Forward-Looking Statements
This document, including information incorporated by reference, contains
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995). All statements, trend analyses and other
information contained in this Form 10-Q relative to markets for our products and
trends in our operations or financial results, as well as other statements
including words such as "may," "target," "anticipate," "believe," "plan,"
"estimate," "expect," "intend," "project," and other similar expressions,
constitute forward-looking statements. We made these statements based on our
plans and current analyses of our business and the insurance industry as a
whole. We caution that these statements may and often do vary from actual
results and the differences between these statements and actual results can be
material. Factors that could contribute to these differences include, among
other things:
• general economic conditions, weakness of the financial markets and other
factors, including prevailing interest rate levels and stock and credit
market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us,
our ability to access capital resources and the costs associated with such
access to capital and the market value of our investments;
• our ability to manage our growth strategy;
• customer response to new products and marketing initiatives;
• tax law and accounting changes;
• increasing competition in the sale of our insurance products and services
and the retention of existing customers;
• changes in legal environment;
• regulatory changes or actions, including those relating to the regulation
of the sale, underwriting and pricing of insurance products and services
and capital requirements;
• levels of natural catastrophes, terrorist events, incidents of war and
other major losses;
• adequacy of insurance reserves; and
• availability of reinsurance and ability of reinsurers to pay their obligations.
The forward-looking statements herein are made only as of the date of this
report. We assume no obligation to publicly update any forward-looking
statements.
General
We underwrite and sell traditional and alternative risk transfer ("ART")
property and casualty insurance products primarily to the passenger
transportation industry, the trucking industry and moving and storage
transportation companies, general commercial insurance to small businesses in
Hawaii and Alaska and personal insurance to owners of recreational vehicles and
commercial vehicles throughout the United States.
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Effective July 1, 2010, we and our principal insurance subsidiary, National
Interstate Insurance Company ("NIIC"), completed the acquisition of Vanliner
Group, Inc. ("Vanliner") from UniGroup, Inc. ("UniGroup") whereby NIIC acquired
all of the issued and outstanding capital stock of Vanliner and we acquired
certain information technology assets. As part of this acquisition, UniGroup
agreed to provide us with comprehensive financial guarantees, including a four
and a half-year balance sheet guaranty whereby both favorable and unfavorable
balance sheet developments inure to UniGroup. Through the acquisition of
Vanliner, NIIC acquired Vanliner Insurance Company ("VIC"), a market leader in
providing insurance for the moving and storage industry. Obtaining a presence in
this industry was our primary strategic objective associated with the
acquisition.
We have five property and casualty insurance subsidiaries: NIIC, VIC, National
Interstate Insurance Company of Hawaii, Inc. ("NIIC-HI"), Triumphe Casualty
Company ("TCC") and Hudson Indemnity, Ltd. ("HIL") and five active agency and
service subsidiaries. We write our insurance policies on a direct basis through
NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed in all 50 states and the
District of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New
Jersey. TCC holds licenses for multiple lines of authority, including
auto-related lines, in 27 states and the District of Columbia. HIL is domiciled
in the Cayman Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC,
primarily for the ART component. Insurance products are marketed through
multiple distribution channels, including independent agents and brokers,
program administrators, affiliated agencies and agent internet initiatives. We
use our five active agency and service subsidiaries to sell and service our
insurance business.
As of June 30, 2012, Great American Insurance Company ("Great American") owned
52.4% of our outstanding common shares. Great American is a wholly-owned
subsidiary of American Financial Group, Inc.
Results of Operations
Overview
Through the operations of our subsidiaries, we are engaged in property and
casualty insurance operations. We generate underwriting profits by providing
what we view as specialized insurance products, services and programs not
generally available in the marketplace. We focus on niche insurance markets
where we offer insurance products designed to meet the unique needs of targeted
insurance buyers that we believe are underserved by the insurance industry.
We derive our revenues primarily from premiums generated by our insurance
policies and income from our investment portfolio. Our expenses consist
primarily of losses and loss adjustment expenses ("LAE"), commissions and other
underwriting expenses and other operating and general expenses.
The following table sets forth our June 30, 2012 and 2011 net income from
operations, which is a non-GAAP measure and excludes the after-tax impact from
the operating results of Vanliner's guaranteed runoff business, as well as
after-tax net realized gains from investments, which we believe is a useful tool
for investors and analysts in analyzing ongoing operating trends.
Three Months Ended June 30,
2012 2011(1)
Amount Per Share Amount Per Share
(Dollars in thousands, except per share data)
Net income from operations $ 6,951 $ 0.36 $ 7,662 $ 0.39
After-tax net realized gain from
investments 274 0.01 855 0.04
After-tax impact from balance sheet
guaranty for Vanliner 40 0.00 (458 ) (0.02 )
Net income $ 7,265 $ 0.37 $ 8,059 $ 0.41
Six Months Ended June 30,
2012 2011(1)
Amount Per Share Amount Per Share
(Dollars in thousands, except per share data)
Net income from operations $ 15,515 $ 0.79 $ 17,571 $ 0.90
After-tax net realized gain from
investments 1,406 0.08 1,635 0.08
After-tax impact from balance sheet
guaranty for Vanliner 90 0.00 (1,729 ) (0.08 )
Net income $ 17,011 $ 0.87 $ 17,477 $ 0.90
(1) 2011 results have been retrospectively adjusted for the changes to
accounting for deferred policy acquisition costs required under Accounting
Standards Update No. 2010-26 ("ASU 2010-26").
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As discussed above, UniGroup provided us with comprehensive financial guarantees
related to the runoff of Vanliner's final balance sheet whereby both favorable
and unfavorable balance sheet development inures to the seller. In accordance
with purchase accounting requirements we were required to determine the fair
value of the future economic benefit of the financial guarantees and acquired
loss reserves as of the date of acquisition, despite the fact that certain gains
and losses related to the financial guaranty would be reflected in operations as
they are incurred in future periods. As a result, the recognition of the
revenues and expenses associated with the guaranteed runoff business will not
occur in the same period and will result in combined ratios which are
inconsistent with the negotiated combined ratio which was to approximate 100%
for the Vanliner guaranteed business. As such, the after-tax impact from the
runoff business guaranteed by the seller for the three and six months ended
June 30, 2012 and 2011 have been removed from the net after-tax earnings from
operations to reflect only those results of the ongoing business.
Our net income from operations for the three and six months ended June 30, 2012
was $7.0 million ($0.36 per share diluted) and $15.5 million ($0.79 per share
diluted), respectively, compared to $7.7 million ($0.39 per share diluted) and
$17.6 million ($0.90 per share diluted) for the same periods in 2011. These
decreases were driven by the elevated loss and LAE ratios from our ongoing
operations for the three and six months ended June 30, 2012 of 74.7% and 73.9%,
respectively, which excludes the impact from the runoff of the guaranteed
Vanliner business, as compared to 72.2% and 69.7% for the same periods in 2011.
The loss ratio increase for the second quarter of 2012 was driven by higher than
average claims severity experienced in several of our historically profitable
commercial products, while the loss ratio elevation for the first six months of
2012 was concentrated in an ART product also included in the quarterly period's
unfavorable loss results and another typically profitable product in our Hawaii
and Alaska component. Adverse claim development from prior years' loss reserves
also contributed to the claims results for the first half of 2012. Partially
offsetting the elevated loss results was the growth in net investment income for
both the second quarter and first six months of 2012, which was attributable to
a shift into higher-yielding state and local government obligations and
mortgage-backed securities that was concentrated in the second half of 2011.
We recorded after-tax net realized gains from investments of $0.3 million ($0.01
per share diluted) and $1.4 million ($0.08 per share diluted) for the second
quarter and first six months of 2012, respectively, compared to $0.9 million
($0.04 per share diluted) and $1.6 million ($0.08 per share diluted) for the
comparative periods in 2011. Our after-tax net realized gains for the three
months ended June 30, 2012 were primarily generated by sales of securities
partially offset by net losses associated with equity partnership investments,
while the after-tax net realized gains for the comparable period in 2011 related
primarily to sales of securities. The after-tax net realized gains for both the
six months ended June 30, 2012 and 2011 were driven by sales of securities.
Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We
manage this segment through a product management structure. The following table
sets forth an analysis of gross premiums written by business component during
the periods indicated:
Three Months Ended June 30,
2012 2011
Amount Percent Amount Percent
(Dollars in thousands)
Alternative Risk Transfer $ 92,006 57.5 % $ 88,584 56.6 %
Transportation 47,731 29.8 % 46,322 29.6 %
Specialty Personal Lines 14,149 8.8 % 15,130 9.7 %
Hawaii and Alaska 4,709 2.9 % 4,515 2.9 %
Other 1,535 1.0 % 1,934 1.2 %
Gross premiums written $ 160,130 100.0 % $ 156,485 100.0 %
Six Months Ended June 30,
2012 2011
Amount Percent Amount Percent
(Dollars in thousands)
Alternative Risk Transfer $ 168,444 57.9 % $ 169,445 58.3 %
Transportation 82,938 28.6 % 80,419 27.7 %
Specialty Personal Lines 27,202 9.4 % 29,790 10.2 %
Hawaii and Alaska 8,589 3.0 % 8,193 2.8 %
Other 3,182 1.1 % 2,951 1.0 %
Gross premiums written $ 290,355 100.0 % $ 290,798 100.0 %
Three months ended June 30, 2012 compared to June 30, 2011. Gross premiums
written includes both direct and assumed premium. During the second quarter of
2012, our gross premiums written increased $3.6 million, or 2.3%, compared to
the same period in 2011, primarily attributable to the growth experienced in
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our ART and transportation components. Gross premiums written in our ART
component increased $3.4 million, or 3.9%, during the second quarter of 2012
compared to the same period in 2011 due to a combination of growth in existing
ART programs, both from the addition of new customers and an increase in
exposures and rates on renewal business, and near 100% member retention in group
ART programs renewing during the period. The ART component grew despite the
impact from actions taken in 2011 in two ART programs, as previously reported.
These programs, one of which underwent significant underwriting actions while
the other was terminated, comprised 8.2% of our gross premiums written during
the second quarter of 2011. Our transportation component's gross premiums
written increased by $1.4 million, or 3.0%, in the second quarter of 2012
compared to the same period in 2011, primarily due to growth in our trucking
transportation product which saw increases in both rates and exposures, as well
as Vanliner's moving and storage products which grew due to a combination of
rate increases and the addition of new customers during the period. The decrease
of $1.0 million, or 6.5%, in our specialty personal lines component was
primarily related to the decline in our recreational vehicle product due to the
continued trend toward recreational vehicle owners going directly to insurance
companies for quotes versus using an agent.
Six months ended June 30, 2012 compared to June 30, 2011. During the first six
months of 2012, our gross premiums written were relatively flat, decreasing $0.4
million, or 0.2%, compared to the same period in 2011, primarily attributable to
the impact from actions taken in the two programs in 2011, as discussed above
for the three month period. These programs comprised 7.6% of our gross written
premiums during the first six months of 2011. Gross premiums written in our ART
component decreased $1.0 million, or 0.6%, for the six months ended June 30,
2012 compared to the same period in 2011. Excluding the impact of the two
aforementioned programs, the remainder of our ART component increased $17.6
million, or 11.9%, due to a combination of growth in existing ART programs,
primarily due to the addition of new customers, and near 100% member retention
in group ART programs renewing during the period. Our transportation component
grew by $2.5 million, or 3.1%, driven by our trucking transportation and
Vanliner's moving and storage products due to the same factors discussed above
for the three month period. This growth was partially offset by a decrease in
our specialty personal lines component of $2.6 million, or 8.7%, for the six
months ended June 30, 2012 compared to the same period in 2011 due to the
decline in our recreational vehicle product as discussed above for the three
month period, as well as the impact of the previously reported ongoing pricing
and underwriting actions associated with our commercial vehicle product which
have continued into 2012.
Our group ART programs, which focus on specialty or niche businesses, provide
various services and coverages tailored to meet specific requirements of defined
client groups and their members. These services include risk management
consulting, claims administration and handling, loss control and prevention and
reinsurance placement, along with providing various types of property and
casualty insurance coverage. Insurance coverage is provided primarily to
companies with similar risk profiles and to specified classes of business of our
agent partners.
As part of our ART programs, we have analyzed, on a quarterly basis, members'
loss performance on a policy year basis to determine if there would be a premium
assessment to participants or if there would be a return of premium to
participants as a result of less-than-expected losses. Assessment premium and
return of premium are recorded as adjustments to premiums written (assessments
increase premiums written; returns of premium reduce premiums written). For the
second quarter of 2012 and 2011, we recorded a $1.0 million return of premium
and a $0.5 million premium assessment, respectively. For the first six months of
2012 and 2011, we recorded premium assessments of $0.5 million and $1.7 million,
respectively.
Premiums Earned
Three months ended June 30, 2012 compared to June 30, 2011. The following table
shows premiums earned summarized by the broader business component description,
which were determined based primarily on similar economic characteristics,
products and services:
Three Months Ended June 30, Change
2012 2011 Amount Percent
(Dollars in thousands)
Premiums earned:
Alternative Risk Transfer $ 57,946 $ 49,509 $ 8,437 17.0 %
Transportation 36,079 38,221
(2,142 ) (5.6 %)
Specialty Personal Lines 11,786 13,551 (1,765 ) (13.0 %)
Hawaii and Alaska 3,511 3,492 19 0.5 %
Other 1,544 1,691 (147 ) (8.7 %)
Total premiums earned $ 110,866 $ 106,464 $ 4,402 4.1 %
Our premiums earned increased $4.4 million, or 4.1%, to $110.9 million during
the three months ended June 30, 2012 compared to $106.5 million for the same
period in 2011. The increase is primarily attributable to our ART component,
which grew $8.4 million, or 17.0%, over 2011 mainly due to the gross premiums
written growth from existing and new programs experienced throughout 2011.
Partially offsetting this increase were decreases in our transportation and
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specialty personal lines components of $2.1 million, or 5.6%, and $1.8 million,
or 13.0%, respectively. The $2.1 million decline in our transportation component
was driven by an $8.3 million decrease related to the runoff of Vanliner's
earned premiums associated with the business covered by the balance sheet
guaranty, which was partially offset by growth experienced in our moving and
storage products throughout 2011 and the first six months of 2012. The decrease
in our specialty personal lines component was due to the decline in premiums
written in our commercial vehicle and recreational vehicle products experienced
throughout 2011 and the first half of 2012.
Six months ended June 30, 2012 compared to June 30, 2011. The following table
shows premiums earned summarized by the broader business component description,
which were determined based primarily on similar economic characteristics,
products and services:
Six Months Ended June 30, Change
2012 2011 Amount Percent
(Dollars in thousands)
Premiums earned:
Alternative Risk Transfer $ 116,156 $ 95,617 $ 20,539 21.5 %
Transportation 71,216 78,608 (7,392 ) (9.4 %)
Specialty Personal Lines 23,603 27,413 (3,810 ) (13.9 %)
Hawaii and Alaska 6,895 6,854 41 0.6 %
Other 3,121 3,111 10 0.3 %
Total premiums earned $ 220,991 $ 211,603 $ 9,388 4.4 %
Our premiums earned increased $9.4 million, or 4.4%, to $221.0 million during
the six months ended June 30, 2012 compared to $211.6 million for the same
period in 2011. The increase is primarily attributable to our ART component,
which grew $20.5 million, or 21.5%, over 2011 due to the same factors discussed
above for the three month period. Partially offsetting this increase were
decreases in our transportation and specialty personal lines components of $7.4
million, or 9.4%, and $3.8 million, or 13.9%, respectively. The $7.4 million
decline in our transportation component was driven by a $23.4 million decrease
related to the runoff of Vanliner's earned premiums associated with the business
covered by the balance sheet guaranty, which was partially offset by growth
experienced in our moving and storage products, as discussed above for the three
month period. The decrease in our specialty personal lines component was due to
the same factors discussed above for the three month period.
Underwriting and Loss Ratio Analysis
Underwriting profitability, as opposed to overall profitability or net earnings,
is measured by the combined ratio. The combined ratio is the sum of the loss and
LAE ratio and the underwriting expense ratio. A combined ratio under 100% is
indicative of an underwriting profit.
Losses and LAE are a function of the amount and type of insurance contracts we
write and of the loss experience of the underlying risks. We seek to establish
case reserves at the maximum probable exposure based on our historical claims
experience. Our ability to accurately estimate losses and LAE at the time of
pricing our contracts is a critical factor in determining our profitability. The
amount reported under losses and LAE in any period includes payments in the
period net of the change in reserves for unpaid losses and LAE between the
beginning and the end of the period.
Our underwriting expense ratio includes commissions and other underwriting
expenses and other operating and general expenses, offset by other income.
Commissions and other underwriting expenses consist principally of brokerage and
agent commissions reduced by ceding commissions received from assuming
reinsurers, and vary depending upon the amount and types of contracts written
and, to a lesser extent, premium taxes.
Our underwriting approach is to price our products to achieve an underwriting
profit even if we forgo volume as a result. After several years of modest single
digit decreases in rate levels on our renewal business as a whole, beginning in
2011 and continuing through the first six months of 2012, we saw rate levels
begin to stabilize on renewal business, with a number of our products
experiencing single digit rate level increases on renewal business.
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The table below presents our net premiums earned and combined ratios for the
periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
(Dollars in thousands) (Dollars in thousands)Gross premiums written $ 160,130 $ 156,485 $ 290,355 $ 290,798
Ceded reinsurance (24,375 ) (22,742 ) (47,885 ) (46,804 )
Net premiums written 135,755 133,743 242,470 243,994
Change in unearned premiums, net of
ceded (24,889 ) (27,279 ) (21,479 ) (32,391 )
Total premiums earned $ 110,866 $ 106,464 $ 220,991 $ 211,603
Combined Ratios:
Loss and LAE ratio (1) 74.7 % 73.8 % 73.9 % 72.4 %
Underwriting expense ratio (2) (3) 23.8 % 23.2 % 23.6 % 23.0 %
Combined ratio 98.5 % 97.0 % 97.5 % 95.4 %
(1) The ratio of losses and LAE to premiums earned.
(2) The ratio of the sum of commissions and other underwriting expenses, other
operating expenses less other income to premiums earned.
(3) 2011 results have been retrospectively adjusted for the changes to
accounting for deferred policy acquisition costs required under ASU 2010-26.
Three months ended June 30, 2012 compared to June 30, 2011. Our consolidated
loss and LAE ratio for the second quarter of 2012 increased 0.9 percentage
points to 74.7% compared to 73.8% in the same period in 2011. The loss and LAE
ratio for our ongoing operations, which excludes the impact from the runoff of
the guaranteed Vanliner business, was 74.7% for the three months ended June 30,
2012 compared to 72.2% for the same period in 2011. This increase over the prior
period is primarily attributable to higher than average claims severity
experienced in several of our historically profitable commercial products during
the three months ended June 30, 2012. We expect that these products' results in
future periods will be more consistent with our historical results. However, we
will continue to closely monitor the products' performance and will respond with
rate increases or non-renewals, as necessary. For the second quarter of 2012, we
had favorable development from prior years' loss reserves of $0.2 million, or
0.2 percentage points, compared to favorable development of $0.7 million, or 0.7
percentage points, in the second quarter of 2011. This favorable development was
primarily related to settlements below the established case reserves and
revisions to our estimated future settlements on an individual case by case
basis. The prior years' loss reserve development for both periods is not
considered to be unusual or significant to prior years' reserves based on the
history of our business and the timing of events in the claims adjustment
process.
The consolidated underwriting expense ratio for the second quarter of 2012
increased 0.6 percentage points to 23.8% compared to 23.2% for the same period
in 2011. The underwriting expense ratio for our ongoing business remained
relatively flat at 23.8% and 23.6% for the three months ended June 30, 2012 and
2011, respectively.
Six months ended June 30, 2012 compared to June 30, 2011. Our consolidated loss
and LAE ratio for the six months ended June 30, 2012 increased 1.5 percentage
points to 73.9% compared to 72.4% in the same period in 2011. The loss and LAE
ratio for our ongoing operations, which excludes the impact from the runoff of
the guaranteed Vanliner business, was 73.9% for the first six months of 2012
compared to 69.7% for the same period in 2011. This increase over the prior
period is primarily attributable to higher than average claims severity
experienced in two historically profitable products within our Hawaii and Alaska
and ART transportation components during the six months ended June 30, 2012, as
well as adverse claim development from prior years' loss reserves. For the six
months ended June 30, 2012, we had unfavorable development from prior years'
loss reserves of $1.7 million, or 0.8 percentage points, compared to favorable
development of $0.5 million, or 0.3 percentage points, for the first six months
of 2011.
The consolidated underwriting expense ratio for the six months ended June 30,
2012 increased 0.6 percentage points to 23.6% compared to 23.0% for the same
period in 2011. The underwriting expense ratio for our ongoing business remained
flat at 23.6% for both the six months ended June 30, 2012 and 2011.
Net Investment Income
2012 compared to 2011. For the three and six month periods ended June 30, 2012,
net investment income was $9.0 million and $18.1 million, respectively, compared
to $7.8 million and $14.7 million for the same periods in 2011. The increase in
investment income for both the three and six months ended June 30, 2012 is
primarily due to a shift into higher yielding securities in the second half of
2011. This shift was primarily concentrated in state and local government
obligations and mortgage-backed securities with a decreased focus on lower
yielding U.S. government and government agency obligations.
Net Realized Gains (Losses) on Investments
2012 compared to 2011. Pre-tax net realized gains on investments were
$0.4 million for the second quarter of 2012 compared to $1.3 million for the
second quarter of 2011. For the six months ended June 30, 2012 and 2011, pre-tax
net realized gains were
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$2.2 million and $2.5 million, respectively. The pre-tax net realized gains for
both the second quarter and first six months of 2012 were primarily generated
from net realized gains associated with sales or redemptions of securities
totaling $1.8 million and $2.2 million, respectively. Equity partnership
investments produced net losses of $1.3 million and net gains of $0.1 million
for the second quarter and first half of 2012, respectively. The pre-tax net
realized gains for both the three and six months ended June 30, 2011 were
primarily generated from net realized gains associated with sales of securities
totaling $1.0 million and $2.0 million, respectively. Additionally, we recorded
gains of $0.3 million and $0.5 million associated with equity partnership
investments for the three and six months ended June 30, 2011, respectively.
Commissions and Other Underwriting Expenses
2012 compared to 2011. During the second quarter of 2012, commissions and other
underwriting expenses of $22.6 million increased $1.2 million, or 5.7%, from
$21.4 million in the comparable period in 2011. For the six months ended
June 30, 2012 and 2011, commissions and other underwriting expenses were $44.2
million and $41.9 million, respectively, increasing $2.3 million, or 5.4%. Both
the quarter and year-to-date increases are primarily attributable to changes in
business mix written during the periods. Commissions and other underwriting
expenses, as a percentage of premiums earned, were relatively flat at 20.4% and
20.0% for the three months and six months ended June 30, 2012, respectively,
compared to 20.1% and 19.8% for the same periods in 2011. Commissions and other
underwriting expenses for the three and six months ended June 30, 2011 have been
retrospectively adjusted for the changes to accounting for deferred policy
acquisition costs required under ASU 2010-26.
Other Operating and General Expenses
2012 compared to 2011. Other operating and general expenses increased $0.5
million, or 11.6%, to $4.6 million during the quarter ended June 30, 2012
compared to $4.1 million for the same period in 2011. For the six months ended
June 30, 2012 and 2011, other operating and general expenses were $9.5 million
and $8.6 million, respectively, increasing $0.9 million, or 10.0%. Both the
quarter and year-to-date increases are primarily attributable to growth in our
employee headcount and other expenses necessary to support the growth in our
business. Other operating and general expenses, as a percentage of premiums
earned, were relatively flat at 4.1% and 4.3% for the three months and six
months ended June 30, 2012, respectively, compared to 3.8% and 4.1% for the same
periods in 2011.
Income Taxes
2012 compared to 2011. The effective tax rate of 27.0% for the three month
period ended June 30, 2012 decreased 1.8 percentage points, from 28.8%, as
compared to the same period in 2011. The 2012 year-to-date effective tax rate
decreased 2.0 percentage points to 28.3%, as compared to 30.3% for the same
period in 2011. These decreases are primarily attributable to increased
tax-exempt income.
Financial Condition
Investments
At June 30, 2012, our investment portfolio contained $960.1 million in fixed
maturity securities and $25.3 million in equity securities, all carried at fair
value, with unrealized gains and losses reported as a separate component of
shareholders' equity and $34.8 million in other investments, which are limited
partnership investments accounted for in accordance with the equity method. At
June 30, 2012, we had pre-tax net unrealized gains of $34.0 million on fixed
maturities and $2.6 million on equity securities. Our investment portfolio
allocation is based on diversification among primarily high quality fixed
maturity investments and guidelines in our investment policy.
At June 30, 2012, 89.6% of the fixed maturities in our portfolio were rated
"investment grade" (credit rating of AAA to BBB-) by nationally recognized
rating agencies. Investment grade securities generally bear lower degrees of
risk and corresponding lower yields than those that are unrated or
non-investment grade.
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Summary information for securities with unrealized gains or losses at June 30,
2012 is shown in the following table. Approximately $0.4 million of fixed
maturities and $0.2 million of equity securities had no unrealized gains or
losses at June 30, 2012.
Securities with Securities with
Unrealized Gains Unrealized Losses
(Dollars in thousands)
Fixed Maturities:
Fair value of securities $ 833,106 $ 126,639
Amortized cost of securities 794,961 130,782
Gross unrealized gain or (loss) $ 38,145 $ (4,143 )
Fair value as a % of amortized cost 104.8 % 96.8 %
Number of security positions held 722 115
Number individually exceeding $50,000
gain or (loss) 266 13
Concentration of gains or losses by
type or industry:
U.S. Government and government agencies $ 6,498 $ (6 )
Foreign governments 65 -
State, municipalities and political
subdivisions 15,695 (443 )
Residential mortgage-backed securities 4,995 (2,462 )
Commercial mortgage-backed securities 803 (232 )
Banks, insurance and brokers 3,261 (218 )
Industrial and other 6,828 (782 )
Percent rated investment grade (a) 92.6 % 70.4 %
Equity Securities:
Fair value of securities $ 18,997 $ 6,175
Cost of securities 15,896 6,645
Gross unrealized gain or (loss) $ 3,101 $ (470 )
Fair value as a % of cost 119.5 % 92.9 %
Number individually exceeding $50,000
gain or (loss) 16 -
(a) Investment grade of AAA to BBB- by nationally recognized rating agencies.
The table below sets forth the scheduled maturities of available for sale fixed
maturity securities at June 30, 2012, based on their fair values. Actual
maturities may differ from contractual maturities because certain securities may
be called or prepaid by the issuers.
Securities with Securities with
Unrealized Gains Unrealized Losses
Maturity:
One year or less 2.1 % 0.4 %
After one year through five years 21.4 %
20.1 %
After five years through ten years 39.2 % 17.0 %
After ten years 15.4 % 11.4 %
78.1 % 48.9 %
Mortgage-backed securities 21.9 % 51.1 %
100.0 % 100.0 %
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The table below summarizes the unrealized gains and losses on fixed maturities
and equity securities by dollar amount.
At June 30, 2012
Aggregate Fair Value
Aggregate Unrealized as % of
Fair Value Gain (Loss) Cost Basis
(Dollars in thousands)
Fixed Maturities:
Securities with unrealized gains:
Exceeding $50,000 and for:
Less than one year (173 issues) $ 332,326 $ 18,724 106.0 %
More than one year (93 issues) 165,453 11,785 107.7 %
Less than $50,000 (456 issues) 335,327 7,636 102.3 %
$ 833,106 $ 38,145
Securities with unrealized losses:
Exceeding $50,000 and for:
Less than one year (6 issues) $ 11,911 $ (773 ) 93.9 %
More than one year (7 issues) 8,490 (2,208 ) 79.4 %
Less than $50,000 (102 issues) 106,238 (1,162 ) 98.9 %
$ 126,639 $ (4,143 )
Equity Securities:
Securities with unrealized gains:
Exceeding $50,000 and for:
Less than one year (14 issues) $ 10,435 $ 2,073 124.8 %
More than one year (2 issues) 1,412 401 139.7 %
Less than $50,000 (51 issues) 7,150 627 109.6 %
$ 18,997 $ 3,101
Securities with unrealized losses:
Exceeding $50,000 and for:
Less than one year (0 issue) $ - $ - 0.0 %
More than one year (0 issues) - - 0.0 %
Less than $50,000 (31 issues) 6,175 (470 ) 92.9 %
$ 6,175 $ (470 )
When a decline in the value of a specific investment is considered to be
other-than-temporary, a provision for impairment is charged to earnings
(accounted for as a realized loss) and the cost basis of that investment is
reduced. The determination of whether unrealized losses are other-than-temporary
requires judgment based on subjective as well as objective factors. Factors
considered and resources used by management include those discussed in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Other-Than-Temporary Impairment."
Premiums and Reinsurance
Premiums receivable increased $35.6 million, or 20.7%, and unearned premiums
increased $27.7 million, or 11.9%, from December 31, 2011 to June 30, 2012.
Prepaid reinsurance premiums increased $6.2 million, or 18.7%, and reinsurance
balances payable increased $4.9 million, or 20.9%, from December 31, 2011 to
June 30, 2012. Under most of our group ART programs, all members of the group
share a common renewal date. These common renewal dates are scheduled throughout
the year. However, we have several large ART programs that renew during the
first six months of a given fiscal year resulting in a large increase in
premiums receivable, unearned premiums, prepaid reinsurance premiums and
reinsurance balances payable. These balances gradually decline throughout the
remainder of the year.
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Liquidity and Capital Resources
The liquidity requirements of our insurance subsidiaries relate primarily to the
liabilities associated with their products as well as operating costs and
payments of dividends and taxes to us from insurance subsidiaries. Historically
and during the first six months of 2012, cash flows from premiums and investment
income have provided sufficient funds to meet these requirements, without
requiring significant liquidation of investments. If our cash flows change
dramatically from historical patterns, for example as a result of a decrease in
premiums, an increase in claims paid or operating expenses, or financing an
acquisition, we may be required to sell securities before their maturity and
possibly at a loss. Our insurance subsidiaries generally hold a significant
amount of highly liquid, short-term investments or cash and cash equivalents to
meet their liquidity needs. Our historic pattern of using receipts from current
premium writings for the payment of liabilities incurred in prior periods
provides us with the option to extend the maturities of our investment portfolio
beyond the estimated settlement date of our loss reserves. Funds received in
excess of cash requirements are generally invested in additional marketable
securities.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay
claims and operating expenses, as well as meet commitments in the event of
unforeseen events such as reserve deficiencies, inadequate premium rates or
reinsurer insolvencies. Our principal sources of liquidity are our existing
cash, cash equivalents and short-term investments. Cash and cash equivalents
increased $16.7 million from $23.7 million at December 31, 2011 to $40.4 million
at June 30, 2012. We generated net cash from operations of $37.3 million for the
six months ended June 30, 2012, compared to $20.2 million during the comparable
period in 2011. This increase of $17.1 million is primarily attributable to a
decrease in claim payments related to the runoff of the guaranteed Vanliner
reserves and lower estimated federal income tax payments made during the first
six months of 2012 as compared to the same period in 2011, partially offset by
unearned premiums due to our flat premiums written in the first half of 2012
compared to the significant premium growth experienced during the same period in
2011. Estimated tax payments made during the first half of 2011 included $8.4
million associated with the Vanliner acquisition (included in the line item
"Increase (decrease) in accounts payable, commissions and other liabilities and
assessments and fees payable" on our Consolidated Statement of Cash Flows at
June 30, 2011), which was offset by cash received of an equal amount included in
"Collection of amounts refundable on the purchase price of Vanliner" in the
investing activities section of our Consolidated Statement of Cash Flows for the
six months ended June 30, 2011.
Net cash used in investing activities was $16.7 million and $6.3 million for the
six months ended June 30, 2012 and 2011, respectively. Contributing to the $10.4
million increase in cash used in investing activities was a $75.1 million
decrease in the proceeds from maturities and redemptions of fixed maturity
investments, partially offset by a $45.1 million decrease in the purchases of
fixed maturity investments. The decreases in investment activity in 2012 were
due to a large number of securities obtained as part of the Vanliner acquisition
maturing during the first six months of 2011, and the subsequent reinvestment of
the proceeds from those securities. The net purchases of fixed maturities during
the first six months of 2012 were primarily concentrated in state and local
government obligations and commercial mortgage-backed securities. Included in
the change in cash used in investing activities was the receipt of the $14.3
million refund in the first six months of 2011 on the purchase price of Vanliner
related to making the election under Section 338(h)(10) of the Internal Revenue
Code and the finalization of the tangible book value. Also contributing to the
change in cash used in investing activities was a $14.7 million increase in the
proceeds from the sale of fixed maturity investments, a $9.1 million decrease in
the purchases of equity securities and a $6.3 million decrease in the purchases
of other investments, which are comprised of limited partnership investments.
Net cash used in financing activities was $3.9 million and $1.6 million for the
six months ended June 30, 2012 and 2011, respectively. This $2.3 million
increase in cash used in financing activities was primarily driven by the $2.0
million draw on our credit facility in the second quarter of 2011. There have
been no such draws on the credit facility during the first six months of 2012.
We have continuing cash needs for administrative expenses, the payment of
principal and interest on borrowings, shareholder dividends and taxes. Funds to
meet these obligations will come primarily from parent company cash, dividends
and other payments from our insurance company subsidiaries.
We have a $50.0 million unsecured Credit Agreement (the "Credit Agreement") that
terminates in December 2012, which includes a sublimit of $10.0 million for
letters of credit. We have the ability to increase the line of credit to $75.0
million subject to the credit facility's accordion feature. At June 30, 2012
there was $22.0 million drawn on this credit facility. Amounts borrowed bear
interest at either (1) a rate per annum equal to the greater of the
administrative agent's prime rate or 0.5% in excess of the federal funds
effective rate or (2) rates ranging from 0.45% to 0.90% over LIBOR based on our
A.M. Best insurance group rating, or 0.65% at June 30, 2012. As of June 30,
2012, the interest rate on this debt is equal to the six-month LIBOR (0.4375% at
June 30, 2012) plus 65 basis points, with interest payments due quarterly.
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The Credit Agreement requires us to maintain specified financial covenants
measured on a quarterly basis, including consolidated net worth, fixed charge
coverage ratio and debt-to-capital ratio. In addition, the Credit Agreement
contains certain affirmative and negative covenants, including negative
covenants that limit or restrict our ability to, among other things, incur
additional indebtedness, effect mergers or consolidations, make investments,
enter into asset sales, create liens, enter into transactions with affiliates
and other restrictions customarily contained in such agreements. As of June 30,
2012, we were in compliance with all financial covenants.
We expect to procure a new line of credit during 2012 to replace the current
Credit Agreement prior to its expiration, although potentially at a higher cost.
Due to the favorable terms of the Credit Agreement relative to those currently
available in the commercial lending marketplace, we do not anticipate executing
a new credit agreement until the fourth quarter of 2012.
We believe that funds generated from operations, including dividends from
insurance subsidiaries and parent company cash will provide sufficient resources
to meet our liquidity requirements for at least the next 12 months. However, if
these funds are insufficient to meet fixed charges in any period, we would be
required to generate cash through sale of assets, sale of portfolio securities
or similar transactions. If we were required to sell portfolio securities early
for liquidity purposes rather than holding them to maturity, we would recognize
gains or losses on those securities earlier than anticipated. Our ongoing
corporate initiatives include actively evaluating potential acquisitions. At
such time that we would execute an agreement to enter into an acquisition, such
a transaction, depending upon the structure and size, could have an impact on
our liquidity. Since our ability to meet our obligations in the long-term
(beyond a 12-month period) is dependent upon factors such as market changes,
insurance regulatory changes and economic conditions, no assurance can be given
that the available net cash flow will be sufficient to meet our long-term
operating needs. We are not aware of any trends or uncertainties affecting our
liquidity, including any significant future reliance on short-term financing
arrangements.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect amounts reported in the financial statements. As
more information becomes known, these estimates and assumptions could change and
thus impact amounts reported in the future. Management believes that the
establishment of losses and LAE reserves and the determination of
"other-than-temporary" impairment on investments are the two areas where the
degree of judgment required in determining amounts recorded in the financial
statements make the accounting policies critical. For a more detailed discussion
of these policies, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Policies" in our
Annual Report on Form 10-K for the year ended December 31, 2011.
Losses and LAE Reserves
Significant periods of time can elapse between the occurrence of an insured
loss, the reporting of that loss to us and our final payment of that loss and
its related LAE. To recognize liabilities for unpaid losses, we establish
reserves as balance sheet liabilities. At June 30, 2012 and December 31, 2011,
we had $786.9 million and $776.6 million, respectively, of gross loss and LAE
reserves, representing management's best estimate of the ultimate
loss. Management records, on a monthly and quarterly basis, its best estimate of
loss reserves. For purposes of computing the recorded reserves, management
utilizes various data inputs, including analysis that is derived from a review
of prior quarter results performed by actuaries employed by Great American. In
addition, on an annual basis, actuaries from Great American review the recorded
reserves for NIIC, VIC, NIIC-HI and TCC utilizing current period data and
provide a Statement of Actuarial Opinion, required annually in accordance with
state insurance regulations, on the statutory reserves recorded by these U.S.
insurance subsidiaries. The actuarial analysis of NIIC's, VIC's, NIIC-HI's and
TCC's net reserves for the year ending December 31, 2011 reflected point
estimates that were within 2% of management's recorded net reserves as of such
dates. Using this actuarial data along with its other data inputs, management
concluded that the recorded reserves appropriately reflect management's best
estimates of the liability as of June 30, 2012 and December 31, 2011.
The quarterly reviews of unpaid loss and LAE reserves by Great American
actuaries are prepared using standard actuarial techniques. These may include
(but may not be limited to):
• the Case Incurred Development Method;
• the Paid Development Method;
• the Bornhuetter-Ferguson Method; and
• the Incremental Paid LAE to Paid Loss Methods.
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The period of time from the occurrence of a loss through the settlement of the
liability is referred to as the "tail." Generally, the same actuarial methods
are considered for both short-tail and long-tail lines of business because most
of them work properly for both. The methods are designed to incorporate the
effects of the differing length of time to settle particular claims. For
short-tail lines, management tends to give more weight to the Case Incurred and
Paid Development methods, although the various methods tend to produce similar
results. For long-tail lines, more judgment is involved and more weight may be
given to the Bornhuetter-Ferguson method. Liability claims for long-tail lines
are more susceptible to litigation and can be significantly affected by changing
contract interpretation and the legal environment. Therefore, the estimation of
loss reserves for these classes is more complex and subject to a higher degree
of variability.
Supplementary statistical information is reviewed to determine which methods are
most appropriate and whether adjustments are needed to particular methods. This
information includes:
• open and closed claim counts;
• average case reserves and average incurred on open claims;
• closure rates and statistics related to closed and open claim percentages;
• average closed claim severity;
• ultimate claim severity;
• reported loss ratios;
• projected ultimate loss ratios; and
• loss payment patterns.
Other-Than-Temporary Impairment
Our investments are exposed to at least one of three primary sources of
investment risk: credit, interest rate and market valuation risks. The financial
statement risks are those associated with the recognition of impairments and
income, as well as the determination of fair values. We evaluate whether
impairments have occurred on a case-by-case basis. Management considers a wide
range of factors about the security issuer and uses its best judgment in
evaluating the cause and amount of decline in the estimated fair value of the
security and in assessing the prospects for near-term recovery. Inherent in
management's evaluation of the security are assumptions and estimates about the
operations of the issuer and its future earnings potential. Considerations we
use in the impairment evaluation process include, but are not limited to:
• the length of time and the extent to which the market value has been below
amortized cost;
• whether the issuer is experiencing significant financial difficulties;
• economic stability of an entire industry sector or subsection;
• whether the issuer, series of issuers or industry has a catastrophic type
of loss;
• the extent to which the unrealized loss is credit-driven or a result of changes in market interest rates;
• historical operating, balance sheet and cash flow data;
• internally and externally generated financial models and forecasts;
• our ability and intent to hold the investment for a period of time
sufficient to allow for any anticipated recovery in market value; and
• other subjective factors, including concentrations and information
obtained from regulators and rating agencies.
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Under current other-than-temporary impairment accounting guidance, if management
can assert that it does not intend to sell an impaired fixed maturity security
and it is not more likely than not that it will have to sell the security before
recovery of its amortized cost basis, then an entity may separate the
other-than-temporary impairments into two components: 1) the amount related to
credit losses (recorded in earnings) and 2) the amount related to all other
factors (recorded in other comprehensive income (loss)). The credit related
portion of an other-than-temporary impairment is measured by comparing a
security's amortized cost to the present value of its current expected cash
flows discounted at its effective yield prior to the impairment charge. Both
components are required to be shown in the Consolidated Statements of Income. If
management intends to sell an impaired security, or it is more likely than not
that it will be required to sell the security before recovery, an impairment
charge is required to reduce the amortized cost of that security to fair value.
Additional disclosures required by this guidance are contained in Note 4 -
"Investments."
We closely monitor each investment that has a fair value that is below its
amortized cost and make a determination each quarter for other-than-temporary
impairment for each of those investments. There were no material
other-than-temporary impairment charges recorded during the three and six months
ended June 30, 2012 and 2011.
While it is not possible to accurately predict if or when a specific security
will become impaired, given the inherent uncertainty in the market, charges for
other-than-temporary impairment could be material to net income in subsequent
quarters. Management believes it is not likely that future impairment charges
will have a significant effect on our liquidity. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Financial
Condition - Investments."
Contractual Obligations/Off-Balance Sheet Arrangements
During the first six months of 2012, our contractual obligations did not change
materially from those discussed in our Annual Report on Form 10-K for the year
ended December 31, 2011.
We do not have any relationships with unconsolidated entities of financial
partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes.
