First Mercury Financial Corporation (“FMFC”) is a holding company for our operating subsidiaries. Our operations are conducted with the goal of producing overall profits by strategically balancing underwriting profits from our insurance subsidiaries with the commissions and fee income generated by our non-insurance subsidiaries. FMFC’s principal operating subsidiaries are CoverX Corporation (“CoverX”), First Mercury Insurance Company (“FMIC”), First Mercury Casualty Company (“FMCC), First Mercury Emerald Insurance Services, Inc. (“FM Emerald), and American Management Corporation (“AMC”).
In preparing our consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the consolidated financial statements, and revenues and expenses reported for the periods then ended. Actual results may differ from those estimates. Material estimates that are susceptible to significant change in the near term relate primarily to the determination of the reserves for losses and loss adjustment expenses and valuation of investments, intangible assets and goodwill.
investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss, based upon a change in market and other factors described above. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the Company’s portfolio as available-for-sale.
Ceded written premiums increased $18.6 million, or 18%, and ceded earned premiums increased $6.3 million, or 6%, for the year ended December 31, 2009 compared to the year ended December 31, 2008. Ceded written premiums increased to 34.8% of direct and assumed written premiums during the year ended December 31, 2009 compared to 31.5% of direct and assumed written premiums during the year ended December 31, 2008 principally due to purchasing more quota share reinsurance during the year ended December 31, 2009 for the Company’s primary casualty business compared to the same period of 2008. The increase in quota share cessions was partially offset by an assumed reinsurance transaction that was fully retained by the Company and by lower cessions under our excess of loss treaties during the year ended December 31, 2009 and the elimination of a 50% quota share on a contract underwriting class of business during the fourth quarter of 2008, which impacted the year ended December 31, 2009.
During 2009 the Company experienced approximately $5.7 million of favorable development of December 31, 2008 prior years’ loss and loss adjustment expense reserves. Favorable development of $2.4 million in our Security general liability classes in 2001, 2006 and 2007 accident years and $3.6 million in our Specialty general liability classes in the 2006 through 2007 accident years was due to lower than expected claim frequency and lower than expected severity. There was $0.5 million of unfavorable development in our Specialty general liability classes in the 2000 accident year. Net favorable development of $0.2 million in unallocated loss adjustment expenses was recorded for the 2006 through 2007 accident years.
Following is a description of the more significant risks facing property/casualty insurers and how the Company mitigates those risks:
FASB guidance establishes a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”). The estimated fair values of the Company’s fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. The prices provided by this service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices, except as otherwise disclosed. The Company obtains an understanding of the methods, models and inputs used by the independent pricing service, and has controls in place to validate that amounts provided represent fair values, consistent with this standard. The Company’s controls include, but are not limited to, initial and ongoing evaluation of the methodologies used by the independent pricing service, a review of specific securities and an assessment for proper classification within the fair value hierarchy. The hierarchy level assigned to each security in our available-for-sale, hybrid securities, and alternative investments portfolios is based on our assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:
The following is a reconciliation of basic number of common shares outstanding to diluted common and common equivalent shares outstanding.
For purposes of the cash flow statement, cash flows from derivative instruments are classified with the cash flows from the hedged item.
In January 2010, the FASB issued an update to the Accounting Standards Codification (ASC) related to fair value measurements and disclosures. This ASC update provides for additional disclosure requirements to improve the transparency and comparability of fair value information in financial reporting. Specfically, the new guidance requires separate disclosure of the amounts of significant transfers in and out of Levels 1 and 2, as well as the reasons for the transfers, and separate disclosure for the purchases, sales, issuances and settlement activity in Level 3. In addition, this ASC update requires fair value measurement disclosure for each class of assets and liabilities, and disclosures about the input and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements in Levels 2 and 3. The new disclosures and clarifications of existing disclosures are effective for annual or interim reporting periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity detail which will become effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Early adoption is permitted. These amendments do not require disclosures for earlier periods presented for comparative purposes at intital adoption. The Company is currently evaluating the potential impact of the adoption of this standard on its financial statements.
FASB guidance related to accounting for uncertainty in income taxes requires an entity to recognize the benefit of tax positions only when it is more-likely-than-not, based on the position’s technical merits, that the position would be sustained upon examination by the respective taxing authorities. The tax benefit is measured as the largest benefit that is more than fifty-percent likely of being realized upon final settlement with the respective taxing authorities. The application of this guidance does not have an impact on our financial position or results of operations and we have taken no tax positions which would require accrual or disclosure under this guidance. Although the IRS is not currently examining any of our income tax returns, tax years 2006, 2007 and 2008 remain open and are subject to examination.
The Company’s prior share repurchase program, announced in August 2008, originally authorized the repurchase of up to 1.5 million shares of the Company’s outstanding common stock. During the year ended December 31, 2009, the Company repurchased the remaining 801,423 shares of common stock for $10.5 million at an average cost of $13.09 per share. These purchases fulfilled the remaining capacity of the Company’s 1.5 million share repurchase plan.
The aggregate intrinsic value of fully vested options outstanding and exercisable under the 1998 Plan was $4.6 million at December 31, 2009. There was $0.2 million of aggregate intrinsic value of options expected to vest under the Omnibus Plan at December 31, 2009.
As of December 31, 2009, there was approximately $3.5 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Omnibus Plan and related to non-vested restricted stock. That cost is expected to be recognized over a weighted-average period of 1.9 years.