During the fourth quarter of 2005, the Company recorded a $25.7 million impairment charge related to the write-down of goodwill arising from the acquisition of the Company’s personal lines segment. This loss, which was the same on a pre-tax and after-tax basis, was a result of the Company’s annual evaluation of the carrying value of goodwill. The write-down was determined by comparing the fair value of the Company’s personal lines segment and the implied value of the goodwill with the carrying amounts on the balance sheet. The write-down resulted from changes in business assumptions primarily due to the following: the unprecedented hurricane activity and associated catastrophe losses experienced in 2004 and 2005; the uncertainty of 2006 catastrophe reinsurance renewal rates; the decision to change the personal lines segment business model to discontinue writing the mobile homeowners business and target new construction homeowners business; and the disruption in the Florida marketplace.
Each of the generally accepted actuarial methods employed generates discrete point estimates of ultimate loss by line of business, by accident year. While the estimates are often similar across methods, a diverse array of estimates may be generated, particularly for current and recently completed accident years of longer-tailed lines and lines of business experiencing growth. Often the outlying point estimates among these diverse results can be dismissed as unreasonable because either the key assumptions of the method generating those outliers are violated or the underlying data feeding that method are too “thin” for meaningful results. The remaining indications generally form a reasonable range of point estimates from which informed judgment is utilized to select the actuarially determined estimate.
A $41.5 million reduction in ceded loss and loss adjustment expenses pursuant to quota share agreement (See Premiums). Ceded loss and loss adjustment expenses pursuant to this quota share agreement for the year ended December 31, 2005 were $18.3 million vs. $59.8 million for the same period during 2004.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $49.4 million (23.0%) to $263.8 million for the year ended December 31, 2005 from $214.4 million for the same period of 2004, and the expense ratio decreased to 27.0% in 2005 from 27.8% in 2004. The increase in acquisition costs and other underwriting expenses was due primarily to:
Other Operating Expenses: Other operating expenses increased $7.7 million to $17.1 million for the year ended December 31, 2005 from $9.4 million for the same period of 2004. $2.0 million of the increase results from a bonus accrual under the terms of an employment agreement with the Company’s founder and Chairman. The remaining increase in the level of expenses is primarily due to the overall growth of the business, offset in part by reduced commissions paid on brokered personal lines business (see Other Income).
Goodwill impairment testing requires the evaluation of the fair value of each reporting unit to its carrying value, including the goodwill, and an impairment charge is recorded if the carrying amount of the reporting unit exceeds its estimated fair value. As a
Additionally, the Company conducts its impairment evaluation and recognition for interests in securitized assets in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board (the “EITF”). Pursuant to this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $0 million, $7.3 million and $9.3 million for the years ended December 31, 2005, 2004 and 2003, respectively. These non-cash realized investment losses were from investments primarily in collateralized bond obligations which were impacted by recent years’ non investment grade default rates that were higher than historic averages and from investments in other asset backed securities which experienced extension of cash flows on the underlying collateral.
The Company had no debt or equity investments in a single issuer totaling in excess of 10% of shareholders’ equity at December 31, 2005.
There was one remaining non-income producing fixed maturity security in the investment portfolio as of December 31, 2005.
During 2005, the Company decreased its estimated total net ultimate losses and loss adjustment expenses for prior accident years by the following amounts:
The Company increased the estimated gross and net loss for unreported claims incurred and related claim adjustment expenses on residual value polices issued during the years 1998 through 2002 by $38.8 million. The residual value policies provide coverage guaranteeing the value of a leased automobile at the lease termination, which can be up to five years from lease inception. The increase in the estimated gross and net loss was a result of:
Philadelphia Insurance has entered into tax sharing agreements with each of its subsidiaries. Under the terms of these agreements, the income tax provision is computed as if each subsidiary were filing a separate federal income tax return, including adjustments for the income tax effects of net operating losses and other special tax attributes, regardless of whether those attributes are utilized in the Company’s consolidated federal income tax return. As of December 31, 2005, included in Other Liabilities in the Consolidated Balance Sheets were income taxes payable amounting to $7.8 million. As of December 31, 2004, included in Other Assets in the Consolidated Balance Sheets were income taxes recoverable amounting to $5.4 million.
Florida Citizens reported a deficit for the 2004 plan year. During 2005, the Company paid its portion of the assessment totaling $12.5 million, of which $8.6 million is recoverable from certain of the Company’s reinsurers, resulting in a $3.9 million net assessment expense being recognized during 2005 for Citizen’s amounts assessed and paid during 2005. Any recoupments of the Citizens assessment through future policy surcharges will be allocated between the Company and its reinsurers. Recoupments are recorded as the related premiums are written.