For several years, the Company’s investment philosophy has emphasized the purchase of short-term bonds with maximum quality and liquidity. As interest rates and yield curves have not provided a strong incentive to lengthen maturities in recent years, the Company has continued to maintain its fixed maturity portfolio at very conservative levels. The average contractual life of the Company’s bond and short-term investment portfolio increased from 3.0 to 3.7 years during 2007 as it was determined that after-tax investment yields could be enhanced by moving portions of the short-term portfolio into high grade municipal bonds with short to moderate maturities. The average duration of the Company’s fixed maturity portfolio is shorter than the contractual maturity average and much shorter than the duration of the Company’s liabilities. The Company also remains an active participant in the equity securities market using capital which is in excess of amounts considered necessary to fund current operations. The long-term horizon for the Company’s equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by the Company’s domestic insurance subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners which are designed to provide protection for both policyholders and shareholders.
It is important to note that all investments included in the Company’s financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments does not change these valuations but, rather, determines when the decline in value will be recognized in the income statement (other-than-temporary decline) as opposed to a charge to shareholders’ equity (temporary decline). Subsequent recoveries in value of investments which have incurred other-than-temporary impairment adjustments are accounted for as unrealized gains until the security is actually disposed of or sold. At December 31, 2007, unrealized gains include $4.8 million of appreciation on investments previously adjusted for other-than-temporary impairment, compared to $2.7 million of impairment write-downs at that date. See Note B to the consolidated financial statements for additional detail with respect to this process. This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors which relate to an industry, in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process which results in income statement recognition of any investment which, over a six month period, is unable to recover from a 20% decline in value from our cost basis. However, to the extent that certain declines in value are reported as unrealized at December 31, 2007, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2007, the total gross unrealized loss included in the Company’s investment portfolio was less than $2.0 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2006, investment gains would have decreased by $.09 per share for the year, after tax. There would, however, have been no impact on total shareholders equity or book value per share since the decline in value of these securities was already recognized as a reduction to shareholders equity at December 31, 2007.
• The selection of loss development factors in the establishment of bulk reserves for incurred but reported losses and loss expenses
Recognition of Revenue and Costs: Premiums are earned over the period for which insurance protection is provided. A reserve for unearned premiums, computed by the daily pro-rata method, is established to reflect amounts applicable to subsequent accounting periods. Commissions to unaffiliated companies and premium taxes applicable to unearned premiums are deferred and expensed as the related premiums are earned. The Company does not defer acquisition costs which are not directly variable with the production of premium and are not refundable in the event of policy cancellation. If it is determined that expected losses and deferred expenses will likely exceed the related unearned premiums, the asset representing deferred policy acquisition costs is reduced and an expense is charged against current operations to reflect any such premium deficiency. In the event that the expected premium deficiency exceeds deferred policy acquisition costs, an additional liability would be recorded with a corresponding expense to current operations for the amount of the excess premium deficiency. Anticipated investment income is considered in determining recoverability of deferred
The Company has invested a total of $24,000 in three limited partnerships, with an aggregate market value of $58,380 at December 31, 2007, that are managed by organizations in which two directors of the Company are executive officers, directors and owners. The Company’s ownership interest in these limited partnerships ranges from 4% to 25%. These limited partnerships added $19,177, $7,942 and $7,145, net of fees, to investment gains in 2007, 2006 and 2005
Loss reserves on certain permanent total disability workers’ compensation reserves have been discounted to present value at pre-tax rates not exceeding 3.5%. At December 31, 2007 and 2006, loss reserves have been reduced by approximately $5,591 and $4,883, respectively. Discounting is applied to these claims since the amount of periodic payments to be made during the lifetime of claimants is fixed and determinable.
The Company maintains two stock option plans which are described below. Compensation cost charged against income for those plans was $0, $20, and $197, for 2007, 2006, and 2005, respectively.
In addition, the Company’s balance sheet includes paid and unpaid amounts recoverable from reinsurers under various agreements totaling $132,812 at December 31, 2007, as more fully discussed in Note D - Reinsurance. With minor exception, these recoverables are uncollateralized. The largest estimated amount due from a single reinsurer totaled $19,857 at December 31, 2007. Included in the total recoverable amount are case basis and estimated IBNR losses of approximately $8,016 due from Converium Insurance (North America) Inc. and $2,682 due from PMA Re., each of which reported substantial reserve strengthening and/or impairment of assets in 2005 which have negatively affected their reported financial positions. All amounts due from these reinsurers on paid claims as of December 31, 2007 are current and the Company has no information at this time to indicate that all obligations of these reinsurers will not be met.