penalties, accounting in interim periods, disclosure and transition issues. At the date of adoption no adjustments were made to retained earnings. The total amount of unrecognized tax benefits as of the date of adoption that, if recognized, would affect the effective tax rate was $185 thousand.
The Company’s internal actuarial staff conducts annual reviews of projected loss development information by line of business to assist management in making estimates of reserves for ultimate losses and loss adjustment expenses payable. Several factors are considered in estimating ultimate liabilities including consistency in relative case reserve adequacy, consistency in claims settlement practices, recent legal developments, historical
medical procedures, social inflation, and other inflationary changes in costs beyond assumed levels. Inflation changes have much less impact on short-tail personal lines reserves and more impact on long-tail commercial lines. The Company does not have any significant long-tailed lines of business, so the actuarial assumptions and methodologies are consistent across all lines of business, regardless of the expected payout patterns. This is further evidenced by the fact that approximately 90% of ultimate losses for a given accident year are reported in the first year and by the end of the second year more than 99% are reported.
Noninsurance operating income increased $366 thousand to an operating profit of $328 thousand for 2006. Agency operations increased operating income by $2.8 million due to increases in Vision’s operations; loan operations decreased operating income by $2.8 million due to increases in loan losses; commercial leasing operations increased operating income by $263 thousand; and ABC increased operating income by $91 thousand.
The overall loss ratio includes 2.2% of catastrophe losses in 2007 and 2.3% in 2006. The Company had $13.9 million in gross catastrophe losses during 2007 due to severe weather occurring in the first quarter compared to $13.8 million in similar losses in the first and second quarters of 2006. The effect of claims from these events impacted underwriting results by $0.11 per share, after taxes, in both 2007 and 2006. The Company’s allocated share of catastrophe losses is described in Note 2 - Pooling Agreement in the Notes to Consolidated Financial Statements under the section Catastrophe Protection Program.
For 2007, pretax operating income increased $4.7 million and operating income, net of tax, increased $341 thousand when compared to 2006. The effective tax rate increased from 22.0% in 2006 to 24.9% in 2007. The tax rate for both 2007 and 2006 was impacted by increases in investments in affordable housing tax credits. The tax rate for 2006 was also impacted by a release of reserves for uncertain tax positions.
At December 31, 2007, the Company’s property casualty subsidiaries’ Adjusted Capital calculated in accordance with National Association of Insurance Commissioners (NAIC) Risk-Based Capital (RBC) guidelines was $508.9 million compared to the Authorized Control Level (Required) RBC of $33.5 million. These statutory measures serve as a benchmark for the regulation of an organization’s solvency by state insurance regulators.
For 2006, pretax operating income increased $3.3 million and operating income, net of tax, increased $4.8 million as a result of a decrease in the effective tax rate from 24.1% to 22.0%. The tax rate for 2005 was impacted by the Company’s tax allocation agreement and an increase in investment in affordable housing tax credits. The tax rate for 2006 was impacted by a change in the Company’s tax allocation agreement, the release of a reserve for uncertain tax positions and an increase in investment in affordable housing tax credits. The uncertain tax position release resulted from the closing of tax years 1999 through 2001, which were under audit by the Internal Revenue Service.
Total life insurance inforce as of December 31, 2006 increased $1.4 billion, with term insurance increasing $1.3 billion, or 11.7%, compared to 2005. Annualized premiums for inforce business increased 5.2%, or $6.6 million, with term insurance increasing 15.9% or $5.4 million. Policies inforce increased 1.4% for 2006 compared to 2005. The persistency ratio for life business was 90.7% at December 31, 2006, compared to 91.2% at December 31, 2005.
During the third quarter of 2007, the Company recorded a loss through its investment in MidCountry resulting from the fraudulent misappropriation of principal payments by one of MidCountry’s third-party loan servicers. In addition, the Company was negatively impacted by increased loan loss reserves and charge-offs related to a portfolio of residential construction loans at MidCountry during the third and fourth quarters of 2007.
Loan operations in Financial, including MidCountry, produced an operating loss of $2.0 million for 2007 compared to an operating profit of $308 thousand for 2006. During the first quarter of 2007, $815 thousand was received in loan loss recoveries related to the 2006 write-off in Financial’s portfolio. This was offset by a net loss in MidCountry equity earnings of $4.6 million for 2007. During the second quarter of 2006, loans totaling $5.5 million were written off in Financial’s portfolio as a result of fraudulent activity by one agent. These write-offs were offset by $2.0 million of insurance recoveries recorded in the third quarter of 2006. In addition, loan operations declined over the past twelve months with a 5.6% decrease in the loan portfolio due to more competitive interest rates and more conservative underwriting practices based on economic conditions. The loan portfolio yield increased to 8.11% from 7.88% with an average delinquency ratio of 3.12%.
As a result of the overall positive cash flows from operations, total invested assets grew 4.0% since December 31, 2006. The decrease in cash flow from operations in 2007 was primarily due to decreases in property casualty production offset by the effects of the termination of the quota share agreement between Virginia Mutual and Fire along with Alliance becoming a participant in the intercompany property casualty insurance pooling agreement. The premium collection from the COLI plan in the life insurance subsidiary provided positive cash flow in the first quarter of both periods. During 2007, the Company decreased its investment in fixed maturity securities by $129.0 million despite Alliance contributing an increase of $22.1 million. The Company also decreased its investment in equity securities by $8.4 million during 2007. Financial invested an additional $26.6 million in its equity-method investment in MidCountry during the second quarter along with a $3.0 million investment in MidCountry preferred stock in the third quarter. Short-term investments increased $245.3 million.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of the Company and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15 (a)(2) presents fairly, in all material respects, the information set forth therein at December 31, 2007 and 2006 and for the two years in the period ended December 31, 2007 when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
In the opinion of the management of Alfa Corporation and its subsidiaries (the Company), the accompanying consolidated financial statements contain all adjustments (consisting primarily of normal recurring accruals) necessary to present fairly its financial position, results of operations and cash flows. The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (GAAP).
Commissions and other costs of acquiring insurance that vary with and are primarily related to the production of new and renewal business have been deferred.
employees adversely affected by a 1998 amendment to the qualified plan. In addition, a post-employment life and medical insurance benefit plan was sponsored covering substantially all of its employees. At June 30, 2001, a curtailment occurred. The plans were frozen and all participants were vested.
Approximately 61.2%, 68.1% and 75.6% of the Company’s property casualty premium income and 53.6%, 59.9% and 66.5% of its total premium income were derived from the Company’s participation in the Pooling Agreement in 2007, 2006 and 2005, respectively.
Mutual owns 42.8%, Fire owns 11.4% and Alfa Mutual General Insurance Company (General) owns 0.8% of the Company’s common stock. The Board of Directors of the Company consists of eleven members, six of whom serve as Directors of Mutual, Fire and General and two of whom at December 31, 2007 were executive officers of the Company. One of the Company’s directors and most of the Company’s executive officers, including the Company’s President, also hold the same positions with Mutual, Fire, General and Specialty. The Company paid stockholder dividends to the Mutual Group totaling $20.4 million in 2007, $19.0 million in 2006 and $17.2 million in 2005.
The Company’s property casualty subsidiaries have agreed to guarantee payment on debt owed by three real estate partnerships affiliated with Fire. These guarantees expire between 2008 and 2035 and, in the unlikely circumstance of a guarantee call, could negatively impact the Company by up to $4.2 million (refer to Note 11 - Commitments and Contingencies).
The Company had net investment income from partnerships and joint ventures of $4.3 million, $2.8 million and $6.7 million in 2007, 2006 and 2005, respectively. At December 31, 2007 and 2006, partnerships yielding tax credits from investments in low-income housing of $66.3 million and $64.2 million are included in the Company’s other long-term investments. The Company realized losses from its investments in low-income housing partnerships of $7.9 million in 2007, $7.4 million in 2006 and $4.1 million in 2005. In addition, the Company’s investment in MidCountry was $79.6 million and $57.2 million at December 31, 2007 and 2006, respectively. Net investment loss from MidCountry, net of cost of capital, was $7.3 million in 2007 while net investment income from MidCountry, net of cost of capital, was $1.4 million and $1.2 million in 2006 and 2005, respectively.
Components of comprehensive income are depicted in the Consolidated Statements of Stockholders’ Equity. The reclassification adjustment for net realized investment losses, net of tax, was $717 thousand in 2007. Similarly, the reclassification for net realized investment gains, net of tax, was $2.2 million in 2006 and $3.9 million in 2005. Refer to Note 9 - Income Taxes for the income tax expense (benefit) allocated to each component of accumulated other comprehensive income.
On January 1, 2005, the Company issued 325,035 non-registered shares of common stock to Mr. John C. Russell, President and one of the owners of Vision. The shares were issued as part of the Company’s acquisition of Vision on January 1, 2005. The shares were issued pursuant to the exemption found in section 4(2) of the Securities Act of 1933 for non-public offerings.
The Company’s insurance subsidiaries follow the customary industry practice of reinsuring a portion of their exposures and paying to the reinsurers a portion of the premiums received. Insurance is ceded principally to reduce net liability on individual risks or for individual loss occurrences, including catastrophic losses. Although reinsurance does not legally discharge the individual subsidiary from primary liability for the full amount of limits applicable under their policies, it does make the assuming reinsurer liable to the extent of the reinsurance ceded. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurance to minimize exposure to significant losses from reinsurance insolvencies. Failure of reinsurers to honor their obligations could result in losses to the Company; therefore, allowances are established if amounts are believed to be uncollectible. At December 31, 2007 and 2006, there were no amounts deemed uncollectible. At December 31, 2007, the Company does not believe there to be a significant concentration of credit risk related to its reinsurance program.
The weighted average grant-date fair value of options granted for the year was $6.85 in 2007, $5.97 in 2006 and $6.09 in 2005.
Expected dividend yield is the expected dividend to be paid on the underlying share.
On July 17, 2007, the Company received an offer from Alfa Mutual Insurance Company, Alfa Mutual Fire Insurance Company and Alfa Mutual General Insurance Company (referred to collectively as the Mutual Group), which collectively own a majority of its common stock, for a transaction that would result in the privatization of the Company. The Mutual Group proposed to acquire all of the outstanding shares of the Company’s common stock that are not currently owned by them. The Company’s Board of Directors appointed a special committee of its four independent directors to review, evaluate and negotiate the proposal. The special committee retained the law firms of Skadden, Arps, Slate, Meagher & Flom, LLP and Maynard Cooper & Gale, P.C. to provide legal advice and the investment banking firm of Lazard Freres & Co., LLC to provide financial advice to it in evaluating the proposal.