Per share amounts have been restated where appropriate to reflect 2-for-1 stock split in June 2002.
Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of Alfa Corporation and its subsidiaries (the Company) as of December 31, 2006, compared with December 31, 2005 and the results of operations for each of the three years ended December 31, 2006. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements that are included in Item 8 of this Form 10-K.
In accordance with the provisions of SFAS No. 60 and the AICPA Audit and Accounting Guide, credit insurance reserves are held as unearned premium reserves calculated using the “rule of 78” method. Reserves for supplementary contracts with life contingencies are determined using the 1971 Individual Annuity Mortality Table and an interest rate of 7.5%. Likewise, reserves for accidental death benefits are determined predominantly by using the 1959 Accidental Death Benefit Mortality Table and an interest rate of 3%. Reserves for disability benefits, both active and disabled lives, are calculated primarily from the 1952 Disability Study and a rate of 2.5%. A small portion of the Company’s disabled life reserves are calculated based on the 1970 Intercompany Group Disability Study and a rate of 3%.
For 2006, the expense ratio has been impacted 3.4% by AVIC’s expense structure, 1.2% by Virginia Mutual, 0.3% with the adoption of SFAS No. 123(R) and 0.7% due to technology costs. For 2005, the expense ratio was impacted 1.5% by AVIC, 1.4% by Virginia Mutual and 0.5% due to technology costs.
Net investment income decreased 1.9% for 2006, as a result of lower partnership income and a decline in interest income on fixed maturities offset by increases in dividend income and short-term investment income.
Index to Financial Statements ABC had an operating loss of $840 thousand in 2006 compared to an operating loss of $931 thousand in 2005. The operating loss in 2006 is a result of increased benefit expenses offset by an increase in net investment income.
As a result of the overall positive cash flows from operations, invested assets grew 6.2% since December 31, 2005 while net investment income decreased 1.8%. The increase in cash flow from operations in 2006 was due primarily to the increase in net written premiums partially offset by increases in losses paid. Property casualty underwriting income of $55.9 million in 2006, $55.9 million in 2005 and $50.2 million in 2004 positively impacted cash flow from operations. In addition, the COLI plan in the life insurance subsidiary provided $15 million in additional cash flow in 2006, $15 million in 2005 and $15 million in 2004. Cash remained relatively unchanged as increased cash flows from operations were used for investing and financing activities. During 2006, the Company also increased its investment in fixed maturity securities by $41.3 million. The Company’s decrease in net investment income resulted primarily from the write-off of loans in Financial’s portfolio, increased borrowing costs and lower partnership earnings. These items were partially offset by increased earnings on fixed maturities, equity securities and short-term investments.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
To meet this objective, management entered into an interest rate swap to manage fluctuations in cash flows resulting from interest rate risk. The interest rate swap changes the variable-rate cash flow exposure of the variable-rate long term debt obligation to fixed-rate cash flows by entering into a receive-variable, pay-fixed interest rate swap. Under the interest rate swap, the Company receives variable interest payments and makes fixed interest rate payments, thereby creating long-term debt with a fixed rate of 4.945%. During 2006, interest received ranged from 4.469% to 5.372%.
“Agent Relationships” intangible asset represents on-going contractual relationships between existing agents at acquisition date and the managing general agent.
The following table shows other intangible assets that continue to be subject to amortization and aggregate amortization expense as of December 31, 2006:
Index to Financial Statements The cost of other intangible assets is being amortized over a range of 5 to 20 years, with a weighted average original life of 17.5 years. Amortization expenses for 2006 and 2005 were $683 thousand in each year. Amortization expense for intangible assets is estimated to be $683 thousand in 2007, $683 thousand in 2008, $683 thousand in 2009 and $379 thousand in 2010 and thereafter.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of SFAS No. 123 to all awards of share-based employee compensation in 2005 and 2004.
The Company’s finance subsidiary leases certain equipment to Marshall Creek, Ltd., a joint real estate venture with Mutual (refer to Note 3 - Related Party Transactions). These equipment leases have various expiration dates through 2009.