Reinsurance operations are conducted through EMC Reinsurance Company, and represented approximately 20 percent of consolidated premiums earned in 2009. The Company’s reinsurance subsidiary is a party to a quota share reinsurance retrocessional agreement with Employers Mutual (the “quota share agreement”). Under the terms of the quota share agreement, the reinsurance subsidiary assumes a 100 percent quota share portion of Employers Mutual’s assumed reinsurance business, exclusive of certain reinsurance contracts. This includes all premiums and related losses, settlement expenses, and other underwriting and administrative expenses of this business, subject to a maximum loss of $2,000,000 per event. The cost of the $2,000,000 cap on losses assumed per event, which is treated as a reduction to premiums written, is 10.5 percent. The reinsurance subsidiary does not directly reinsure any of the insurance business written by Employers Mutual or the other pool participants; however, the reinsurance subsidiary assumes reinsurance business from the Mutual Reinsurance Bureau (MRB) pool and this pool provides a small amount of reinsurance protection to the EMC Insurance Companies. As a result, the reinsurance subsidiary’s assumed exposures include a small portion of the EMC Insurance Companies’ direct business, after ceded reinsurance protections purchased by the MRB pool are applied. In addition, the reinsurance subsidiary does not reinsure any “involuntary” facility or pool business that Employers Mutual assumes pursuant to state law. The reinsurance subsidiary assumes all foreign currency exchange gain/loss associated with contracts incepting on January 1, 2006 and thereafter that are subject to the quota share agreement. Operations of the quota share agreement give rise to inter-company balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the reinsurance subsidiary are not subject to the quota share agreement.
Direct Premiums Written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten and issued by the Company’s property and casualty insurance subsidiaries. These direct premiums written are transferred to Employers Mutual under the terms of the pooling agreement and are reflected in the Company’s consolidated financial statements as premiums written ceded to affiliates. See note 3 of Notes to Consolidated Financial Statements.
Segment information and consolidated net income for the three years ended December 31, 2009 are as follows:
An expected decline in the amount of favorable development experienced on prior years’ reserves also contributed to the increase in the loss and settlement expense ratio of the property and casualty insurance segment. Lastly, the moderate, but steady, decline in premium rate levels over the prior several years was estimated to have added approximately 3 percentage points to the loss and settlement expense ratio in 2008.
Premiums assumed by the reinsurance subsidiary from Employers Mutual amounted to $72,206,486, $73,617,740 and $71,002,733 in 2009, 2008 and 2007, respectively. It is customary in the reinsurance business for the assuming company to compensate the ceding company for the acquisition expenses incurred in the generation of the business. Commissions paid by the reinsurance subsidiary to Employers Mutual amounted to $14,111,273, $15,766,979 and $17,386,129 in 2009, 2008 and 2007, respectively.
The following tables set forth the amounts recognized in the Company’s financial statements as a result of the property and casualty insurance subsidiaries’ aggregate 30 percent participation in the pooling agreement and amounts allocated to the reinsurance subsidiary as of December 31, 2009 and 2008:
Employers Mutual uses Global Portfolio Strategies, Inc. to advise on asset allocation strategy for its pension plan. The asset allocation strategy and process of Global Portfolio Strategies, Inc. uses a diversified allocation of equity, debt and real estate exposures that is customized to the plan’s payment risk and return targets.
Global Portfolio Strategies, Inc. reviews the plan’s assets and liabilities in relation to expectations of long-term market and liability development to determine the appropriate asset allocation. The data for the contributions and emerging liabilities is provided from the plan’s actuarial valuation, while the current assets and monthly benefit payment data is provided by the plan administrator.
The fair values of Employers Mutual’s defined benefit retirement plan by asset category are as follows:
The weighted average fair value of options granted in 2009, 2008 and 2007 amounted to $2.30, $2.77 and $3.82, respectively. Employers Mutual estimated the fair value of each option grant on the date of grant using the Black-Scholes-Merton option-pricing model and the following weighted-average assumptions:
The 1993 Plan and 2003 Plan do not generally generate tax deductions for the Company because only incentive stock options could be issued under these plans. The Company did receive a deferred tax benefit for the March 2009 grant and a portion of the March 2008 grant made under the 2007 Plan because non-qualified options were issued. The Company’s portion of the current tax deduction realized from exercises of stock options was $1,970 in 2009 (no realized tax deduction prior to 2009). No cash flow effects have resulted from share-based payment arrangements. The income tax benefit that results from disqualifying dispositions of stock purchased through incentive stock options is deemed immaterial.
During 2009, a total of 3,878 options were exercised at prices ranging from $14.15 to $16.35. Activity under the plan was as follows:
The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions. The Company’s share of case loss reserves eliminated by the purchase of these annuities was $1,711,614 at December 31, 2009. The Company has a contingent liability of $1,711,614 at December 31, 2009 should the issuers of these annuities fail to perform. The probability of a material loss due to failure of performance by the issuers of these annuities is considered remote. The Company’s share of the amount due from any one life insurance company does not equal or exceed one percent of its subsidiaries’ aggregate policyholders’ surplus.