The industry combined ratios are from A.M. Best. The 2006 industry combined ratio is preliminary.
Our Pooled Companies and SA National are rated A+ (Superior) by the A.M. Best Company.
The reader is referred to the complete disclosure on reportable segments in Note 15, Reportable Segments, of the Notes to our Consolidated Financial Statements included in Item 8 of this Form 10-K.
We monitor the performance of our insurance segments by concentrating on segment underwriting profit and combined ratio. Underwriting profit under Statutory Accounting Principles (“SAP”) is determined by subtracting from earned premiums, losses and loss expenses and net underwriting expenses incurred. SAP requires all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. U.S. Generally Accepted Accounting Principles (“GAAP”), however, require the recognition of acquisition costs as the premiums are earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized over the periods the related written premiums are earned. For a discussion of deferred policy acquisition costs see “Critical Accounting Policies-Deferred Acquisition Costs” included herein. The “GAAP Combined Ratio” is defined as the sum of the “GAAP loss and LAE ratio” (loss and loss expenses, as a percentage of earned premiums) plus “GAAP expense ratio” (acquisition and operating expenses, as a percentage of earned premiums). When the combined ratio is less than 100%, the insurer is operating at an underwriting profit. When the combined ratio is greater than 100%, the insurer is operating at an underwriting loss.
Standard segment net written premiums for 2006 decreased $19.6 million (2.0%) compared to 2005. The decrease in net written premiums in the standard segment was attributable primarily to personal and commercial auto which had a combined decrease in net written premiums of $21.5 million or 4.5%.
Within the fire and allied lines, the 5.9 point increase in GAAP loss and LAE ratio from the same period in 2004 is due to our reinsurance assessment of $7.9 million related to hurricane Katrina, previously discussed, which increased this line’s loss and LAE ratio by 9.4 points. The significant improvement in other and products liability resulted from a decline in the number of large losses (in terms of both frequency and severity), including umbrella losses, as compared to 2004. While still a profitable line of business, nonetheless, the increase within the miscellaneous personal and commercial lines’ GAAP loss and LAE ratio in 2005 from 2004 is attributable to two large surety bond losses that accounted for 4.3 points of the 2005 loss ratio for those lines.
Our total investments, at fair value, grew approximately 3.1% during 2006 to $1,937.9 million at December 31, 2006, from $1,879.9 million at December 31, 2005. This growth was generated primarily from net cash flows provided by operations, along with an increase of $19.1 million in the cumulative net unrealized gains on investments. The net unrealized gain on our equity portfolio increased $22.6 million to $53.4 million at December 31, 2006, while our net unrealized gains on our fixed maturity portfolio declined $3.2 million to $16.8 million at December 31, 2006. Cumulative unrealized gains related to other invested assets decreased $0.3 million to $0.5 million at December 31, 2006.
The following table provides the incremental effects of adopting the provisions of SFAS 158 on our balance sheet at December 31, 2006. The adoption of SFAS 158 had no effect on our consolidated statement of income for the year ended December 31, 2006, or for any prior period presented, and it will not affect our operating results in the future.
We use a number of different methodologies to estimate the IBNR component of the Loss and ALAE Reserves. Our reserves include amounts related to short tail and long tail lines of business. “Tail” refers to the time period between the occurrence of a loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. The reserving methods and strengths and weaknesses of each are described below.
Reserve ranges provide a quantification of the variability in the reserve projections, which is often referred to as the standard deviation or error term, while the point estimates establish a mean, or expected value for the ultimate reserve. The primary determinant in estimating the reserve range boundaries are the variances measured within the historical reserving data for lines of business. Property lines typically have smaller variances, while liability lines can experience significant variability. MBE of loss reserves considers the actuarial point estimate and expected variation to establish an appropriate position within a range. MBE for SA National and the STFC Pooled Companies’ share of the Pooled Companies’ Loss and ALAE Reserves at December 31, 2006 is $709.5 million, compared with an actuarial point estimate of $688.3 million that is within a projected range of $652.4 million to $726.1 million. (These values presented are on a direct basis, gross of salvage and subrogation
Hurricane Wilma, which occurred in the fourth quarter of 2005, also accounted for outstanding reserves at the end of 2005 in the same property lines as reserves relating to Hurricane Katrina.
All investments in fixed maturity and equity securities are classified as available-for-sale and, therefore, are carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are shown as a separate component of stockholders’ equity as a part of “accumulated other comprehensive (loss) income” and, as such, are not included in the determination of net income. Realized gains and losses on the sales of investments are computed using the first-in, first-out method.
Stateco provides State Auto Mutual and it’s affiliates investment management services. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of each company managed. Revenue related to these services amounted to $2.5 million, $2.3 million and $2.5 million in 2006, 2005 and 2004, respectively, and is included in other income (affiliates).
The Company also has a supplemental executive retirement plan (“SERP”) for certain executives for which the accrued obligation at December 31, 2006 and 2005 was $4.3 million that is included in the balance sheet postretirement benefit liabilities amount.