The Company leases office space at One Bala Plaza, Bala Cynwyd, PA which serves as its headquarters location, and also leases 38 offices for its field marketing organization.
The Company believes its product distribution marketing platform and its creation of value added features not typically found in property and casualty products contribute to generating premium growth above industry averages. Written premium information for the Company’s business segments for the years ended December 31, 2006 and 2005 is as follows:
The table below classifies as of December 31, 2006 the components of the reserve for gross losses and loss adjustment expenses (“loss” or “losses”) with respect to major lines of business:
Changes may occur in the actuarial assumption that ultimate losses are determinable by extrapolation of claim emergence and settlement patterns observed in the past (via loss development factor selection) that can reasonably be expected to persist into the future. Changes may also occur in the actuarial assumption that ultimate loss ratios in the current and most recent accident years can be projected from ultimate loss ratios of prior years. A 5% increase to the actuarially selected loss development factors and a 5% increase to the expected loss ratios, in the aggregate, as applicable to all lines of business in accident years 2004 to 2006, would increase the actuarially determined loss reserve estimate by approximately $100.5 million. The results of aggregate changes in the loss development factors and expected loss ratios are approximately linear over reasonable ranges. A 1% increase in the loss development factors and expected loss ratios, in the aggregate, would have impact equal to approximately 20% of the impact stated above.
Since share-based compensation expense recognized in the Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant, and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. In the Company’s pro-forma information required under SFAS 123 for the periods prior to January 1, 2006, forfeitures were estimated based upon historical experience. If factors change and different assumptions are employed in the application of SFAS 123(R) in future periods, the actual compensation expense under SFAS 123(R) may differ significantly from what was recorded in the current period.
As of December 31, 2006, there was $28.9 million of total unrecognized compensation costs related to stock options, SARS and restricted stock granted under the Company’s stock compensation plan. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.2 years.
A decision by the Company to terminate its net liability cession under its quota share reinsurance agreement whereby the Company had ceded 10% of its commercial and specialty lines net written and earned premiums and loss and loss adjustment expenses for policies commencing during 2004. Pursuant to the agreement, during the year ended December 31, 2005, the Company ceded $43.7 million ($36.5 million for the commercial lines segment, $7.1 million for the specialty lines segment, and $0.1 million for the personal lines segment) of net earned premiums, which represented the unearned premium reserves as of December 31, 2004 on policies commencing during 2004. No earned premiums were ceded pursuant to this agreement during 2006 due to the Company’s decision to terminate the agreement on a run-off basis effective December 31, 2004.
Net Realized Investment Gain (Loss): Net realized investment gains (losses) were $(9.9) million and $9.6 million for the years ended December 31, 2006 and 2005, respectively. For the year ended December 31, 2006, the Company realized net investment gains (losses) of $(1.5) million and $0.4 million from the sale of fixed maturity and equity securities, respectively, and $4.6 million and $4.2 million in realized investment losses for fixed maturity and equity securities, respectively, as a result of the Company’s impairment evaluation. The $4.6 million in realized investment losses for fixed maturities resulting from the Company’s impairment evaluation included approximately $4.2 million of realized investment losses on available for sale fixed maturity investments that were recognized as of September 30, 2006 and subsequently sold during the fourth quarter of 2006 as a result of tax planning and investment portfolio management strategies.
Establishing loss reserve estimates is a necessarily complex and imprecise process. The Company’s methodology is to employ several generally accepted actuarial methods to determine net unpaid loss and loss adjustment expenses. Over time, more reliance is placed on actuarial methods based on actual loss development, and accordingly, over time, less reliance is placed on actuarial methods based on expected loss development. The principal factor contributing to the decreases in the estimated net unpaid loss and loss adjustment expenses for prior accident years is the reconsideration of an assumption underlying previous estimates that loss ratio deterioration would result from the high growth rates experienced by the Company in the most recent accident years. As actual losses experienced on these accident years have continued to be lower than anticipated, it has become more likely that the ultimate loss ratio will prove to be better than originally estimated. Over time, greater credibility has been given to this favorable trend by applying greater weight to actuarial methods based on actual loss development. The result is a reduction to these years’ net unpaid loss and loss adjustment expenses, which, in turn, leads to lower ultimate loss ratio expectations for the more recent accident years. As significant weight is given to actuarial methods based on expected losses for the more recent accident years, the result of lower expectations is a reduction to these years’ net unpaid loss and loss adjustment expenses.
Under certain reinsurance agreements, the Company is required to maintain investments in trust accounts to secure its reinsurance obligations (primarily the payment of losses and loss adjustment expenses on business it does not write directly). At December 31, 2006, the investment and cash balances in such trust accounts totaled approximately $2.0 million. In addition, various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. As of December 31, 2006, the balance on deposit for the benefit of such policyholders totaled approximately $15.1 million.
To the Board of Directors and Shareholders Of Philadelphia Consolidated Holding Corp.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Philadelphia Consolidated Holding Corp. and Subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 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 accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements 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 of financial statements 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 audits provide a reasonable basis for our opinion.
Effective January 1, 2006 and January 1, 2005, the Company entered into Reinsurance Commutation and Release Agreements with respect to the 2004 Whole Account Net Quota Share Reinsurance Contract and the 2003 Whole Account Net Quota Share
The Company uses the Black-Scholes pricing model to calculate the fair value of the SARS awarded as of the date of grant.
The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance receivables (excluding amounts ceded to voluntary and mandatory pool mechanisms) that are with reinsurers rated “A” (Excellent) or better by A.M. Best Company or are fully collateralized was 92.4% and 89.7% as of December 31, 2006 and 2005, respectively.
The Company has a defined contribution Profit Sharing Plan, which includes a 401K feature, covering substantially all employees. Under the plan, employees may contribute up to an annual maximum of the lesser of 15% of eligible compensation or the applicable Internal Revenue Code limit in a calendar year. The Company makes a matching contribution in an amount equal to 75% of the participant’s pre-tax contribution, subject to a maximum of 6% of the participant’s eligible compensation. The Company may also make annual discretionary profit sharing contributions at each plan year end. Participants are fully vested in the Company’s contribution upon completion of four years of service. The Company’s total contributions to the plan were $1.8 million, $1.3 million and $1.2 million for the years ended December 31, 2006, 2005, and 2004, respectively.