In early 2011, massive snowstorms affected the Midwest to Northeast regions of the United States and brought blizzard conditions to much of the Country. Such events typically increase claims frequency and severity; however, they occasionally decrease frequency as automobile drivers stay off the road due to business closures. The Company is unable to determine what the impact, if any, from these storms will be.
The low percentage increases in the more recent periods is likely indicative of the Company’s efforts to route the majority of first notice of loss calls through the 24/7 call center, thereby speeding up the reporting process for our customers. There are many other potential factors that can affect the number of claims reported after a period end. These factors include changes in weather patterns, a change in the number of litigated files, and whether the last day of the year falls on a weekday or a weekend. However, the Company is unable to determine which, if any, of the factors actually impact the number of claims reported and, if so, by what magnitude.
Discussion of losses and loss reserves and prior period loss development at December 31, 2010
Management’s recoverability assessment of its deferred tax assets which are ordinary in character takes into consideration the Company’s strong history of generating ordinary taxable income and a reasonable expectation that it will continue to generate ordinary taxable income in the future. Further, the Company has the capacity to recoup its ordinary deferred tax assets against taxes paid in prior years. Finally, the Company has various deferred tax liabilities which represent sources of future ordinary taxable income.
Included in net income are net realized investment gains of $57.1 million and $346.4 million in 2010 and 2009, respectively. Net realized investment gains include gains of $46.6 million and $395.5 million in 2010 and 2009, respectively, due to changes in the fair value of total investments pursuant to application of the fair value accounting option. The net gains during 2010 arise from $1.0 million and $45.7 million increases in the market value of the Company’s fixed maturity and equity securities, respectively. The primary cause of the gains on the Company’s equity securities was the overall improvement in the equity markets.
During 2010, the Company recognized approximately $57.1 million in net realized investment gains, which include approximately $5.9 million and $46.5 million related to fixed maturity securities and equity securities, respectively. Included in the gains were $1.0 million and $45.7 million in gains due to changes in the fair value of the Company’s fixed maturity portfolio and equity security portfolio, respectively, as a result of applying the fair value option.
The Company has a $120 million credit facility and an $18 million bank loan that contain certain financial covenants pertaining to minimum statutory surplus, debt to capital ratio, and risk based capital ratio. As of December 31, 2010, the Company was in compliance with these covenants.
Unpaid losses and loss adjustment expenses are determined in amounts estimated to cover incurred losses and loss adjustment expenses and established based upon the Company’s assessment of claims pending and the development of prior years’ loss liabilities. These amounts include liabilities based upon individual case estimates for reported losses and loss adjustment expenses and estimates of such amounts that are IBNR. Changes in the estimated liability are charged or credited to operations as the losses and loss adjustment expenses are settled. The liability is stated net of anticipated salvage and subrogation recoveries. The amount of reinsurance recoverable is included in other receivables.
The claim count development method analyzes historical claim count development to estimate future incurred claim count development for current claims. The Company applies development factors against current claim counts by accident period to calculate ultimate expected claim counts.
On February 6, 2009, the Company entered into an interest rate swap of its floating LIBOR rate on the $120 million credit facility, which was used for the acquisition of AIS, resulting in a fixed rate of 3.18%. The purpose of the swap is to offset the variability of cash flows resulting from the variable interest rate. The swap is not designated as a hedge and changes in the fair value are adjusted through the consolidated statement of operations in the period of change.
Effective January 1, 2009, the Company acquired all of the membership interests of AISM, which is the parent company of AIS and PoliSeek. AIS is a major producer of automobile insurance in the state of California and was the Company’s largest independent broker. This preexisting relationship did not require measurement at the date of acquisition as there was no settlement of executory contracts between the Company and AIS as part of the acquisition.
Management anticipates that it is reasonably possible that the Company’s total amount of unrecognized tax benefits will increase within the next twelve months by approximately $300,000 to $500,000 related to its ongoing California state tax apportionment factor issues.