Goodwill and Other Intangible Assets. Goodwill and other intangible assets represent the consideration we pay for the acquisition of access to distribution networks and renewal rights from certain third parties. In such a transaction, we purchase the right, but not the obligation, to offer insurance coverage to a defined group of the seller’s current policyholders when the current in-force policies expire (we do not acquire any in-force policies) as well as existing agency lists and certain operating platforms. We record intangible assets based on minimum future consideration that is paid or to be paid to the seller as provided in the acquisition agreement with the seller. In future periods if the minimum consideration is exceeded due to production incentive payments to the seller, the additional consideration will be recorded as goodwill. Additionally, when entering into a stock purchase agreement, we record distribution networks, trademarks, licenses and goodwill based on their fair value related to the acquired Company. Finite-lived intangible assets are amortized over their useful life. Intangible assets are evaluated periodically to ensure that there is no change required in the amortization period based on required accounting standards. Goodwill and indefinite-lived intangible assets are not amortized. The carrying amount is evaluated annually for impairment. If there is an impairment to goodwill or intangible assets, we will recognize a reduction in intangible assets with a corresponding charge to expense in the period in which the impairment occurs.
Commission and Fee Income. Commission and Fee income increased $8.0 million or 64.2% from $12.4 million for the year ended December 31, 2006 to $20.4 million for the year ended December 31, 2007. The increase resulted from brokerage and asset management fees earned from Maiden Insurance during the last six months of 2007, a contract awarded to the Company’s subsidiary TIC, effective January 1, 2007, to administer a portion of the Virginia Workers’ Compensation Assigned Risk Plan and fees for warranty administration from specialty risk and extended warranty customers for which a subsidiary of the Company acts as warranty administrator.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $66.9 million or 31.8% from $210.1 million to $277.0 million for the year ended December 31, 2006 and 2007, respectively. The Company’s loss ratio for the year ended December 31, 2007 decreased to 62.4% from 63.9% for the year ended December 31, 2006. The decrease in the loss ratio resulted from revised actuarially projected ultimate losses based on the Company’s experience. As the Company writes more business in the small workers’ compensation segment and its data becomes more reliable, the Company assigns more weight to its individual loss development factors than to industry-wide factors in setting its reserves. Because the Company’s losses (with the exception of losses attributable to the NCCI Pools) have developed more favorably than the industry, as a whole, the Company’s actuarially projected reserves have proportionally decreased.
Consolidated Results of Operations 2006 Compared to 2005 Gross Premium Written. Gross premiums written increased from $286.1 million for the year ended December 31, 2005 to $526.1 million for the year ended December 31, 2006. The increase of $240.0 million or 83.9% was attributable to our commencement in January 2006 of business in the specialty middle-market property and casualty segment, which generated gross premiums written of $134.3 million or 56.0% of the increase in premiums, as well as a $54.4 million increase in our small business workers’ compensation and a $51.3 million increase in gross premiums written in our specialty risk and extended warranty business. A majority of the increase to workers’ compensation gross premiums were due to increases in policy premiums and acquisitions. Additionally, specialty risk and extended warranty gross premiums increased primarily attributable to new business programs in the U.S.
Policy Acquisition Expense, Salaries and Benefits Expense and Other Insurance General and Administrative Expense. Policy acquisition expense, salaries and benefits expense and other insurance general and administrative expense increased from $63.5 million for the year ended December 31, 2005 to $92.4 million for the year ended December 31, 2006, an increase of $28.9 million or 45.5%. The expense ratio for the same periods decreased from 29.4% to 28.1%, respectively.
Policy Acquisition Expense, Salaries and Benefits Expense and Other Insurance General and Administrative Expense less Ceding Commission. Policy acquisition expense, salaries and benefits expense and other insurance general and administrative expense less ceding commission decreased $13.7 million or 20.0% from $68.8 million to $55.1 million for the year ended December 31, 2006 and 2007, respectively. The decrease in expense ratio resulted primarily from ceding commission of $32.6 million earned from the reinsurance agreement with Maiden Insurance during the second half of 2007. As a result, the expense ratio declined to 23.2% in 2007 from 31.1% in 2006.
primarily from ceding commission of $11.5 million earned through the reinsurance agreement with Maiden Insurance during the second half of 2007.
• any reduction or elimination of dividends, or nonpayment of scheduled interest payments: and
Liquidity and Capital Resources Our principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund our anticipated growth, by providing capital to increase the surplus of our insurance company subsidiaries as well as for payment of claims and operating expenses, payment of interest on our junior subordinated debentures and other holding company expenses until at least December 31, 2008. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth.
Note Payable - Collateral for Proportionate Share of Reinsurance Obligation In conjunction with the reinsurance agreement described above, AII entered into a loan agreement with Maiden Insurance during the fourth quarter of 2007, whereby, Maiden Insurance will lend to AII from time to time for the amount of obligation of the AmTrust Ceding Insurers that AII is obligated to secure, not to exceed an amount equal to the Maiden Insurance’s proportionate share of such obligations to such AmTrust Ceding Insurers in accordance with the reinsurance agreement. The Company is required to deposit all proceeds from the advances into a sub-account of each trust account that has been established for each AmTrust Ceding Insurer. To the extent of the loans, Maiden Insurance shall be discharged from otherwise providing security for its proportionate share of the obligations as contemplated by the reinsurance agreement. If an AmTrust Ceding Insurer withdraws loan proceeds from the trust account for the purpose of reimbursing such AmTrust Ceding Insurer, for an ultimate net loss, the outstanding principal balance of the loan shall be reduced by the amount of such withdrawal. The loan was amended in February 2008 such that the loan bears interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Each advance under the loan is secured by a promissory note. Advances totaled $113.2 million as of December 31, 2007.
Inflation Property and casualty insurance premiums are established before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings.