The net underwriting expense ratio is calculated by dividing net underwriting expenses (consisting of direct commission expenses and other underwriting expenses net of policy billing fees and ceding commission revenue) by net premiums earned. Historically, the ceding commission revenue we earn on our ceded premiums has been higher than our expenses incurred to produce those premiums; our extensive use of quota share reinsurance has caused our net underwriting expense ratio in certain periods to be lower than our gross underwriting expense ratio under GAAP.
Net premiums earned. Premiums written include all premiums received in an accounting period. Premiums are earned over the term of the related policy. The portion of the premium that relates to the policy term that has not yet expired is included in the balance sheet as unearned premium to be earned in subsequent accounting periods. Premiums can be assumed from or ceded to reinsurers. Direct premiums combined with assumed premiums are referred to as gross premiums and subtracting premiums ceded to reinsurers results in net premiums.
reliably estimated as a percentage of premiums, which is reflected in the B-F method. For each line of business, the actuarial reserving method usually given the most weight shifts from the loss ratio projection to the B-F method to the incurred loss projection as each accident year matures. These methods are described in “Business-Loss and Loss Adjustment Expense Reserves.”
Loss and loss adjustment expenses. For the year ended December 31, 2010 the net loss ratio increased 5.1 percentage points due to the impact of changing business mix, price competition and losses from the Northeast U.S. Storm occurring in March 2010 which increased the loss ratio by 1.2 points. These impacts were partially offset during the second half of the year by lower property losses.
We measure organic growth by including CPIC gross premiums written as if we owned CPIC in the comparable prior year period. We believe this is meaningful because CPIC wrote business that was managed by Tower and Tower wrote program business that was managed by CPIC. Organic growth, as defined, was 14% for the year ended December 31, 2009 and resulted from expansion of the commercial business outside of the Northeast, the growth of programs that began in late 2008 and the addition of several new specialty programs in 2009.
Commission and fee income. Commission and fee income decreased primarily due to our decision to not cede as much commercial premiums in 2009 as discussed above. Ceding commission revenue in 2009 represents commissions on ceded premiums earned from quota share reinsurance contracts written in 2008 and continuing to earn in 2009, as well as ceding commission earned on the commercial liability quota share agreement described above, effective October 1, 2009. TRM also ceased producing business on behalf of CPIC subsequent to the CastlePoint acquisition date. Commission and fee income during 2009 included $55.4 million in fee income earned from CPIC and $71.2 million earned on quota share ceded premiums from CastlePoint Reinsurance. In 2009, the effects of transactions between Tower and CastlePoint are eliminated in consolidation.
Underwriting expenses and underwriting expense ratio. Underwriting expenses include direct commissions and other underwriting expenses. The increase in underwriting expenses resulted from the increase in gross premiums earned, which was primarily due to the SUA, CastlePoint and Hermitage acquisitions. The gross underwriting expense ratio was 30.3% for the year ended December 31, 2010 as compared to 30.6% for 2009. The net expense ratio was 31.9% for the year ended December 31, 2010 as compared to 31.5% for 2009.
During 2009, premiums on renewed business decreased 1.4% in commercial lines and our renewal retention was 75%. In commercial lines we increased pricing on middle and large accounts that had the effect of lowering the renewal retention for those size categories, although these underwriting actions were largely offset by strong renewal retentions for small commercial policies.
Ceding commission revenue. Ceding commission revenue decreased in 2009 by 42.0% compared to 2008. The decrease was due to the lower cession of quota share premiums described above and a reduction in the ceding commission rate. Ceding commission revenue also decreased by $1.8 million during 2009 as a result of increases in ceded loss ratios on prior years’ quota share treaties, compared to a decrease of $1.4 million for 2008.
Loss and loss adjustment expenses and loss ratio The loss ratio increased on both a gross and net basis for 2009 compared to 2008. We had unfavorable development of approximately $2.5 million stemming from the runoff of business in CastlePoint Re. On an accident year basis the gross and net loss ratios increased due to the inclusion of reinsurance business and other programs underwritten by CastlePoint and SUA that impacted the business mix in 2009. In addition, the net accident year loss ratio was favorably impacted by 0.6 percentage points due to the amortization of the reserve risk premium on loss reserves in accordance with GAAP for the business combinations occurring during 2009.
The following table shows the number of securities, fair value, unrealized loss amount and percentage below amortized cost and the ratio of fair value by security rating as of December 31, 2010:
The following table summarizes information about contractual obligations and commercial commitments. The minimum payments under these agreements as of December 31, 2010 were as follows:
In May 2010, the Company entered into a $125.0 million credit facility agreement. The credit facility is a revolving credit facility with a letter of credit sublimit of $25.0 million. The credit facility will be used for general corporate purposes. The Company may request that the facility be increased by an amount not to exceed $50.0 million, and the facility expires May 2013. The Company has no outstanding balances under the credit facility as of December 31, 2010.
The liability for loss and LAE represents management’s best estimate of the ultimate cost and expense of all reported and unreported losses that are unpaid as of the balance sheet date and the fair value adjustments related to the acquisitions of CastlePoint, Hermitage, SUA and OBPL. The liability for loss and LAE is recorded net of a tabular reserve discount for workers’ compensation and excess workers’ compensation claims in the amount of $3.7 million and $4.5 million at December 31, 2010 and 2009, respectively. The 2010 discount relates to $300 million total reserves for workers’ compensation. The gross undiscounted amount of these reserves was $166.8 million at December 31, 2009. The projection of future claims payments and reporting is based on an analysis of the Company’s historical experience, supplemented by analyses of industry loss data. Management believes that the liability for loss and LAE is adequate to cover the ultimate cost of losses and claims to date; however, because of the uncertainty from various sources, including changes in reporting patterns, claims settlement patterns, judicial decisions, legislation, and economic conditions, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liability at the balance sheet date. As adjustments to these estimates become necessary, such adjustments are reflected in expense for the period in which the estimates are changed. Because of the nature of the business historically written, the Company’s management believes that the Company has limited exposure to environmental claim liabilities.
Fair value for fixed-maturity securities and equity securities is primarily based on quoted market prices or a matrix pricing using observable inputs, with limited exceptions as discussed in “Note 6 - Fair Value Measurements”. Changes in unrealized gains and losses, net of tax effects, are reported as a separate component of other comprehensive income while cumulative unrealized gains and losses are reported net of tax effects within accumulated other comprehensive income in stockholders’ equity. Realized gains and losses are determined on the specific identification method. Investment income is recorded when earned and includes the amortization of premium and discount on investments.
Our largest agent accounted for 12%, 4% and 7%, respectively, of the Insurance Subsidiaries and TRM’s premiums receivable balances at December 31, 2010, 2009 and 2008. Our largest agent accounted for 4%, 10% and 10% of the Insurance Subsidiaries’ direct premiums written and TRM’s premiums produced in 2010, 2009 and 2008, respectively.
The Company’s Insurance Subsidiaries are required to prepare statutory basis financial statements in accordance with practices prescribed or permitted by the state or country in which they are domiciled. See “Note 18 - Statutory Financial Information and Accounting Policies” for more details.
Aggregate scheduled maturities of the Company’s borrowings at December 31, 2010 are:
On November 13, 2009, the date of acquisition, SUA non-vested restricted stock awards were converted into 92,276 shares of the Company’s common stock. These awards had a weighted grant date fair value of $23.74. No additional grants have been made under this plan since the date of acquisition. For the period from acquisition to December 31, 2009, 46,088 of these vested. For the year ended December 31, 2010, 41,820 of these vested resulting in 4,368 outstanding at December 31, 2010.
Compensation expense (net of tax) related to stock options was $0.3 million and $1.0 million for the year ended December 31, 2010 and 2009, respectively. The intrinsic value of stock options outstanding as of December 31, 2010 was $5.4 million, of which $5.0 million was related to vested options.
The provision for Federal income taxes incurred is different from that which would be obtained by applying the Federal income tax rate to net income before taxes. The items causing this difference are as follows: