We believe that the delivery of non-standard personal automobile insurance policies to individual consumers requires the interaction of three basic operations, each with a specialized function:
Historically, one of the factors we considered in the course of estimating our reserves has included the input of several reinsurance companies, which we used in determining our initial provisional (expected) loss ratio to book the current treaty year loss ratio. Typically, this ratio has been monitored for adequacy, but not adjusted until 12 months after the beginning of each treaty period. At the time this process was implemented, we had a nominal amount of prior year experience to project ultimate loss reserves, which differed significantly by program. Additionally, we were in the process of developing a consistent set of practices within our claims organization, which reduced our ability to rely on historical patterns. As a result, we placed more weight on initial projected loss ratios than we do presently.
step of testing involves calculating the implied fair value of goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the Company determined in step one over the fair value of the net assets and identifiable intangibles as if the Company were being acquired. If the amount of the goodwill allocated to the reporting unit exceeds the implied fair value of the goodwill in the pro forma purchase price allocation, an impairment charge is recorded for the excess. An impairment charge recognized cannot exceed the amount of goodwill and cannot be reversed subsequently even if the fair value increases.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Affirmative Insurance Holdings, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
Commission income - Commission income and related policy fees, written for unaffiliated insurance companies, are recognized, net of an allowance for estimated policy cancellation, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. Commissions on premium endorsements are recognized when premiums are processed. Our allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary.
Beginning January 1, 2007, we have accounted for uncertainty in income taxes recognized in the financial statements in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 requires that a more-likely-than-not threshold be met before the benefit of a tax position may be recognized in the financial statements and prescribes how such benefit should be measured. It also provides guidance on derecognition, classification, accrual of interest and penalties, accounting in interim periods, disclosure and transition. It requires that the standard be applied to the balances of assets and liabilities as of the beginning of the period of adoption and that a corresponding adjustment be made to the opening balance of retained earnings. As a result of the adoption, we recognized no additional liability or reduction in deferred tax asset for unrecognized tax benefits. We are no longer subject to federal, state, local or non-US income tax examinations by tax authorities for years prior to 2004. While we typically do not incur significant interest or penalties on income tax liabilities, our policy is to classify those amounts as administrative expense. We did not change our policy on classification of interest and penalties on income tax liabilities upon adoption of FIN 48.
acquisition date to be measured and recognized at the acquisition date fair value with subsequent changes recognized in earnings, and the change in deferred tax benefit that are recognizable because of a business combination to be recognized either in income or directly in contributed capital in the period of business combination. SFAS No. 141R is effective for business combinations occurring after December 15, 2008. If we have business combinations after that date, SFAS No. 141R could have a material impact in the future on our consolidated results of operations or financial condition.
We had adverse reserve development relating to prior year losses of $3.7 million in 2008 and favorable development of $5.0 million and $5.2 million in 2007 and 2006, respectively. These reserve changes resulted from revisions to the estimates of the ultimate liability for losses and related loss adjustment expense for claims reported in previous periods.
The following table summarizes our term loan scheduled payments (in thousands):
In April 2007, we entered into an interest rate swap with a notional amount of $50.0 million that was designated as a hedge of variable cash flows associated with that portion of the facility. This derivative instrument requires quarterly settlements whereby we pay a fixed rate of 4.993% and receive a three-month Libor rate. The derivative expires in April 2011. In January 2008, we entered into an additional interest rate swap with a notional amount of $95.0 million that was also designated a hedge of variable cash flows associated with the senior term loan. The notional amount of the swap gradually declines to $40.0 million prior to its expiration and was $85.0 million as of December 31, 2008. For this swap, we pay a fixed rate of 3.031% and receive a three-month LIBOR rate. The derivative expires in February 2011. We utilize the hypothetical derivative methodology for the measurement of ineffectiveness. Derivative gains and losses not effective in hedging the expected cash flows are recognized immediately in earnings. There were no components of the derivative instrument that were excluded from the assessment of hedge effectiveness.
As of December 31, 2008, we have available for income tax purposes approximately $26.7 million in federal net operating loss carryforwards (NOLs), which may be used to offset future taxable income. Our NOLs expire as follows (in thousands):
In January 2006, Judge Bigelow absolved Hawaiian and SCJ of all counts plaintiff filed against them in this litigation on the trial court level by virtue of court order on motions for summary judgment that were submitted by both Hawaiian and SCJ. A partial dismissal without prejudice was entered as to defendant Paul Ruelas. Plaintiff filed a notice of appeal in April 2006. In September 2006, Hawaiian moved to stay appellate proceedings pursuant to an Order of Liquidation entered in August 2006, in the Circuit Court for the State of Hawaii.
Stock Options • We used the modified Black-Scholes model to estimate the value of employee stock options on the date of grant that used the assumptions noted below. The risk-free rate is based on the U.S. Treasury bill yield curve in effect at the time of grant for the expected term of the option. The expected term of options granted represents the period of time that the options are expected to be outstanding. Expected volatilities are based on historical volatilities of our common stock. The dividend yield was based on expected dividends at the time of grant.
The condensed financial information of the parent company, Affirmative Insurance Holdings, Inc. as of December 31, 2008 and 2007, and for each of the three years ended December 31, 2008, 2007 and 2006 is presented as follows (in thousands, except share data):