Although 2001 signified the beginning of the hard market, it also was the beginning of an economic downturn. The economic downturn increased unemployment, which generally has a negative impact on workers’ compensation loss results. The two components of a worker’s compensation claim are medical and indemnity. The medical component of a claim is the amount paid to treat work-related injuries, while the indemnity portion of a claim is the amount of lost time wages that are paid to an employee as a result of work absenteeism related to an injury that was sustained while operating in the scope of employment. In a favorable economy, an employer may have a better chance of offering an injured worker modified duty, relieving the workers’ compensation insurer of some or all of the indemnity exposure. If an employer is unable to take an injured employee back to work or offer modified duty positions, the indemnity portion of the workers’ compensation claim will result an increased expense to the insurer.
Expense ratio. The expense ratio is the ratio (expressed as a percentage) equal to the sum of the acquisition and other underwriting expenses and other expenses to net premiums earned, and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.
Net income and return on average equity. The Company uses net income to measure its profits and return on average equity to measure its effectiveness in utilizing shareholders’ equity to generate net income. In determining return on average equity for a given year, net income is divided by the average of the beginning and ending shareholders’ equity for that year.
Bornhuetter-Ferguson Methodology. The Bornhuetter-Ferguson expected loss projection method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected ultimate losses rather than a function of the currently reported losses. The expected ultimate losses in this analysis are based on historical results, adjusted for known pricing changes and inflationary trends. The expected ultimate losses are multiplied by the unreported percentage to
Moody’s or Standard & Poor’s rate the security below investment grade; or
The increase in net investment income primarily reflects an increase in the equity interest in limited partnership investments.
The decrease in other expenses primarily reflects the reduction in the postretirement liability totaling $1.5 million, partially offset by the additional pension expense totaling $294,000 and the absorption of certain expenses, including office rent and information technology, that were previously allocated to IBSi.
The increase in income tax expense reflects the increase in pre-tax income, offset by a decrease in the effective tax rate. The effective tax rate was 32.6% in 2005, compared to 35.4% in 2004. The decrease in the effective tax rate from 2004 to 2005 reflects the release of the prior year valuation allowance totaling $227,000 related to low income housing credits, offset by a prior year tax return adjustment totaling $183,000.
Property, equipment and software are reviewed for impairment whenever changes in circumstances indicate that the carrying value of such assets may not be recoverable. Impairment losses are recognized to the extent the carrying amount of the asset exceeds the undiscounted cash flows expected to result from the use of the asset and its eventual disposal. There were no impairments recorded in 2006 or 2005. The Company recorded an impairment loss related to the write-down of certain property, equipment and software totaling $81 in 2004, which is included in other expenses in the consolidated statements of operations and comprehensive income (loss).
The statutory net loss of ELH for the year ended December 31, 2005 included the recognition of a realized loss on the sale of IBSi, totaling $10.3 million. Under SAP, the equity in income or loss of affiliates is recorded directly to statutory surplus as an unrealized gain or loss. As a result of the sale of IBSi, the cumulative unrealized loss was reclassified to a realized loss. There was no impact to statutory surplus as a result of this transaction.
The following tables provide the amortized cost and estimated fair value of the Company’s investments as of December 31, 2006 and 2005 (in thousands):
The gross unrealized losses and estimated fair value of investments classified as available-for-sale securities by investment category and length of time an individual security has been in a continuous unrealized position as of December 31, 2006 and 2005 are as follows (in thousands):
Segregated Portfolio Cell Reinsurance. The Company’s results of operations in its segregated portfolio cell reinsurance segment included a decrease in estimated incurred losses and LAE primarily related to accident years 2005, 2004 and 2003 of $2.1 million for the year ended December 31, 2006. The favorable development on prior accident years relates primarily to significant claim settlements during 2006 for amounts at, or less than, previously established case and IBNR reserves. Any change in the reserves for unpaid losses and LAE in the segregated portfolio cell reinsurance segment is recorded to the segregated portfolio dividend payable/receivable account and would only impact the Company’s net income or shareholders’ equity if the Company was a segregated portfolio cell dividend participant.
The Company issued 747,500 shares of its common stock to the ESOP on June 16, 2006, and the ESOP signed a promissory note in the amount of $7.5 million for the purchase of the shares, which is due in ten equal installments, with interest accruing annually at 4%. Shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid.
Shares committed to be released and stock compensation expense for the period from June 17, 2006 to December 31, 2006 were as follows: