bureaus and taxes, which are the assessments of statistical agencies for items such as rating manuals, rating plans and experience data, as well as state and local taxes based on premiums, licenses and fees, assessments for fire patrol and contributions to workers’ compensation and state and local security funds. Other insurance services expenses include general administrative expenses, principally reimbursements to TICNY for underwriting services, and exclude expenses that are incurred by TRM’s issuing companies such as boards, bureau and taxes. It also excludes general administrative expenses related to claims administration services, which is billed on an hourly basis to TRM’s issuing companies.
Income tax expense. Our income tax expense was $11.1 million for 2005 compared to $5.7 million for the same period in 2004. The increased income tax expense was due primarily to the increase in income before income taxes. The effective income tax rate was 34.8% in 2005 compared to 38.7% in 2004. The effective tax rate in 2005 was lower due to a proportionally larger benefit of tax-exempt interest income in 2005 as compared to 2004.
The gross combined ratio increased to 36.1% in 2005 compared to a negative 33.0% in 2004. The higher gross combined ratio in 2005 was the result of a higher gross loss ratio, while the negative gross combined ratio for the same period in 2004 was the result of the negative gross loss ratio.
In 2005, cash flows from financing activities were a net use of funds of $1.6 million due principally to dividend payments to stockholders. Cash flows from financing activities for 2004 of $125.7 million included $107.8 million of net proceeds from the IPO and concurrent private placement in the fourth quarter of 2004 and $26.0 million in net proceeds from the issuance of subordinated debentures in connection with offerings of trust preferred securities in December 2004. In 2004, we repaid $5.6 million of notes payable and redeemed all of our Series A cumulative redeemable preferred shares for $3.0 million. Additionally the Company collected its employee notes receivable balance of $1.4 million before December 31, 2004. The Company paid stockholder dividends of $2.0 million and $1.2 million in 2005 and 2004, respectively.
For the year ended December 31, 2004 net cash provided by operating activities was $76.1 million compared to operating cash flow of $22.7 million in 2003. The increase in net cash provided by operations in 2004 resulted from an increase in collected premiums as a result of the growth in gross premiums and the reduction in the effective quota share reinsurance ceding percentage from 77.2% in 2003 to 41.6% in 2004, an increase of $29.2 million in funds withheld as collateral for reinsurance recoverable and a $15.7 million collection of a receivable for cancelled reinsurance.
· bankruptcy or liquidation of us or of either of the financing trusts through which the trust preferred securities were issued.
On June 22, 2004 the Company’s Board of Directors approved a 1.8:1 stock split, the maintaining of a par value of $0.01 after the split and the amendment and restatement of the Company’s Certificate of Incorporation which among other things, combined the Class A and Class B common stock into one class of common stock and increased the authorized common stock to 40,000,000 shares. These actions became effective on October 20, 2004, which is the effective date of the Company’s IPO. All consolidated financial statements and per share amounts have been retroactively adjusted for the above stock split and maintaining the par value at $0.01 per share.
amounts; however, as changes in the estimated ultimate liability for loss and loss adjustment expenses are determined, the estimated ultimate amount recoverable from the reinsurer will also change. Accordingly, the ultimate recoverable could be significantly in excess of or less than the amount indicated in the consolidated financial statements. As adjustments to these estimates become necessary, such adjustments are reflected in current operations. Loss and loss adjustment expenses incurred as presented in the consolidated statement of income and comprehensive net income are net of reinsurance recoveries.
At December 31, 2005 and 2004, U.S. Treasury Notes with fair values of approximately $6,597,000 and $651,000, respectively, were on deposit with various states to comply with the insurance laws of the states in which the Company is licensed.
The Company has recorded, as an asset, acquired identifiable intangible assets with finite useful lives. In accounting for such assets, the Company follows “Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).
The following collateral is available to the Company for amounts recoverable from reinsurers (in 000’s) as of December 31, 2005 and 2004:
additional ceded premiums are earned in 2006 (assuming the estimated ultimate loss ratio remains the same). The ceded premiums for the 2002, 2003 and 2004 treaty years have been fully earned as of December 31, 2005.
The estimated ultimate loss ratios are the Company’s best estimate based on facts and circumstances known at the end of each period that losses are estimated. The estimation process is complex and involves the use of informed estimates, judgments and actuarial methodologies relative to future claims severity and frequency, the length of time for losses to develop to their ultimate level, possible changes in law and other external factors. The same uncertainties associated with estimating loss and loss adjustment expense reserves affect the estimates of ceding commissions earned. The Company monitors and adjusts the ultimate loss ratio on a quarterly basis to determine the effect on the commission rate and ceding commissions earned. The decrease in estimated ceding commission income relating to prior years recorded in 2005 was $810,000 and an increase of 1,663,000 and $1,326,000, respectively, in 2004 and 2003.
On March 25, 2005, Tower Group, Inc. closed on its purchase of the outstanding common stock of a shell property casualty insurance company, North American Lumber Insurance Company (“NALIC”), that was renamed Tower National Insurance Company. The purchase price was for $1,050,000 and included nine active state licenses and two inactive state licenses. The two inactive states are Pennsylvania and Maine. The inactive state licenses have an additional contingent purchase price of $75,000 per state payable upon license reactivation within one year of the closing. Prior to the closing, all liabilities and assets (other than insurance licenses) of Tower National Insurance Company were transferred to a liquidating trust. The Company capitalized these purchases as an intangible asset related to state licenses with an indefinite life subject to annual impairment testing. Subsequently, during 2005, the two inactive state licenses were reactivated and an additional contingent price totaling $150,000 was paid. The total amount capitalized as of December 31, 2005, was $1,303,000 and included the purchase price, legal fees and a broker’s fee.
For regulatory purposes, TICNY, domiciled in the State of New York, and TNIC domiciled in the Commonwealth of Massachusetts, prepare their statutory basis financial statements in accordance with practices prescribed or permitted by the State of New York Insurance Department or the Massachusetts Department of Insurance (“statutory basis” or “SAP”). The more significant SAP variances from GAAP are as follows: