Our principal executive offices are located in approximately 17,200 square feet of leased office space in Seattle, Washington. We also lease office space consisting of approximately 3,200 square feet in Honolulu, Hawaii; 1,700 square feet in Anchorage, Alaska; 8,300 square feet in Orange, California; 3,400 square feet in Houston, Texas; 800 square feet in San Francisco, California; 300 square feet in Fresno, California; 3,000 square feet in Chicago, Illinois and 1,800 square feet in Tampa, Florida. We conduct claims and underwriting operations in our branch offices, with the exception of our Honolulu office, where we conduct only claims operations, and our Fresno and San Francisco offices, where we conduct only underwriting operations. We do not own any real property. We consider our leased facilities to be adequate for our current operations.
Net Premiums Earned. Net premiums earned totaled $158.9 million in 2005 compared to $78.0 million in 2004, representing an increase of $80.9 million, or 103.7%. We record the entire annual policy premium as unearned premium when written and earn the premium over the life of the policy, which is generally twelve months. Because we acquired renewal rights and not policies in the Acquisition, our actual results for the year ended December 31, 2004 did not reflect premiums earned on any policies written prior to September 30, 2003, the date of the Acquisition. Consequently, the ratio of net premiums earned to net premiums written increased from 57.5% in 2004 to 77.6% in 2005.
Net Realized Gains (Losses) on Investments. Our predecessor’s realized gain on investments was $14,000 for the nine months ended September 30, 2003, compared to $4.5 million in realized losses for the year ended December 31, 2002. In 2002 our predecessor realigned its portfolio with a greater emphasis on cash and short-term investments, which resulted in approximately $0.8 million in realized losses from the sale of securities with values that had declined substantially below their cost. In addition, our predecessor adjusted the carrying value of investments in equity securities by $3.6 million for other-than-temporary impairments.
Unpaid loss and loss adjustment expenses represent estimates of the ultimate net cost of all unpaid losses incurred through the specified period. Loss adjustment expenses are estimates of unpaid expenses to be incurred in settlement of the claims included in the liability for unpaid losses. These liabilities, which anticipate salvage and subrogation recoveries and are presented gross of amounts recoverable from reinsurers, include estimates of future trends in claim severity and frequency and other factors that could vary as the losses are ultimately settled. Liabilities for unpaid loss and loss adjustment expenses are not discounted to account for the time value of money.
The Company recorded no write-offs of uncollectible reinsurance recoverables in the years ended December 31, 2005 and 2004 or the three month period ended December 31, 2003.
Deferred federal income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those amounts used for federal income tax reporting purposes. The significant components of the deferred tax assets and liabilities at December 31, 2005 and 2004 are as follows:
The Company maintains a defined contribution retirement plan covering substantially all of its employees. The Company matches 100% of the first three percent of eligible compensation contributed to the plan on a pre-tax basis, and 50% of the next two percent of eligible compensation contributed to the plan on a pre-tax basis. In addition, the Company makes an additional contribution equal to one percent of compensation and a discretionary contribution in an amount determined by the Board of Directors at plan year end. The discretionary contribution was one percent for the year ended December 31, 2005 and two percent for the year ended December 31, 2004. Employees are 100% vested in all matching contributions when they are made. Contribution expense for the years ended December 31, 2005 and 2004 was $571,000 and $316,000, respectively, and $60,000 for the three month period ended December 31, 2003.
The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse, net of any applicable valuation allowances.
Effective October 1, 2002, EPIC and PEIC entered into reinsurance agreements with nonaffiliated insurance companies wherein EPIC and PEIC retain the first $500,000 of each loss occurrence; the next $500,000 of such loss occurrence is 50% retained by EPIC or PEIC after meeting a $1,500,000 aggregate deductible. Losses in excess of $1,000,000 up to $5,000,000 are 100% reinsured with third party reinsurers. Losses in excess of $5,000,000 are 100% reinsured under LMC’s internal reinsurance treaties and Catastrophe Excess of Loss Treaty up to a $315,000,000 limit. The upper limit on losses ceded prior to October 1, 1998 is $49,500,000.
Management evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from activities or economic characteristics of the reinsurers to minimize its exposure to losses from reinsurer insolvencies. In the event a reinsurer is unable to meet its obligations, the Predecessor would be liable for the losses under the agreement.
LMC has a written tax allocation agreement, approved by the Companies, that provides for Federal income taxes to be paid to or recovered from LMC based on each subsidiary company’s taxable income or taxable loss as if the subsidiary were filing a separate Federal income tax return. The following is a reconciliation of the difference between the expected income tax computed by applying the Federal statutory income tax rate of 35% to income before income taxes and the total Federal income taxes reflected on the books for the nine months ended September 30, 2003 and the year ended December 31, 2002:
In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 supersedes Accounting Principles Board Opinion No. 17, “Intangible Assets”, and requires goodwill and other intangible assets that have indefinite lives to no longer be amortized; however, these assets must be tested at least annually for impairment. SFAS No. 142 also requires an evaluation of