treaty, effective January 1, 2001, Continental General ceded 75% of the premiums of the eligible policies, and in return received reimbursement for 75% of the claims paid, plus a commission and expense allowance. If the combined loss ratio (defined as benefits plus expense allowances divided by premium) was less than 100%, an experience refund was paid from London to Continental General. The expense and profit charge was 200 basis points and 85 basis points of reinsurance premium for 2002 and 2001, respectively. Beginning January 1, 2002, London retroceded any losses on these policies in excess of a combined ratio of 110% to Central Reserve. In exchange for coverage on this business, Central Reserve received 100 basis points of reinsurance premium in 2002 from London. On June 2, 2002, these reinsurance agreements were terminated. The Company determined that this contract did not transfer risk in accordance with generally accepted accounting principles, and reflected this agreement as a deposit in 2002 and 2001.
Our insurance companies remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations. Initial ceding allowances received from reinsurers are accounted for as deferred reinsurance gain and are amortized into income over the estimated remaining life of the underlying policies reinsured, except for interest sensitive products that are amortized over the expected profit stream of the in force business. The above table does not include the amortization of initial ceding allowances received from reinsurers. Amortization of deferred reinsurance gain for the years ended December 31, 2004, 2003 and 2002 was $1.5 million, $1.7 million, and $2.8 million, respectively.
Substantially all of our reinsurance recoverable is due from a single reinsurer, Hannover. At December 31, 2004, Hannover has an “A” rating from the A.M. Best Company. We perform periodic evaluations of this reinsurer’s credit standing.