UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
Annual Report Pursuant to
Section 13 or 15(d) of the
Securities Exchange Act of
1934
For the Fiscal Year Ended December 31, 2009
Commission File No. 000-51130
National Interstate
Corporation
(Exact name of registrant as
specified in its charter)
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Ohio
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34-1607394
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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3250 Interstate Drive
Richfield, Ohio
44286-9000
(330) 659-8900
(Address and telephone number of
principal executive offices)
Securities Registered Pursuant to Section 12(b) of the
Act:
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Name of Exchange on
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Title of each class
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Which registered
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Common Shares, $0.01 par value
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Nasdaq Global Select Market
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Securities registered pursuant to Section 12(g) of the
Act:
None
Other securities for which reports are submitted pursuant to
Section (d) of the Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such
files). Yes o No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in
Rule 12b-2
of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
State the aggregate market value of the voting and non-voting
common equity held by non-affiliates computed by reference to
the price at which the common equity was last sold, or the
average bid and asked price of such common equity, as of the
last business day of the registrants most recently
completed second fiscal quarter: $100.2 million (based upon
non-affiliate holdings of 6,600,144 shares and a market
price of $15.18 at June 30, 2009).
As of March 1, 2010 there were 19,422,916 shares of
the Registrants Common Shares ($0.01 par value)
outstanding.
Documents
Incorporated by Reference:
Proxy Statement for 2010 Annual Meeting of Shareholders
(portions of which are incorporated by reference into
Part III hereof).
National
Interstate Corporation
Index to
Annual Report on
Form 10-K
2
FORWARD-LOOKING
STATEMENTS
This document, including information incorporated by reference,
contains forward-looking statements (within the
meaning of Private Securities Litigation Reform Act of 1995).
All statements, trend analyses and other information contained
in this
Form 10-K
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:
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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;
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our ability to manage our growth strategy;
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customer response to new products and marketing initiatives;
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tax law changes;
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increasing competition in the sale of our insurance products and
services and the retention of existing customers;
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changes in legal environment;
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regulatory changes or actions, including those relating to
regulation of the sale, underwriting and pricing of insurance
products and services and capital requirements;
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levels of natural catastrophes, terrorist events, incidents of
war and other major losses;
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adequacy of insurance reserves; and
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availability of reinsurance and ability of reinsurers to pay
their obligations.
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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.
3
PART I
Please refer to Forward-Looking Statements
following the Index in the front of this
Form 10-K.
Introduction
National Interstate Corporation (the Company,
we, our) and its subsidiaries operate as
an insurance holding company group that underwrites and sells
traditional and alternative property and casualty insurance
products primarily to the passenger transportation industry and
the trucking industry, 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. We were organized in Ohio in January 1989. In
December 1989, Great American Insurance Company (Great
American), a wholly-owned subsidiary of American Financial
Group, Inc., became our majority shareholder. Our principal
executive offices are located at 3250 Interstate Drive,
Richfield, Ohio, 44286 and our telephone number is
(330) 659-8900.
Securities and Exchange Commission (the SEC)
filings, news releases, our Code of Ethics and Conduct and other
information may be accessed free of charge through our website
at www.NationalInterstate.com. Information on the website is not
part of this
Form 10-K.
For both years ended December 31, 2009 and 2008, Great
American owned 52.6% of our outstanding shares. Our common
shares trade on the Nasdaq Global Select Market under the symbol
NATL.
We have four property and casualty insurance subsidiaries:
National Interstate Insurance Company (NIIC),
National Interstate Insurance Company of Hawaii, Inc.
(NIIC-HI), Triumphe Casualty Company
(TCC), Hudson Indemnity, Ltd. (HIL) and
six other agency and service subsidiaries. We write our
insurance policies on a direct basis through NIIC, NIIC-HI and
TCC. NIIC is licensed in all 50 states and the District of
Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New
Jersey. TCC, a Pennsylvania domiciled company, holds licenses
for multiple lines of authority, including auto-related lines,
in 24 states and the District of Columbia. HIL is domiciled
in the Cayman Islands and provides reinsurance for NIIC, NIIC-HI
and TCC primarily for the alternative risk transfer product.
Insurance products are marketed through multiple distribution
channels, including independent agents and brokers, program
administrators, affiliated agencies and agent internet
initiatives. We use our six agency and service subsidiaries to
sell and service our insurance business.
Property
and Casualty Insurance Operations
We are a specialty property and casualty insurance company with
a niche orientation and a focus on the transportation industry.
Founded in 1989, we have had an uninterrupted record of
profitability in every year since 1990, our first full year of
operation. We have also reported an underwriting profit in 19 of
the 21 years we have been in business. For the year ended
December 31, 2009, we had gross premiums written (direct
and assumed) of $344.9 million and net income of
$46.4 million.
We believe, based upon an informal survey of brokers
specializing in transportation insurance, that we are the
largest writer of insurance for the passenger transportation
industry in the United States. 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 believe these niche
markets typically are too small, too remote or too difficult to
attract or sustain most competitors. Examples of products that
we write for these markets include captive programs primarily
for transportation companies that we also refer to as
alternative risk transfer (55.9% of 2009 gross premiums
written), traditional property and casualty insurance for
transportation companies (19.3%), specialty personal lines,
consisting primarily of recreational and commercial vehicle
coverage (17.8%) and transportation and general commercial
insurance in Hawaii and Alaska (5.5%).
While many companies write property and casualty insurance for
transportation companies, we believe, based on financial
responsibility filings with the Federal Motor Carrier Safety
Administration, that few write passenger transportation coverage
nationwide. We know of only one or two other insurance companies
that have offered high limits coverage to motor coach, school
bus and limousine operators in all states or nearly all states
for more than a few years. We believe that we have been one of
the only two insurance companies to consistently provide
passenger
4
transportation insurance across all passenger transportation
classes and all regions of the country for at least the past ten
years. In addition to being one of only two national passenger
transportation underwriters, we also believe, based on our
discussions with brokers and customers in the passenger
transportation insurance market, that we are the only insurance
company offering homogeneous (i.e., to insureds in the same
industry) group captive insurance programs to this industry.
Product Management Organization. We believe we
have a competitive advantage in our major lines of business, in
part, as a result of our product management focus. Each of our
product lines is headed by a manager solely responsible for
achieving that product lines planned results. We believe
that the use of a product management organization provides the
focus required to successfully offer and manage a diverse set of
product lines. For example, we are willing to design custom
insurance programs, such as unique billing plans and
deductibles, for our large transportation customers based on
their needs. Our claims, accounting, information technology and
other support functions are organized to align their resources
with specific product line initiatives and needs. We know of
only one other insurance company that uses this type of hybrid
product management organization. We believe that most insurance
companies rely upon organization structures aligned around
functional specialties such as underwriting, actuarial,
operations, marketing and claims. Under the traditional
functional organization, the managers of each of these functions
typically provide service and support to multiple insurance
products. Our product managers are responsible for the
underwriting, pricing and marketing and they are held
accountable for underwriting profitability of a specific
insurance product. Other required services and support are
provided across product lines by functional managers.
Our
Products
We offer over 35 product lines in the specialty property and
casualty insurance market, which we group into four general
business components (transportation, alternative risk transfer,
specialty personal lines and Hawaii and Alaska) based on the
class of business, insureds risk participation or
geographic location.
The following table sets forth an analysis of gross premiums
written by business component during the years indicated:
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Year Ended December 31,
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2009
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2008
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2007
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Percent of
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Percent of
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Percent of
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Amount
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Total
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Amount
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Total
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Amount
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Total
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(Dollars in thousands)
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Alternative Risk Transfer
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$
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192,953
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55.9
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%
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$
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206,342
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54.3
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%
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$
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167,717
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48.5
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%
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Transportation
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66,537
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19.3
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%
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87,246
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22.9
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%
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90,984
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26.3
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%
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Specialty Personal Lines
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61,523
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17.8
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%
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59,065
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15.5
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%
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55,169
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15.9
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%
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Hawaii and Alaska
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18,576
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5.5
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%
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22,489
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5.9
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%
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25,126
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7.3
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%
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Other
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5,288
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1.5
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%
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5,154
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1.4
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%
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7,010
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2.0
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%
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Gross premiums written
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$
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344,877
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100.0
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%
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$
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380,296
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100.0
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%
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$
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346,006
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100.0
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%
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For 2009, the range of premiums for our business components and
their annual premium averages were as follows:
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Premium Range
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Annual Premium Average
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Alternative Risk Transfer
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$5,800-$2,652,000
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$69,300
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Transportation
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$24,200-$55,300
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$35,500
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Specialty Personal Lines
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$900-$2,700
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$1,100
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Hawaii and Alaska
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$2,000-$29,000
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$3,700
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Alternative Risk Transfer. We underwrite,
market and distribute primarily truck and passenger
transportation alternative risk insurance products, also known
as captives, as well as workers compensation coverage.
Captives are insurance or reinsurance companies that are owned
or rented by the participants in the captive
insurance program. Program participants share in the
underwriting profits or losses and the investment results
associated with
5
the risks of being insured by the captive insurance program.
Participants in these programs typically are interested in the
improved risk control, increased participation in the claims
settlement process and asset investment features associated with
a captive insurance program.
We support two forms of captive programs
member-owned and rented. In a member-owned captive, the
participants form, capitalize and manage their own reinsurance
company. In a rental captive, the reinsurance company is formed,
capitalized and managed by someone other than the participants.
The participants in a rental captive program pay a fee to the
reinsurance company owner to use the reinsurance facility in
their captive program; in other words, the participants
rent it. In both member-owned and rented captives,
we typically underwrite and price the risk, issue the policies
and adjust the claims. A portion of the risk and premium is
ceded to the captive insurance program. That captive insurance
program serves the same purpose for the captive participants
regardless of whether they own the reinsurance company or
rent it.
The revenue we earn, our profit margins and the risks we assume
are substantially consistent in member-owned captives and rented
captives. The primary differences to us are the expenses
associated with these programs and who ultimately bears those
expenses. In a member-owned captive, the participants own and
manage their own reinsurance company. Managing an off-shore
insurance company includes general management responsibilities,
financial statement preparation, actuarial analysis, investment
management, corporate governance, regulatory management and
legal affairs. If the actual expenses associated with managing a
member-owned captive exceed the funded projections, the
participants pay for these added expenses outside the insurance
transaction. Included in the premium we charge participants in
our rental captive programs is a charge to fund our expenses
related to the managing of our Cayman Island reinsurer used for
this purpose. Investment management expenses also are included
in the premium and we cap the participants expense
contribution regardless of whether or not we collect adequate
funds to operate the off-shore reinsurance company.
All other loss, expense and profit margin components are
substantially the same for our member-owned or rental captive
insurance programs. The advantage of a member-owned captive
program to the participants is the ability to change policy
issuing companies and service providers without changing the
makeup of their group. Rental captive participants are not
obligated to capitalize their own reinsurer. They generally
enjoy a slightly lower expense structure and their captive
program expenses are fixed for the policy year regardless of the
amount of expenses actually incurred to operate the reinsurer
and facilitate participant meetings.
The premiums generated by each of the captive insurance programs
offered by us are developed in a similar manner. The most
important component of the premium charged is the development of
the participants loss fund. The loss fund represents the
amount of premium needed to cover the participants
expected losses in the layer of risk being ceded to the captive
reinsurer. Participants may share in the losses on a quota share
or excess of loss basis. For a quota share program, the
participation percentage ranges from 5% to 60% of losses up to
$1 million. For excess of loss programs, the loss fund
typically involves the first loss layer which, depending on the
captive program, currently ranges from the first $50,000 to the
first $350,000 of loss per occurrence. Once the
participants loss fund is established, all other expenses
related to the coverages and services being provided are derived
by a formula agreed to in advance by the captive participants
and the service providers. We are the primary or only service
provider to every rental captive program we support. The service
providers issue policies, adjust claims, provide loss control
consulting services, assume the risk for losses exceeding the
captive program retention and either manage the member-owned
reinsurance company needed to facilitate the transfer of risk to
the participants or provide a rental reinsurance facility that
serves the same purpose. These items, which are included in
premiums charged to the insured, range from approximately 30.0%
to 70.0% of a $1 million policy premium depending on the
program structure and the loss layer ceded to the captive.
We entered the alternative risk transfer market in 1995 through
an arrangement with an established captive insurance consultant.
Together, we created what we believe, based on our discussions
with brokers and customers in the passenger transportation
insurance market, was the first homogeneous, member-owned
captive insurance program, TRAX U.S. Captive Insurance
Programsm,
for passenger transportation operators. Since 1996, we have
established additional group captives for passenger and
commercial transportation, including but not limited to, rental
cars, taxi cabs, liquefied petroleum gas distributors, buses,
crane and rigging operators, railroads and trucks. We expect to
introduce additional transportation captives in 2010. As of
December 31, 2009, we insured more than
6
380 transportation companies in captive insurance programs. No
one customer in our alternative risk transfer business accounted
for 10.0% or more of the revenues of this component of our
business during 2009. We also have partnered with insureds and
agents in captive programs, whereby the insured or agent shares
in underwriting results and investment income with our Cayman
Islands-based reinsurance subsidiary.
Transportation. We believe that we are the
largest writer of insurance for the passenger transportation
industry in the United States. In our transportation component,
we underwrite commercial auto liability, general liability,
physical damage and motor truck cargo coverages for truck and
passenger operators. Passenger transportation operators include
charter and tour bus companies, municipal transit systems,
school transportation contractors, limousine companies,
inter-city bus services and community service and paratransit
operations. No one customer in our transportation component
accounted for 10.0% or more of the revenues of this component
during 2009. We also assume a majority of the net risk related
to policies for transportation risks underwritten by us and
issued by Great American, which accounted for approximately 1.0%
of our gross premiums written for the year ended
December 31, 2009. We do not have similar arrangements with
any other companies.
Specialty Personal Lines. We believe our
specialty recreational vehicle, or RV insurance program, differs
from those offered by traditional personal auto insurers because
we offer coverages written specifically for RV owners, including
those who live in their RV full-time. We offer coverage for
campsite liability, vehicle replacement coverage and coverage
for trailers, golf carts and campsite storage facilities. In
addition to our RV product, we also offer companion personal
auto coverage to RV policyholders. This product covers the
automobiles owned by our insured RV policyholders. One feature
of our companion auto product that we believe is not generally
available from other insurers is the application of a single
deductible when an insured RV and the insured companion auto
being towed are both damaged in an accident. We also assume all
of the net risk related to policies for recreational vehicle
risks underwritten by us and issued by Great American, our
majority shareholder. Also included in the specialty personal
lines component is the commercial vehicle product, which we
began offering in 2006 in one state. This product, offered in
three states as of December 31, 2009, provides coverage for
companies with vehicles used by contractors, artisans and other
small businesses. We currently insure vehicles ranging from
private passenger autos to customized vans and dump trucks.
Although this product is not material to our overall operations,
it experienced strong premium growth in 2009, increasing
$7.2 million over 2008. We expect to continue introducing
this product in additional states, while leveraging current
technology advances to enhance our existing distribution
channels.
Hawaii and Alaska. We entered the Hawaiian
transportation insurance market in 1995. The major insurance
product managed by the Hawaii office was general commercial
insurance sold to Hawaiian small business owners, which remains
an important part of our business. Since 1996, we have expanded
our product offerings in Hawaii by adding our transportation
insurance and believe that we have now become the leading writer
of transportation insurance in that state. Through our office in
Hawaii, we entered the Alaskan insurance market in 2005,
offering similar products to those we offer in Hawaii.
7
Geographic
Concentration
The following table sets forth the geographic distribution of
our direct premiums written for the years indicated:
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Year Ended December 31,
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2009
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2008
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Percent of
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Percent of
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Volume
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Total
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Volume
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Total
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(Dollars in thousands)
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California
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$
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40,693
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12.0
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%
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$
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57,564
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15.5
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%
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Texas
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39,156
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11.6
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%
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33,676
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9.1
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%
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New York
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18,554
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5.5
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%
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20,340
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5.4
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%
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Hawaii
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18,452
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5.5
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%
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22,574
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6.1
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%
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Florida
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16,441
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4.9
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%
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24,849
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6.7
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%
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North Carolina
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15,267
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4.5
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%
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18,015
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4.9
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%
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Massachusetts
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15,119
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4.5
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%
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10,697
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2.9
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%
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Pennsylvania
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14,848
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4.4
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%
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12,971
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3.5
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%
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All other states
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159,442
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47.1
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%
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170,557
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45.9
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%
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Direct premiums written
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$
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337,972
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100.0
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%
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$
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371,243
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100.0
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%
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Concentration
by Statutory Line of Business
The following table sets forth our direct premiums written by
statutory line of business for the years indicated:
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|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
Percent of
|
|
|
|
|
|
Percent of
|
|
|
|
Volume
|
|
|
Total
|
|
|
Volume
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
Auto and other liability
|
|
$
|
197,766
|
|
|
|
58.5
|
%
|
|
$
|
228,119
|
|
|
|
61.4
|
%
|
Auto physical damage
|
|
|
72,375
|
|
|
|
21.4
|
%
|
|
|
74,886
|
|
|
|
20.2
|
%
|
Workers compensation
|
|
|
57,143
|
|
|
|
16.9
|
%
|
|
|
49,634
|
|
|
|
13.4
|
%
|
All other lines
|
|
|
10,688
|
|
|
|
3.2
|
%
|
|
|
18,604
|
|
|
|
5.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct premiums written
|
|
$
|
337,972
|
|
|
|
100.0
|
%
|
|
$
|
371,243
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting
We employ a pricing segmentation approach that makes extensive
use of proprietary data and pricing methodologies. Our pricing
strategy enables our product managers to manage rate structures
by evaluating detailed policyholder information, such as loss
experience based on driver characteristics, financial
responsibility scores (where legally permissible) and the
make/model of vehicles. This pricing segmentation approach
differs by product line and requires extensive involvement of
product managers, who are responsible for the underwriting
profitability of a specific product line with direct oversight
of product design and rate level structure by our most senior
managers. Individual product managers work closely with our
pricing and database managers to generate rate level indications
and other relevant data. We use this data, coupled with the
actuarial loss costs obtained from the Insurance Services
Office, an insurance industry advisory service organization, as
a benchmark in the formulation of pricing for our products. We
believe the quality of our proprietary data, combined with our
rigorous approach, has permitted us to respond more quickly than
our competitors to adverse trends such as the continuing
increase in auto liability loss severity and to obtain accurate
pricing and risk selection for each individual account.
Risk selection and pricing decisions are discussed regularly by
product line underwriters and product managers. We believe this
groups input and deliberation on pricing and risk selection
reaffirms our philosophy and underwriting culture and aids in
avoiding unknown exposures. Underwriting files at both our
regional and
8
corporate offices are audited by senior management on a regular
basis for compliance with our price and risk selection criteria.
Product managers are responsible for the underwriting
profitability resulting from these risk selection and pricing
decisions and the incentive-based portion of their compensation
is based, in part, on that profitability.
Marketing
and Distribution
We offer our products through multiple distribution channels
including independent agents and brokers, program
administrators, affiliated agencies and agent internet
initiatives. During the year ended December 31, 2009,
approximately 89% of our gross premiums written were generated
by independent agents and brokers and approximately 11% were
generated by our affiliated agencies. Together, our top two
independent agents/brokers accounted for less than 12% of our
gross premiums written during 2009.
Reinsurance
We are involved in both the cession and assumption of
reinsurance. We reinsure a portion of our business to other
insurance companies. Ceding reinsurance permits diversification
of our risks and limits our maximum loss arising from large or
unusually hazardous risks or catastrophic events. We are subject
to credit risk with respect to our reinsurers, because the
ceding of risk to a reinsurer generally does not relieve us of
liability to our insureds until claims are fully settled. To
mitigate this credit risk, we cede business only to reinsurers
if they meet our credit ratings criteria of an A.M. Best
rating of A− or better. If a reinsurer is not
rated by A.M. Best or their rating falls below
A−, our contract with them generally requires
that they secure outstanding obligations with cash, a trust or a
letter of credit that we deem acceptable.
We are party to agreements with Great American pursuant to which
we assume a majority of the premiums written by Great American
for transportation and RV risks. We then pay Great American a
service fee based on these premiums. Great American also
participates in several of our commercial transportation
reinsurance programs. Ceded premiums written with Great American
were $3.1 million, $3.5 million and $4.0 million
for the years ended December 31, 2009, 2008 and 2007,
respectively. We also provide administrative services to Great
American in connection with the public transportation risks that
we underwrite on their policies.
Claims
Management and Administration
We believe that effective claims management is critical to our
success and that our process is cost efficient, delivers the
appropriate level of claims service and produces superior claims
results. We are focused on controlling claims from their
inception with thorough investigation, accelerated communication
to insureds and claimants and compressing the cycle time of
claim resolution to control both loss cost and claim handling
cost.
Claims arising under our insurance policies are reviewed,
supervised and handled by our internal claims department. As of
December 31, 2009, our claims organization employed
85 people (24% of our employee group) and operated out of
two regional offices. All of our claims employees have been
trained to handle claims according to our customer-focused
claims management processes and procedures and are subject to
periodic audit. We systematically conduct continuing education
for our claims staff in the areas of best practices, fraud
awareness, legislative changes and litigation management. We do
not delegate liability settlement authority to third party
administrators. All large claim reserves are reviewed on a
monthly basis by executive claims management and adjusters
frequently participate in audits and large loss reviews with
participating reinsurers. We also employ a formal large loss
review methodology that involves senior company management,
executive claims management and adjusting staff in a quarterly
review of all large loss exposures.
We provide
24-hour,
7 days per week, toll-free service for our policyholders to
report claims. In 2009, adjusters were able to initiate contact
with approximately 94% of policyholder claimants within
8 hours of first notice of a loss and approximately 84% of
third-party claimants. When we receive the first notice of loss,
our claims personnel open a file and establish appropriate
reserving to maximum probable exposure (based on our historical
claim settlement experience) as soon as practicable and
continually revise case reserves as new information develops. We
maintain and implement a fraud awareness program designed to
educate our claims employees and others
9
throughout the organization of fraud indicators. Potentially
fraudulent claims are referred for special investigation and
fraudulent claims are contested.
Our physical damage claims processes involve the utilization and
coordination of internal staff, vendor resources and property
specialists. We pay close attention to the vehicle repair
process, which we believe reduces the amount we pay for repairs,
storage costs and auto rental costs. During 2009, our physical
damage settlements in the continental United States averaged
savings of approximately 11% and savings of 14% in Hawaii for
the same period when compared to claimed damages.
Our captive programs have dedicated claims personnel and claims
services tailored to each captive program. Each captive program
has a dedicated claims manager, receives extra communications
pertaining to reserve changes
and/or
payments and has dedicated staff resources. In the captive
programs, 100% of customers completing our survey in 2009 rated
us as timely in our claims handling and 98% for the same period
rated their claims as thoroughly investigated.
We employ highly qualified and experienced liability adjusters
who are responsible for overseeing all injury-related losses
including those in litigation. We identify and retain
specialized outside defense counsel to litigate such matters. We
negotiate fee arrangements with retained defense counsel and
attempt to limit our litigation costs. The liability focused
adjusters manage these claims by placing a priority on detailed
file documentation and emphasizing investigation, evaluation and
negotiation of liability claims.
Reserves
for Unpaid Losses and Loss Adjustment Expenses
(LAE)
We estimate liabilities for the costs of losses and LAE for both
reported and unreported claims based on historical trends
adjusted for changes in loss costs, underwriting standards,
policy provisions, product mix and other factors. Estimating the
liability for unpaid losses and LAE is inherently judgmental and
is influenced by factors that are subject to significant
variation. We monitor items such as the effect of inflation on
medical, hospitalization, material repair and replacement costs,
general economic trends and the legal environment. While the
ultimate liability may be greater than recorded loss reserves,
the reserve tail for transportation coverage is generally
shorter than that associated with many other casualty coverages
and, therefore, generally can be established with less
uncertainty than coverages having longer reserve tails.
We review loss reserve adequacy and claims adjustment
effectiveness quarterly. We focus significant management
attention on claims reserved above $100,000. Further, our
reserves are certified by accredited actuaries from Great
American to state regulators annually. Reserves are routinely
adjusted as additional information becomes known. These
adjustments are reflected in current year operations.
The following tables present the development of our loss
reserves, net of reinsurance, on a U.S. generally accepted
accounting principles (GAAP) basis for the calendar
years 1999 through 2009. The top line of each table shows the
estimated liability for unpaid losses and LAE recorded at the
balance sheet date for the indicated year. The next line,
As re-estimated at December 31, 2009,
shows the re-estimated liability as of December 31, 2009.
The remainder of the table presents intervening development from
the initially estimated liability. This development results from
additional information and experience in subsequent years. The
middle line shows a net
10
cumulative (deficiency) redundancy which represents the
aggregate percentage (increase) decrease in the liability
initially estimated. The lower portion of the table indicates
the cumulative amounts paid as of successive periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Liability for Unpaid
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses And LAE:
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
|
(Dollars in thousands)
|
|
As originally estimated
|
|
$
|
26,566
|
|
|
$
|
30,292
|
|
|
$
|
48,456
|
|
|
$
|
67,162
|
|
|
$
|
86,740
|
|
|
$
|
111,644
|
|
|
$
|
151,444
|
|
|
$
|
181,851
|
|
|
$
|
210,302
|
|
|
$
|
262,440
|
|
|
$
|
276,419
|
|
As re-estimated at December 31, 2009
|
|
|
25,735
|
|
|
|
32,105
|
|
|
|
48,243
|
|
|
|
62,437
|
|
|
|
79,163
|
|
|
|
99,362
|
|
|
|
138,108
|
|
|
|
169,879
|
|
|
|
207,281
|
|
|
|
261,154
|
|
|
|
|
|
Liability re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
24,923
|
|
|
|
32,751
|
|
|
|
48,494
|
|
|
|
63,462
|
|
|
|
84,485
|
|
|
|
106,409
|
|
|
|
143,991
|
|
|
|
176,179
|
|
|
|
209,448
|
|
|
|
261,154
|
|
|
|
|
|
Two years later
|
|
|
26,252
|
|
|
|
33,473
|
|
|
|
47,479
|
|
|
|
64,687
|
|
|
|
83,862
|
|
|
|
103,416
|
|
|
|
142,929
|
|
|
|
173,860
|
|
|
|
207,281
|
|
|
|
|
|
|
|
|
|
Three years later
|
|
|
26,380
|
|
|
|
31,884
|
|
|
|
47,250
|
|
|
|
63,037
|
|
|
|
81,991
|
|
|
|
99,768
|
|
|
|
139,994
|
|
|
|
169,879
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
25,531
|
|
|
|
31,488
|
|
|
|
46,400
|
|
|
|
62,564
|
|
|
|
79,673
|
|
|
|
99,487
|
|
|
|
138,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
25,138
|
|
|
|
31,590
|
|
|
|
46,961
|
|
|
|
60,551
|
|
|
|
79,084
|
|
|
|
99,362
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
24,989
|
|
|
|
31,757
|
|
|
|
46,880
|
|
|
|
61,268
|
|
|
|
79,163
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
25,364
|
|
|
|
31,410
|
|
|
|
47,361
|
|
|
|
62,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
25,372
|
|
|
|
31,505
|
|
|
|
48,243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
25,471
|
|
|
|
32,105
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later
|
|
|
25,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative (deficiency) redundancy
|
|
|
831
|
|
|
|
(1,813
|
)
|
|
|
213
|
|
|
|
4,725
|
|
|
|
7,577
|
|
|
|
12,282
|
|
|
|
13,336
|
|
|
|
11,972
|
|
|
|
3,021
|
|
|
|
1,286
|
|
|
|
|
|
Net cumulative (deficiency) redundancy %
|
|
|
3.1
|
%
|
|
|
(6.0
|
%)
|
|
|
0.4
|
%
|
|
|
7.0%
|
|
|
|
8.7
|
%
|
|
|
11.0
|
%
|
|
|
8.8
|
%
|
|
|
6.6
|
%
|
|
|
1.4
|
%
|
|
|
0.5
|
%
|
|
|
|
|
Cumulative paid of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
10,307
|
|
|
|
14,924
|
|
|
|
18,048
|
|
|
|
22,792
|
|
|
|
29,616
|
|
|
|
37,049
|
|
|
|
51,901
|
|
|
|
63,314
|
|
|
|
67,673
|
|
|
|
91,615
|
|
|
|
|
|
Two years later
|
|
|
17,637
|
|
|
|
20,077
|
|
|
|
28,510
|
|
|
|
36,927
|
|
|
|
48,672
|
|
|
|
59,038
|
|
|
|
85,193
|
|
|
|
95,752
|
|
|
|
111,841
|
|
|
|
|
|
|
|
|
|
Three years later
|
|
|
20,157
|
|
|
|
24,313
|
|
|
|
35,718
|
|
|
|
48,660
|
|
|
|
61,001
|
|
|
|
76,617
|
|
|
|
101,340
|
|
|
|
119,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
22,383
|
|
|
|
26,869
|
|
|
|
40,615
|
|
|
|
53,531
|
|
|
|
68,594
|
|
|
|
84,070
|
|
|
|
112,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
23,413
|
|
|
|
28,591
|
|
|
|
43,474
|
|
|
|
57,697
|
|
|
|
71,904
|
|
|
|
89,821
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
24,033
|
|
|
|
30,180
|
|
|
|
45,365
|
|
|
|
59,035
|
|
|
|
74,938
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
24,594
|
|
|
|
30,813
|
|
|
|
45,828
|
|
|
|
61,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
24,926
|
|
|
|
30,863
|
|
|
|
47,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
25,008
|
|
|
|
31,549
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later
|
|
|
25,397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following is a reconciliation of our net liability to the gross
liability for unpaid losses and LAE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1999
|
|
2000
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
|
(Dollars in thousands)
|
|
As originally estimated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability shown above
|
|
$
|
26,566
|
|
|
$
|
30,292
|
|
|
$
|
48,456
|
|
|
$
|
67,162
|
|
|
$
|
86,740
|
|
|
$
|
111,644
|
|
|
$
|
151,444
|
|
|
$
|
181,851
|
|
|
$
|
210,302
|
|
|
$
|
262,440
|
|
|
$
|
276,419
|
|
Add reinsurance recoverables
|
|
|
11,396
|
|
|
|
12,416
|
|
|
|
22,395
|
|
|
|
35,048
|
|
|
|
41,986
|
|
|
|
59,387
|
|
|
|
71,763
|
|
|
|
84,115
|
|
|
|
91,786
|
|
|
|
137,561
|
|
|
|
140,841
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross liability
|
|
$
|
37,962
|
|
|
$
|
42,708
|
|
|
$
|
70,851
|
|
|
$
|
102,210
|
|
|
$
|
128,726
|
|
|
$
|
171,031
|
|
|
$
|
223,207
|
|
|
$
|
265,966
|
|
|
$
|
302,088
|
|
|
$
|
400,001
|
|
|
$
|
417,260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As re-estimated at December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability shown above
|
|
$
|
25,735
|
|
|
$
|
32,105
|
|
|
$
|
48,243
|
|
|
$
|
62,437
|
|
|
$
|
79,163
|
|
|
$
|
99,362
|
|
|
$
|
138,108
|
|
|
$
|
169,879
|
|
|
$
|
207,281
|
|
|
$
|
261,154
|
|
|
|
N/A
|
|
Add reinsurance recoverables reestimated
|
|
|
6,927
|
|
|
|
13,039
|
|
|
|
34,029
|
|
|
|
47,314
|
|
|
|
50,303
|
|
|
|
57,385
|
|
|
|
63,625
|
|
|
|
70,572
|
|
|
|
69,191
|
|
|
|
122,981
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross liability
|
|
$
|
32,662
|
|
|
$
|
45,144
|
|
|
$
|
82,272
|
|
|
$
|
109,751
|
|
|
$
|
129,466
|
|
|
$
|
156,747
|
|
|
$
|
201,733
|
|
|
$
|
240,451
|
|
|
$
|
276,472
|
|
|
$
|
384,135
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cumulative (deficiency) redundancy
|
|
$
|
5,300
|
|
|
$
|
(2,436
|
)
|
|
$
|
(11,421
|
)
|
|
$
|
(7,541
|
)
|
|
$
|
(740
|
)
|
|
$
|
14,284
|
|
|
$
|
21,474
|
|
|
$
|
25,515
|
|
|
$
|
25,616
|
|
|
$
|
15,866
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cumulative (deficiency) redundancy %
|
|
|
14.0
|
%
|
|
|
(5.7
|
%)
|
|
|
(16.1
|
%)
|
|
|
(7.4%
|
)
|
|
|
(0.6
|
%)
|
|
|
8.4
|
%
|
|
|
9.6
|
%
|
|
|
9.6
|
%
|
|
|
8.5
|
%
|
|
|
4.0
|
%
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
These tables do not present accident or policy year development
data. Furthermore, in evaluating the re-estimated liability and
cumulative (deficiency) redundancy, it should be noted that each
amount includes the effects of changes in amounts for prior
periods. Conditions and trends that have affected development of
the liability in the past may not necessarily exist in the
future. Accordingly, it may not be appropriate to extrapolate
future redundancies or deficiencies based on this table.
The preceding table shows our calendar year development for each
of the last ten years resulting from reevaluating the original
estimate of the loss and LAE liability on both a net and gross
basis. Gross reserves are liabilities for direct and assumed
losses and LAE before a reduction for amounts ceded. At
December 31, 2009, our liability on a gross basis was
$417.3 million and our asset for ceded reserves was
$140.8 million. The difference between gross development
and net development is ceded loss and LAE reserve development.
The range of dollar limits ceded by us is much greater and
therefore more volatile than the range of dollar limits we
retain, which could cause more volatility in estimates for ceded
losses. Therefore, ceded reserves are more susceptible to
development than net reserves. Net calendar year reserve
development affects our income for the year while ceded reserve
development or savings affects the income of reinsurers.
Investments
General
We approach investment and capital management with the intention
of supporting insurance operations by providing a stable source
of income to supplement underwriting income. The goals in our
investment policy are to protect capital while optimizing
investment income and capital appreciation and maintaining
appropriate liquidity. Our Board of Directors has established
investment guidelines and reviews the portfolio performance at
least quarterly for compliance with its established guidelines.
The following tables present the percentage distribution and
yields of our investment portfolio for the dates given:
|
|
|
|
|
|
|
|
|
|
|
At December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
Short term investments
|
|
|
0.1
|
%
|
|
|
0.0
|
%
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
US Government and government agencies
|
|
|
35.6
|
%
|
|
|
41.6
|
%
|
State and local government obligations
|
|
|
26.0
|
%
|
|
|
25.7
|
%
|
Residential mortgage-backed securities
|
|
|
19.6
|
%
|
|
|
16.2
|
%
|
Commercial mortgage-backed securities
|
|
|
0.7
|
%
|
|
|
0.0
|
%
|
Corporate obligations
|
|
|
11.3
|
%
|
|
|
8.6
|
%
|
Redeemable preferred stock
|
|
|
1.9
|
%
|
|
|
2.3
|
%
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
95.1
|
%
|
|
|
94.4
|
%
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
Perpetual preferred stocks
|
|
|
0.2
|
%
|
|
|
1.2
|
%
|
Common stocks
|
|
|
4.6
|
%
|
|
|
4.4
|
%
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
4.8
|
%
|
|
|
5.6
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
During the second quarter of 2009, we terminated our securities
lending program and transferred fixed maturities with a fair
market value of $35.8 million, primarily residential
mortgage-backed securities and corporate obligations, into our
fixed maturities portfolio. At December 31, 2008, the
distribution of holdings within the securities lending program
was as follows: 50.0% in cash and cash equivalents, 22.0% in
mortgage backed securities and 28.0% in corporate obligations.
12
The following table presents the yields of our investment
portfolio for the dates given:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Yield on short term investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Excluding realized gains and losses
|
|
|
1.0
|
%
|
|
|
5.5
|
%
|
|
|
4.9
|
%
|
Including realized gains and losses
|
|
|
1.0
|
%
|
|
|
5.5
|
%
|
|
|
4.9
|
%
|
Yield on fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Excluding realized gains and losses
|
|
|
3.7
|
%
|
|
|
4.5
|
%
|
|
|
4.8
|
%
|
Including realized gains and losses
|
|
|
3.5
|
%
|
|
|
3.4
|
%
|
|
|
4.7
|
%
|
Yield on equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Excluding realized gains and losses
|
|
|
2.3
|
%
|
|
|
3.5
|
%
|
|
|
4.6
|
%
|
Including realized gains and losses
|
|
|
16.5
|
%
|
|
|
(42.8
|
%)
|
|
|
3.4
|
%
|
Yield on all investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Excluding realized gains and losses
|
|
|
3.7
|
%
|
|
|
4.4
|
%
|
|
|
4.8
|
%
|
Including realized gains and losses
|
|
|
4.1
|
%
|
|
|
(0.3
|
%)
|
|
|
4.6
|
%
|
The table below compares total returns on our fixed maturities
and equity securities to comparable public indices. We benchmark
our fixed maturity portfolio to the Barclays Intermediate
Aggregate Index because we believe it best matches our
investment strategy and the resulting composition of our
portfolio. For similar reasons we benchmark our preferred stock
portfolio against the Merrill Lynch Preferred Stock Index and
all other equity investments against the Standard &
Poors 500 Index. Both our performance and the indices
include investment income, realized gains and losses and changes
in unrealized gains and losses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
National Interstate Total Return on Fixed Maturities
|
|
|
7.1
|
%
|
|
|
3.9
|
%
|
|
|
6.9
|
%
|
Barclays Intermediate Aggregate Index
|
|
|
6.5
|
%
|
|
|
4.9
|
%
|
|
|
7.0
|
%
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
National Interstate Total Return on Preferred Stock
|
|
|
33.8
|
%
|
|
|
(27.2
|
%)
|
|
|
(13.9
|
%)
|
Merrill Lynch Preferred Stock Index
|
|
|
26.6
|
%
|
|
|
(37.9
|
%)
|
|
|
(11.7
|
%)
|
National Interstate Total Return on all other Equity
|
|
|
30.8
|
%
|
|
|
(29.6
|
%)
|
|
|
4.3
|
%
|
Standard & Poors 500 Index
|
|
|
26.5
|
%
|
|
|
(37.0
|
%)
|
|
|
5.5
|
%
|
13
Fixed
Maturity Investments
Our fixed maturity portfolio is primarily invested in investment
grade securities. The following table shows our fixed maturity
securities by Standard & Poors
(S&P) Corporation or comparable rating as of
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities
|
|
S&P or Comparable Rating
|
|
Amortized Cost
|
|
|
Fair Value
|
|
|
% of Total
|
|
|
|
(Dollars in thousands)
|
|
|
AAA, AA, A
|
|
$
|
494,950
|
|
|
$
|
501,578
|
|
|
|
88.5
|
%
|
BBB
|
|
|
35,592
|
|
|
|
34,805
|
|
|
|
6.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investment Grade
|
|
|
530,542
|
|
|
|
536,383
|
|
|
|
94.6
|
%
|
BB
|
|
|
15,008
|
|
|
|
13,785
|
|
|
|
2.4
|
%
|
B
|
|
|
6,973
|
|
|
|
7,050
|
|
|
|
1.3
|
%
|
CCC
|
|
|
8,392
|
|
|
|
4,371
|
|
|
|
0.8
|
%
|
CC, C, D
|
|
|
4,838
|
|
|
|
5,312
|
|
|
|
0.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-Investment Grade
|
|
|
35,211
|
|
|
|
30,518
|
|
|
|
5.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
565,753
|
|
|
$
|
566,901
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The maturity distribution of fixed maturity investments held as
of December 31, 2009 is as follows (actual maturities may
differ from scheduled maturities due to the borrower having the
right to call or prepay certain obligations):
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
|
|
Fair Value
|
|
|
% of Total
|
|
|
|
(Dollars in thousands)
|
|
|
One year or less
|
|
$
|
29,578
|
|
|
|
5.2
|
%
|
More than one year to five years
|
|
|
209,201
|
|
|
|
36.9
|
%
|
More than five years to ten years
|
|
|
165,780
|
|
|
|
29.2
|
%
|
More than ten years
|
|
|
41,694
|
|
|
|
7.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
446,253
|
|
|
|
78.7
|
%
|
Mortgage-backed securities
|
|
|
120,648
|
|
|
|
21.3
|
%
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
566,901
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
The fixed income investment funds are generally invested in
securities with short-term and intermediate-term maturities with
an objective of optimizing total return while allowing
flexibility to react to changes in market conditions and
maintaining sufficient liquidity to meet policyholder
obligations. At December 31, 2009, the weighted average
modified duration (unadjusted for call provision) was
approximately 4.1 years, the weighted average effective
duration (adjusted for call provisions) was 3.3 years and
the weighted average maturity was 4.8 years. The concept of
weighted average effective duration takes into consideration the
probability of the exercise of the various call features
associated with many of the fixed income securities we hold.
Fixed income securities are frequently issued with call
provisions that provide the issuer the option of accelerating
the maturity of the security.
Competition
The commercial transportation insurance industry is highly
competitive and, except for regulatory considerations, there are
relatively few barriers to entry. We compete with numerous
insurance companies and reinsurers, including large national
underwriters and smaller niche insurance companies. In
particular, in the specialty insurance market we compete
against, among others, Lancer Insurance Company, RLI
Corporation, American Alternative Insurance Corporation,
Progressive Corporation, Island Insurance Company, Great West
Casualty Company (a subsidiary of Old Republic International
Corporation), Northland Insurance Company (a subsidiary of the
Travelers Companies, Inc.), Century Insurance Group and American
Modern Home Insurance Company (a
14
subsidiary of Munich Re Group). We compete in the property and
casualty insurance marketplace with other insurers on the basis
of price, coverages offered, product and program design, claims
handling, customer service quality, agent commissions where
applicable, geographic coverage, reputation and financial
strength ratings by independent rating agencies. We compete by
developing product lines to satisfy specific market needs and by
maintaining relationships with our independent agents and
customers who rely on our expertise. This expertise, along with
our reputation for offering specialty underwriting products, is
our principal means of distinguishing ourselves from our
competitors.
We believe we have a competitive advantage in our major lines of
business as a result of the extensive experience of our
management, our superior service and products, our willingness
to design custom insurance programs for our large transportation
customers and the extensive use of current technology with
respect to our insureds and independent agent force. However, we
are not top-line oriented and will readily sacrifice
premium volume during periods that we believe exhibit
unrealistic rate competition. Accordingly, should competitors
determine to buy market share with unprofitable
rates, our insurance subsidiaries could experience limited
growth or a decline in business until market pricing returns to,
what we view as, profitable levels.
Ratings
A.M. Best assigned our current group rating of
A (Excellent) to our domestic insurance companies.
According to A.M. Best, A ratings are assigned
to insurers that have, on balance, excellent balance sheet
strength, operating performance and business profile when
compared to the standards established by A.M. Best and, in
A.M. Bests opinion, have a strong ability to meet
their ongoing obligations to policyholders. The objective of
A.M. Bests rating system is to provide potential
policyholders and other interested parties an opinion of an
insurers financial strength and ability to meet ongoing
obligations, including paying claims. This rating reflects
A.M. Bests analysis of our balance sheet, financial
position, capitalization and management. This rating is subject
to periodic review and may be revised downward, upward or
revoked at the sole discretion of A.M. Best. Any changes in
our rating category could affect our competitive position.
Regulation
State
Regulation
General
Our insurance subsidiaries are subject to regulation in all
fifty states, Washington D.C. and the Cayman Islands. The extent
of regulation varies, but generally derives from statutes that
delegate regulatory, supervisory and administrative authority to
a department of insurance in each state in which the companies
transact insurance business. These statutes and regulations
generally require each of our insurance subsidiaries to register
with the state insurance department where the company is
domiciled and to furnish annually financial and other
information about the operations of the company. Certain
transactions and other activities by our insurance companies
must be approved by Ohio, Pennsylvania or Cayman Islands
regulatory authorities before the transaction takes place.
The regulation, supervision and administration also relate to
statutory capital and reserve requirements and standards of
solvency that must be met and maintained, the payment of
dividends, changes of control of insurance companies, the
licensing of insurers and their agents, the types of insurance
that may be written, the regulation of market conduct, including
underwriting and claims practices, provisions for unearned
premiums, losses, LAE and other obligations, the ability to
enter and exit certain insurance markets, the nature of and
limitations on investments, premium rates or restrictions on the
size of risks that may be insured under a single policy, privacy
practices, deposits of securities for the benefit of
policyholders, payment of sales compensation to third parties
and the approval of policy forms and guaranty funds.
State insurance departments also conduct periodic examinations
of the business affairs of our insurance companies and require
us to file annual financial and other reports, prepared under
statutory accounting principles, relating to the financial
condition of companies and other matters. These insurance
departments conduct periodic examinations of the books and
records, financial reporting, policy filings and market conduct
of our insurance companies doing business in their states,
generally once every three to five years, although target
financial, market
15
conduct and other examinations may take place at any time. These
examinations are generally carried out in cooperation with the
insurance departments of other states in which our insurance
companies transact insurance business under guidelines
promulgated by the NAIC. Our last financial examination for our
domestic insurance subsidiaries was completed by the Ohio
Department of Insurance, which coordinated the exam for Ohio,
Pennsylvania and Hawaii, for the period ending December 31,
2005. No significant issues surfaced. In addition to financial
examinations, we may be subject to market conduct examinations
of our claims and underwriting practices. We are currently in
various stages of market conduct examinations by the Departments
of Insurance from California and Delaware. During 2009, we
concluded a market conduct examination of our underwriting
practices by the North Carolina Department of Insurance and in
January of 2010, we concluded an examination of our claims
handling practices by the Nevada Department of Insurance.
Additionally, during 2009, we received notice that the Missouri
Department of Insurance intends to conduct a market conduct
examination. The findings of the North Carolina and Nevada
insurance departments did not result in fines or penalties
against us, but any adverse findings by other insurance
departments could result in significant fines and penalties,
negatively affecting our profitability.
Generally, all material transactions among affiliated companies
in our holding company system to which any of our insurance
subsidiaries is a party, including sales, loans, reinsurance
agreements, management agreements and service agreements must be
fair and reasonable. In addition, if the transaction is material
or of a specified category, prior notice and approval (or
absence of disapproval within a specified time limit) by the
insurance department where the subsidiary is domiciled is
required.
Statutory
Accounting Principle (SAP)
SAP is a basis of accounting developed to assist insurance
regulators in monitoring and regulating the solvency of
insurance companies. One of the primary goals is to measure an
insurers statutory surplus. Accordingly, statutory
accounting focuses on valuing assets and liabilities of our
insurance subsidiaries at financial reporting dates in
accordance with appropriate insurance law and regulatory
provisions applicable in each insurers domiciliary state.
Insurance departments utilize SAP to help determine whether our
insurance companies will have sufficient funds to timely pay all
the claims of our policyholders and creditors. GAAP gives more
consideration to matching of revenue and expenses than SAP. As a
result, assets and liabilities will differ in financial
statements prepared in accordance with GAAP as compared to SAP.
SAP, as established by the NAIC and adopted, for the most part,
by the various state insurance regulators determine, among other
things, the amount of statutory surplus and net income of our
insurance subsidiaries and thus determine, in part, the amount
of funds they have available to pay as dividends to us.
Restrictions
on Paying Dividends
State insurance law restricts the ability of our insurance
subsidiaries to declare shareholder dividends and requires our
insurance companies to maintain specified levels of statutory
capital and surplus. The amount of an insurers surplus
following payment of any dividends must be reasonable in
relation to the insurers outstanding liabilities and
adequate to meet its financial needs. Limitations on dividends
are generally based on net income or statutory capital and
surplus.
The maximum amount of dividends that our insurance companies can
pay to us in 2010 without seeking regulatory approval is
$33.1 million. NIIC paid no dividends in 2009 or 2008.
Assessments
and Fees Payable
Virtually all states require insurers licensed to do business in
their state to bear a portion of the loss suffered by insureds
as a result of the insolvency of other insurers. Significant
assessments could limit the ability of our insurance
subsidiaries to recover such assessments through tax credits or
other means. We paid assessments of $1.7 million,
$2.4 million and $2.3 million in the years ended
December 31, 2009, 2008 and 2007, respectively. Our
estimated liability for anticipated assessments was
$3.2 million and $3.6 million the years ended
December 31, 2009 and 2008, respectively.
16
Risk-Based
Capital (RBC) Requirements
In order to enhance the regulation of insurer solvency, the NAIC
has adopted formulas and model laws to determine minimum capital
requirements and to raise the level of protection that statutory
surplus provides for policyholder obligations. The model law
provides for increasing levels of regulatory intervention as the
ratio of an insurers total adjusted capital and surplus
decreases relative to its RBC, culminating with mandatory
control of the operations of the insurer by the domiciliary
insurance department at the so-called mandatory control
level. At December 31, 2009, the capital and surplus
of all of our insurance companies substantially exceeded the RBC
requirements.
Restrictions
on Cancellation, Non-Renewal or Withdrawal
Many states in which we conduct business have laws and
regulations that limit the ability of our insurance companies
licensed in that state to exit a market, cancel policies or not
renew policies. Some states prohibit us from withdrawing one or
more lines of business from the state, except pursuant to a plan
approved by the state insurance regulator, which may disapprove
a plan that may lead to market disruption.
Federal
Regulation
General
The federal government generally does not directly regulate the
insurance business. However, federal legislation and
administrative policies in several areas, including age and sex
discrimination, consumer privacy, terrorism and federal taxation
and motor-carrier safety, do affect our insurance business.
While we cannot predict whether the federal government will
become significantly involved in insurance regulation in 2010 or
later, if at all, we expect that the federal governments
reaction to the recent economic events that have transpired in
the United States in the last two years, may include some type
of federal oversight of the insurance industry, including
possibly establishing a federal insurance charter and a Federal
Insurance Office. We will continue to monitor all significant
federal insurance legislation.
The
Terrorism Risk Insurance Act (the Act)
The Terrorism Risk Insurance Program Reauthorization Act of 2007
extended the temporary federal program that provides for a
transparent system of shared public and private compensation for
insured losses resulting from acts of terrorism. The Act
requires commercial insurers to make terrorism coverage
available for commercial property/casualty losses, including
workers compensation. Commercial auto, burglary/theft,
surety, professional liability and farmowners multiple-peril are
not included in the program. The event trigger under
the Act provides that in the case of a certified act of
terrorism occurring after March 31, 2006, no federal
compensation shall be paid by the Secretary of Treasury unless
aggregate industry losses exceed $100 billion. The federal
government will pay 85% of covered terrorism losses in 2010 in
excess of the event trigger.
We are continuing to take the steps necessary to comply with the
Act, as well as the state regulations in implementing its
provisions, by providing required notices to commercial
policyholders describing coverage provided for certified acts of
terrorism (as defined by the Act). We do not anticipate
terrorism losses to have a material impact on our results of
operations.
To our knowledge and based on our internal review and control
process for compliance, we believe we have been in compliance in
all material respects with the laws, rules and regulations
described above.
Employees
At December 31, 2009, we employed
351 people. None of our employees are covered by
collective bargaining arrangements.
17
Please
refer to Forward-Looking Statements following the
Index in the front of this
Form 10-K.
All material risks and uncertainties currently known regarding
our business operations are included in this section. If any of
the following risks, or other risks and uncertainties that we
have not yet identified or that we currently consider not to be
material, actually occur, our business, prospects, financial
condition, results of operations and cash flows could be
materially and adversely affected.
Market
fluctuations, changes in interest rates or a need to generate
liquidity can have significant and negative effects on our
investment portfolio.
Our results of operations depend in part on the performance of
our invested assets. As of December 31, 2009, 95.1% of our
investment portfolio (excluding cash and cash equivalents) was
invested in fixed maturities, 4.8% was invested in equity
securities and 0.1% was invested in short-term investments. As
of December 31, 2009, approximately 37.5% of our fixed
maturity portfolio was invested in U.S. Government and
government agency fixed income securities and approximately
94.6% of the fixed maturities were invested in fixed maturities
rated investment grade (credit rating of AAA to
BBB-) by Standard & Poors Corporation.
Investment returns are an important part of our overall
profitability. We cannot predict which industry sectors in which
we maintain investments may suffer losses as a result of
potential declines in commercial and economic activity, or how
any such decline might impact the ability of companies within
the affected industry sectors to pay interest or principal on
their securities and we cannot predict how or to what extent the
value of any underlying collateral might be affected.
Accordingly, adverse fluctuations in the fixed income or equity
markets could adversely impact our profitability, financial
condition or cash flows.
Markets in the United States and around the world have been
experiencing volatility since mid-2007. Initiatives taken by the
U.S. and foreign governments have helped to stabilize the
financial markets and restore liquidity to the banking system
and credit markets. However, the financial system has not
completely stabilized and market volatility could continue in
the future if there is a prolonged recession or a worsening in
key economic indicators. If market conditions deteriorate, our
investment portfolio could be adversely impacted.
Historically, we have not had the need to sell our investments
to generate liquidity. If we were forced to sell portfolio
securities that have unrealized losses for liquidity purposes
rather than holding them to maturity or recovery, we would
recognize investment losses on those securities when that
determination was made.
We may
not have access to capital in the future due to an economic
downturn.
We may need new or additional financing in the future to conduct
our operations, expand our business or refinance existing
indebtedness. Any sustained weakness in the general economic
conditions
and/or
financial markets in the United States or globally could affect
adversely our ability to raise capital on favorable terms or at
all. From time to time we have relied, and may also rely in the
future, on access to financial markets as a source of liquidity
for operations, acquisitions and general corporate purposes. Our
access to funds under our $50 million unsecured Credit
Agreement (Credit Agreement) is dependent on the
ability of the financial institutions that are parties to the
facility to meet their funding commitments. Those financial
institutions may not be able to meet their funding commitments
if they experience shortages of capital and liquidity or if they
experience excessive volumes of borrowing requests within a
short period of time. Financial markets in the
U.S. experienced extreme volatility during the latter part
of 2008 and early 2009, which was characterized by the
bankruptcy, failure, collapse or sale of various financial
institutions and an unprecedented level of intervention from the
United States federal government. Longer term volatility and
continued disruptions in the capital and credit markets could
adversely affect our access to the liquidity needed for our
operations in the longer term. Such disruptions could require us
to take measures to conserve cash until the markets stabilize or
until alternative credit arrangements or other funding for our
business needs can be arranged. Further economic disruptions and
any resulting limitations on future funding, including any
restrictions on access to funds under our Credit Agreement,
could have a material adverse effect on our results of
operations and financial condition.
18
Our
ability to recognize future tax benefits on realized and
unrealized investment losses is limited.
At December 31, 2009, we had gross deferred tax assets of
$6.4 million related to investment securities. This gross
deferred tax asset has been reduced by a valuation allowance on
unrealized losses, primarily impairments on investments of
$0.8 million. Future realization of the remaining deferred
tax asset, as well as the ability to record tax benefits on
future realized and unrealized capital losses, will depend on
managements assessment of available tax planning
strategies such as realizing any appreciation in certain
investment assets. If management believes realization of a
deferred tax asset is not likely, an additional valuation
allowance would be established by increasing income tax expense,
or in the case of additional future unrealized losses, reducing
accumulated other comprehensive income.
If we
expand our operations too rapidly and do not manage that
expansion effectively, our financial performance and stock price
could be adversely affected.
We intend to grow by developing new products, expanding into new
product lines and expanding our insurance distribution network.
Continued growth could impose significant demands on our
management, including the need to identify, recruit, maintain
and integrate additional employees. Our historical growth rates
may not accurately reflect our future growth rates or our growth
potential. We may experience higher than anticipated indemnity
losses arising from new and expanded insurance products. In
addition, our systems, procedures and internal controls may not
be adequate to support our operations as they expand.
In addition to these organic growth strategies, we regularly
explore opportunities to acquire other companies or selected
books of business. Upon the announcement of an acquisition, our
stock price may fall depending on the size of the acquisition,
the purchase price and the potential dilution to existing
shareholders. It is also possible that an acquisition could
dilute earnings per share.
If we grow through acquisitions, we could have difficulty in
integrating an acquired company, which may cause us not to
realize expected revenue increases, cost savings, increases in
geographic or product presence, and other projected benefits
from the acquisition. The integration could result in the loss
of key employees, disruption of our business or the business of
the acquired company, or otherwise harm our ability to retain
customers and employees or achieve the anticipated benefits of
the acquisition. Time and resources spent on integration may
also impair our ability to grow our existing businesses. Also,
the negative effect of any financial commitments required by
regulatory authorities or rating agencies in acquisitions or
business combinations may be greater than expected.
Any failure by us to manage our growth effectively could have a
material adverse effect on our business, financial condition or
results of operations.
Our
growth strategy includes expanding into product lines in which
we have limited experience.
We are continually evaluating new lines of business to add to
our product mix. In some instances, we have limited experience
with marketing and managing these new product lines and insuring
the types of risks involved. Our failure to effectively analyze
new underwriting risks, set adequate premium rates and establish
reserves for these new products or efficiently adjust claims
arising from these new products could have a material adverse
effect on our business, financial condition or results of
operations. During the start up period for new products, we
generally set more conservative loss reserves in recognition of
the inherent risk. This could adversely affect our statutory
capital, net income and ability to pay dividends.
Because
we are primarily a transportation insurer, conditions in that
industry could adversely affect our business.
Approximately 75.2% of our gross premiums written for the year
ended December 31, 2009 and 77.2% for the year ended
December 31, 2008 were generated from transportation
insurance policies, including captive programs for
transportation companies. Adverse developments in the market for
transportation insurance, including those which could result
from potential declines in commercial and economic activity,
could cause our results of operations to suffer. The
transportation insurance industry is cyclical. Historically, the
industry has been characterized by periods of price competition
and excess capacity followed by periods of high premium rates
and
19
shortages of underwriting capacity. These fluctuations in the
business cycle have and could continue to negatively impact our
revenues.
Additionally, our results may be affected by risks that impact
the transportation industry related to severe weather
conditions, such as rainstorms, snowstorms, hail and ice storms,
floods, hurricanes, tornadoes, earthquakes and tsunamis, as well
as explosions, terrorist attacks and riots. Our transportation
insurance business also may be affected by cost trends that
negatively impact profitability, such as a continuing economic
downturn, inflation in vehicle repair costs, vehicle replacement
parts costs, used vehicle prices, fuel costs and medical care
costs. Increased costs related to the handling and litigation of
claims may also negatively impact our profitability.
We
face competition from companies with greater financial
resources, broader product lines, higher ratings and stronger
financial performance than us, which may impair our ability to
retain existing customers, attract new customers and maintain
our profitability and financial strength.
The commercial transportation insurance business is highly
competitive and, except for regulatory considerations, there are
relatively few barriers to entry. Many of our competitors are
substantially larger and may enjoy better name recognition,
substantially greater financial resources, higher ratings by
rating agencies, broader and more diversified product lines and
more widespread agency relationships than we do. We compete with
large national underwriters and smaller niche insurance
companies. In particular, in the specialty insurance market we
compete against, among others, Lancer Insurance Company, RLI
Corporation, American Alternative Insurance Corporation,
Progressive Corporation, Island Insurance Company, Great West
Casualty Company (a subsidiary of Old Republic International
Corporation), Northland Insurance Company (a subsidiary of the
Travelers Companies, Inc.), Century Insurance Group and American
Modern Home Insurance Company (a subsidiary of Munich Re Group).
Our underwriting profits could be adversely impacted if new
entrants or existing competitors try to compete with our
products, services and programs or offer similar or better
products at or below our prices.
We have continued to develop alternative risk transfer programs,
attracting new customers as well as transitioning existing
traditional customers into these programs. Our alternative risk
transfer component constituted approximately 55.9% of our gross
premiums written for the year ended December 31, 2009 and
54.3% of our gross written premiums for the same period in 2008.
We are subject to ongoing competition for both the individual
customers and entire programs. The departure of an entire
captive program due to competition could adversely affect our
results.
If we
are not able to attract and retain independent agents and
brokers, our revenues could be negatively
affected.
We compete with other insurance carriers to attract and retain
business from independent agents and brokers. Some of our
competitors offer a larger variety of products, lower prices for
insurance coverage or higher commissions than we offer. Our top
ten independent agents/brokers accounted for an aggregate of
32.5% of our gross premiums written during the year ended
December 31, 2009 and our top two independent
agents/brokers accounted for an aggregate of 12.0% of our gross
premiums written during the year ended December 31, 2009.
If we are unable to attract and retain independent
agents/brokers to sell our products, our ability to compete and
attract new customers and our revenues would suffer.
We are
subject to comprehensive regulation and our ability to earn
profits may be restricted by these regulations.
We are subject to comprehensive regulation by government
agencies in the states and foreign jurisdictions where our
insurance company subsidiaries are domiciled (Ohio, Pennsylvania
and the Cayman Islands) and, to a lesser degree, where these
subsidiaries issue policies and handle claims. Failure by one of
our insurance company subsidiaries to meet regulatory
requirements could subject us to regulatory action. The
regulations and associated examinations may have the effect of
limiting our liquidity and may adversely affect results of
operations.
In addition, state insurance department examiners perform
periodic financial, market conduct and other examinations of
insurance companies. Compliance with applicable laws and
regulations is time consuming and personnel-intensive. The last
financial examination of our domestic insurance subsidiaries was
completed by the
20
Ohio Department of Insurance in 2006 for the period ending
December 31, 2005, which the Ohio Department of Insurance
coordinated with the Departments of Insurance from Pennsylvania
and Hawaii. No significant issues surfaced. In addition to
financial examinations, we may be subject to market conduct
examinations of our claims and underwriting practices. We are
currently in various stages of market conduct examinations by
the Departments of Insurance from California and Delaware.
During 2009, we concluded a market conduct examination of our
underwriting practices by the North Carolina Department of
Insurance and in January of 2010, we concluded an examination of
our claims handling practices by the Nevada Department of
Insurance. Additionally, during 2009, we received notice that
the Missouri Department of Insurance intends to conduct a market
conduct examination. The findings of the North Carolina and
Nevada insurance departments did not result in fines or
penalties against us, but any adverse findings by other
insurance departments could result in significant fines and
penalties, negatively affecting our profitability.
In addition, insurance-related laws and regulations may become
more restrictive in the future. New or more restrictive
regulation, including changes in current tax or other regulatory
interpretations affecting the alternative risk transfer
insurance model, could make it more expensive for us to conduct
our business, restrict the premiums we are able to charge or
otherwise change the way we do business. In addition, the
economic and financial market turmoil may result in some type of
federal oversight of the insurance industry. For a further
discussion of the regulatory framework in which we operate, see
the subsection of Business entitled
Regulation.
We
cannot predict the impact that changing climate conditions,
including legal, regulatory and social responses thereto, may
have on our business.
Various scientists, environmentalists, international
organization, regulators and other commentators believe that
global climate change has added, and will continue to add, to
the unpredictability, frequency and severity of natural
disasters (including, but not limited to, hurricanes, tornadoes,
freezes, other storms and fires) in certain parts of the world.
In response, a number of legal and regulatory measures and
social initiatives have been introduced in an effort to reduce
greenhouse gas and other carbon emissions that may be chief
contributors to global climate change.
We cannot predict the impact that changing climate conditions,
if any, will have on us or our customers. However, it is
possible that the legal, regulatory and social responses to
climate change could have a negative effect on our results of
operations or our financial condition.
As a
holding company, we are dependent on the results of operations
of our insurance company subsidiaries to meet our obligations
and pay future dividends.
We are a holding company and a legal entity separate and
distinct from our insurance company subsidiaries. As a holding
company without significant operations of our own, one of our
sources of funds are dividends and other distributions from our
insurance company subsidiaries. As discussed under the
subsection of Business entitled
Regulation, statutory and regulatory restrictions
limit the aggregate amount of dividends or other distributions
that our insurance subsidiaries may declare or pay within any
twelve-month period without advance regulatory approval and
require insurance companies to maintain specified levels of
statutory capital and surplus. Insurance regulators have broad
powers to prevent reduction of statutory capital and surplus to
inadequate levels and could refuse to permit the payment of
dividends calculated under any applicable formula. As a result,
we may not be able to receive dividends from our insurance
subsidiaries at times and in amounts necessary to meet our
operating needs, to pay dividends to our shareholders or to pay
corporate expenses.
We are
currently rated A (Excellent) by A.M. Best,
their third highest rating out of 16 rating categories. A
decline in our rating below A- could adversely
affect our position in the insurance market, make it more
difficult to market our insurance products and cause our
premiums and earnings to decrease.
Financial ratings are an important factor influencing the
competitive position of insurance companies. A.M. Best
ratings, which are commonly used in the insurance industry,
currently range from A++ (Superior) to F
(In Liquidation), with a total of 16 separate ratings
categories. A.M. Best currently assigns us a financial
strength rating of A (Excellent). The objective of
A.M. Bests rating system is to provide potential
policyholders and other interested parties an opinion of an
insurers financial strength and ability to meet ongoing
obligations,
21
including paying claims. This rating reflects
A.M. Bests analysis of our balance sheet, financial
position, capitalization and management. It is not an evaluation
of an investment in our common shares, nor is it directed to
investors in our common shares and is not a recommendation to
buy, sell or hold our common shares. This rating is subject to
periodic review and may be revised downward, upward or revoked
at the sole discretion of A.M. Best.
If our rating is reduced by A.M. Best below an
A−, we believe that our competitive position
in the insurance industry could suffer and it could be more
difficult for us to market our insurance products. A downgrade
could result in a significant reduction in the number of
insurance contracts we write and in a substantial loss of
business to other competitors with higher ratings, causing
premiums and earnings to decrease.
New
claim and coverage issues are continually emerging in the
insurance industry and these new issues could negatively impact
our revenues, our business operations or our
reputation.
As insurance industry practices and regulatory, judicial and
industry conditions change, unexpected and unintended issues
related to pricing, claims, coverage and business practices may
emerge. Plaintiffs often target property and casualty insurers
in purported class action litigation relating to claims handling
and insurance sales practices. The resolution and implications
of new underwriting, claims and coverage issues could have a
negative effect on our insurance business by extending coverage
beyond our underwriting intent, increasing the size of claims or
otherwise requiring us to change our business practices. The
effects of unforeseen emerging claim and coverage issues could
negatively impact our revenues, results of operations and our
reputation.
If our
claims payments and related expenses exceed our reserves, our
financial condition and results of operations could be adversely
affected.
Our success depends upon our ability to accurately assess and
price the risks covered by the insurance policies that we write.
We establish reserves to cover our estimated liability for the
payment of all losses and LAE incurred with respect to premiums
earned on the insurance policies that we write. Reserves do not
represent an exact calculation of liability. Rather, reserves
are estimates of our expectations regarding the ultimate cost of
resolution and administration of claims under the insurance
policies that we write. These estimates are based upon actuarial
and statistical projections, assessments of currently available
data, historical claims information, as well as estimates and
assumptions regarding future trends in claims severity and
frequency, judicial theories of liability and other factors. We
continually refine our reserve estimates in an ongoing process
as experience develops and claims are reported and settled. Each
year, our reserves are certified by an accredited actuary from
Great American.
Establishing an appropriate level of reserves is an inherently
uncertain process. The following factors may have a substantial
impact on our future actual losses and LAE experience:
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the amount of claims payments;
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the expenses that we incur in resolving claims;
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legislative and judicial developments; and
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changes in economic conditions, including the effect of
inflation.
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Unfavorable development in any of these factors could cause our
level of reserves to be inadequate. To the extent that actual
losses and LAE exceed expectations and the reserves reflected on
our financial statements, we will be required to immediately
reflect those changes by increasing reserves. When we increase
reserves, the pre-tax income for the period in which we do so
will decrease by a corresponding amount. In addition to having a
negative effect on pre-tax income, increasing or
strengthening reserves cause a reduction in our
insurance companies surplus and could cause a downgrading
of the rating of our insurance company subsidiaries. Such a
downgrade could, in turn, adversely affect our ability to sell
insurance policies.
We may
not be successful in reducing our risk and increasing our
underwriting capacity through reinsurance arrangements, which
could adversely affect our business, financial condition and
results of operations.
In order to reduce our underwriting risk and increase our
underwriting capacity, we transfer portions of our insurance
risk to other insurers through reinsurance contracts. Ceded
premiums written amounted to 20.2% and
22
21.6%, respectively, of our gross premiums written for the years
ended December 31, 2009 and 2008. The availability, cost
and structure of reinsurance protection are subject to
prevailing market conditions that are outside of our control and
which may affect our level of business and profitability. We
continually assess and continue to increase our participation in
the risk retention for certain products in part because we
believe the current price increases in the reinsurance market
are excessive for the reinsurance exposure assumed. In order for
these contracts to qualify for reinsurance accounting and to
provide the additional underwriting capacity that we desire, the
reinsurer generally must assume significant risk and have a
reasonable possibility of a significant loss. Our reinsurance
facilities are generally subject to annual renewal. We may be
unable to maintain our current reinsurance facilities or obtain
other reinsurance facilities in adequate amounts and at
favorable rates. If we are unable to renew our expiring
facilities or obtain new reinsurance facilities, either our net
exposure to risk would increase or, if we are unwilling to bear
an increase in net risk exposures, we would have to reduce the
amount of risk we underwrite which could adversely impact our
results of operations.
We are
subject to credit risk with respect to the obligations of our
reinsurers and certain of our insureds. The inability of our
risk sharing partners to meet their obligations could adversely
affect our profitability.
Although the reinsurer is liable to us to the extent of risk
ceded by us, we remain ultimately liable to the policyholder on
all risks, even those reinsured. As a result, ceded reinsurance
arrangements do not limit our ultimate obligations to
policyholders to pay claims. We are subject to credit risks with
respect to the financial strength of our reinsurers. We are also
subject to the risk that our reinsurers may dispute their
obligations to pay our claims. As a result, we may not recover
sufficient amounts for claims that we submit to our reinsurers
in a timely manner, if at all. As of December 31, 2009, we
had a total of $140.2 million of unsecured reinsurance
recoverables. In addition, our reinsurance agreements are
subject to specified limits and we would not have reinsurance
coverage to the extent that we exceed those limits.
With respect to our insurance programs, we are subject to credit
risk with respect to the payment of claims and on the portion of
risk exposure either ceded to the captives or retained by our
clients. The credit worthiness of prospective risk sharing
partners is a factor we consider when entering into or renewing
these alternative risk transfer programs. We typically
collateralize balances due through funds withheld, letters of
credit or trust agreements. To date, we have not, in the
aggregate, experienced material difficulties in collecting
balances from our risk sharing partners. No assurance can be
given, however, regarding the future ability of these entities
to meet their obligations. The inability of our risk sharing
partners to meet their obligations could adversely affect our
profitability.
Our
inability to retain our senior executives and other key
personnel could adversely affect our business.
Our success depends, in part, upon the ability of our executive
management and other key personnel to implement our business
strategy and on our ability to attract and retain qualified
employees. Although historically we had not entered into
employment agreements with our executive management, in 2007 we
entered into multi-year employment agreements with both our
chairman, Mr. Spachman, and our president and chief
executive officer, Mr. Michelson. Mr. Michelson is
also party to an employee retention agreement with us. The
employment agreements represented an important step in our
succession planning process that began in 2005 and were designed
to provide stability to our organization during that critical
time. Since our formation in 1989, we had been highly dependent
on Mr. Spachman, our founder and chairman.
Mr. Spachman transitioned out of his role as chief
executive officer during 2007, and worked with
Mr. Michelson, other members of senior management and our
Board of Directors (The Board) to ensure an orderly
transition of leadership over the last two years.
Mr. Spachmans employment agreement terminated on
December 31, 2009, but he remains our Chairman of the
Board. A failure of Mr. Michelsons employment and
employee retention agreements to achieve their desired result,
our loss of other senior executives or our failure to attract
and develop talented new executives and managers could adversely
affect our business and the market price for our common shares.
In addition, we must forecast volume and other factors in
changing business environments with reasonable accuracy and
adjust our hiring and employment levels accordingly. Our failure
to recognize the need for such adjustments, or our failure or
inability to react appropriately on a timely basis, could lead
either to over-staffing (which would adversely affect our cost
structure) or under-staffing (impairing our ability to service
our current product lines and new lines of business). In either
event, our financial results and customer relationships could be
adversely affected.
23
Your
interests as a holder of our common shares may be different than
the interests of our majority shareholder, Great American
Insurance Company.
As of December 31, 2009, American Financial Group, Inc.,
through its wholly-owned subsidiary Great American, owns 52.6%
of our outstanding common shares. The interests of American
Financial Group, Inc. may differ from the interests of our other
shareholders. American Financial Group, Inc.s
representatives hold four out of nine seats of the Board. As a
result, American Financial Group, Inc. has the ability to exert
significant influence over our policies and affairs including
the power to affect the election of our Directors, appointment
of our management and the approval of any action requiring a
shareholder vote, such as amendments to our Articles of
Incorporation or Code of Regulations, transactions with
affiliates, mergers or asset sales.
Subject to the terms of our right of first refusal to purchase
its shares in certain circumstances, American Financial Group,
Inc. may be able to prevent or cause a change of control of the
Company by either voting its shares against or for a change of
control or selling its shares and causing a change of control.
The ability of our majority shareholder to prevent or cause a
change of control could delay or prevent a change of control or
cause a change of control to occur at a time when it is not
favored by other shareholders. As a result, the trading price of
our common shares could be adversely affected.
We may
have conflicts of interest with our majority shareholder, Great
American Insurance Company, which we would be unable to resolve
in our favor.
From time to time, Great American and its affiliated companies
engage in underwriting activities and enter into transactions or
agreements with us or in competition with us, which may give
rise to conflicts of interest. We do not have any agreement or
understanding with any of these parties regarding the resolution
of potential conflicts of interest. In addition, we may not be
in a position to influence any partys decision not to
engage in activities that would give rise to a conflict of
interest. These parties may take actions that are not in the
best interests of our other shareholders.
We rely on Great American to provide certain services to us
including actuarial and consultative services for legal,
accounting and internal audit issues and other support services.
If Great American no longer controlled a majority of our shares,
it is possible that many of these services would cease or,
alternatively, be provided at an increased cost to us. This
could impact our personnel resources, require us to hire
additional professional staff and generally increase our
operating expenses.
Provisions
in our organizational documents, Ohio corporate law and the
insurance laws of Ohio and Pennsylvania could impede an attempt
to replace or remove our management or Directors or prevent or
delay a merger or sale, which could diminish the value of our
common shares.
Our Amended and Restated Articles of Incorporation and Code of
Regulations, the corporate laws of Ohio and the insurance laws
of various states contain provisions that could impede an
attempt to replace or remove our management or Directors or
prevent the sale of our Company that shareholders might consider
to be in their best interests. These provisions include, among
others:
|
|
|
|
|
a classified Board of Directors consisting of nine Directors
divided into two classes;
|
|
|
|
the inability of our shareholders to remove a Director from the
Board without cause;
|
|
|
|
requiring a vote of holders of 50% of the common shares to call
a special meeting of the shareholders;
|
|
|
|
requiring a two-thirds vote to amend the shareholder protection
provisions of our Code of Regulations and to amend the Articles
of Incorporation;
|
|
|
|
requiring the affirmative vote of a majority of the voting power
of our shares represented at a special meeting of shareholders;
|
|
|
|
excluding the voting power of interested shares to approve a
control share acquisition under Ohio law; and
|
|
|
|
prohibiting a merger, consolidation, combination or majority
share acquisition between us and an interested shareholder or an
affiliate of an interested shareholder for a period of three
years from the date on which the shareholder first became an
interested shareholder, unless previously approved by our Board.
|
24
These provisions may prevent shareholders from receiving the
benefit of any premium over the market price of our common
shares offered by a bidder in a potential takeover. In addition,
the existence of these provisions may adversely affect the
prevailing market price of our common shares if they are viewed
as discouraging takeover attempts.
The insurance laws of most states require prior notice or
regulatory approval of changes in control of an insurance
company or its holding company. The insurance laws of the States
of Ohio and Pennsylvania, where our U.S. insurance
companies are domiciled, provide that no corporation or other
person may acquire control of a domestic insurance or
reinsurance company unless it has given notice to such insurance
or reinsurance company and obtained prior written approval of
the relevant insurance regulatory authorities. Any purchaser of
10% or more of our aggregate outstanding voting power could
become subject to these regulations and could be required to
file notices and reports with the applicable regulatory
authorities prior to such acquisition. In addition, the
existence of these provisions may adversely affect the
prevailing market price of our common shares if they are viewed
as discouraging takeover attempts. For further discussion of
insurance laws, see the subsection of Business
entitled Regulation.
Future
sales of our common shares may affect the trading price of our
common shares.
We cannot predict what effect, if any, future sales of our
common shares or the availability of common shares for future
sale will have on the trading price of our common shares. Sales
of substantial amounts of our common shares in the public market
by Great American or our other shareholders, or the possibility
or perception that such sales could occur, could adversely
affect prevailing market prices for our common shares. If such
sales reduce the market price of our common shares, our ability
to raise additional capital in the equity markets may be
adversely affected.
In 2006, we registered all of the common shares owned by Great
American and Mr. Spachman, our chairman, pursuant to a
registration statement on
Form S-3.
The original registration statement became effective in 2006 and
was set to expire in April 2009. On March 31, 2009, we
filed a new registration statement on
Form S-3
to maintain the registration of these shares. As of
December 31, 2009, Great American and Mr. Spachman own
10,200,000 and 1,894,000, respectively, of our issued and
outstanding shares. This concentration of ownership could affect
the number of shares available for purchase or sale on a daily
basis. This factor could result in price volatility and serve to
depress the liquidity and market prices of our common shares.
In addition, in 2005, we filed a registration statement on
Form S-8
under the Securities Act to register 1,338,800 common shares
issued or reserved for issuance for awards granted under our
Long Term Incentive Plan. Shares registered under the
registration statement on
Form S-8
also could be sold into the public markets, subject to
applicable vesting provisions and any volume limitations and
other restrictions applicable to our officers and Directors
selling shares under Rule 144. The sale of the shares under
these registration statements in the public market, or the
possibility or perception that such sales could occur, could
adversely affect prevailing market prices for our common shares.
We
face ongoing challenges as a result of being a public company
and our financial results could be adversely
affected.
As a public company, we incur significant legal, accounting and
other expenses that result from corporate governance
requirements, including requirements under the Sarbanes-Oxley
Act of 2002, as well as rules implemented by the SEC and the
Financial Industry Regulatory Authority. We expect these rules
and regulations to increase our legal and finance compliance
costs and to make some activities more time-consuming and
costly. We continue to evaluate and monitor developments with
respect to compliance with public company requirements and we
cannot predict or estimate the amount or timing of additional
costs we may incur.
As a public company, we are required to comply with
Section 404 of the Sarbanes-Oxley Act relating to internal
controls over financial reporting. We have committed, and will
continue to expend, a significant amount of resources to monitor
and address any internal control issues, which may occur in our
business. Any failure to do so could adversely impact our
operating results.
25
|
|
ITEM 1B
|
Unresolved
Staff Comments
|
None.
We own two adjacent buildings that house our corporate
headquarters and the surrounding real estate located in
Richfield, Ohio. The buildings consist of approximately
177,000 square feet of office space on 17.5 acres. We
occupy approximately 142,000 square feet and lease the
remainder to unaffiliated tenants.
We lease office space in Honolulu, Hawaii; Mechanicsburg,
Pennsylvania; and St. Thomas in the United States Virgin
Islands. These leases account for approximately
15,300 square feet of office space. These leases expire
within forty-three months. The monthly rents, exclusive of
operating expenses, to lease these facilities currently total
approximately $25,000. We believe that these leases could be
renewed or replaced at commercially reasonable rates without
material disruption to our business.
Please
refer to Forward-Looking Statements following the
Index in front of this
Form 10-K.
We are subject at times to various claims, lawsuits and legal
proceedings arising in the ordinary course of business. All
legal actions relating to claims made under insurance policies
are considered in the establishment of our loss and LAE
reserves. In addition, regulatory bodies, such as state
insurance departments, the SEC, the Department of Labor and
other regulatory bodies may make inquiries and conduct
examinations or investigations concerning our compliance with
insurance laws, securities laws, labor laws and the Employee
Retirement Income Security Act of 1974, as amended.
Our insurance companies also have lawsuits pending in which the
plaintiff seeks extra-contractual damages from us in addition to
damages claimed or in excess of the available limits under an
insurance policy. These lawsuits, which are in various stages,
generally mirror similar lawsuits filed against other carriers
in the industry. Although we are vigorously defending these
lawsuits, the outcomes of these cases cannot be determined at
this time. We have established loss and LAE reserves for
lawsuits as to which we have determined that a loss is both
probable and estimable. In addition to these case reserves, we
also establish reserves for claims incurred but not reported to
cover unknown exposures and adverse development on known
exposures. Based on currently available information, we believe
that our reserves for these lawsuits are reasonable and that the
amounts reserved did not have a material effect on our financial
condition or results of operations. However, if any one or more
of these cases results in a judgment against or settlement by us
for an amount that is significantly greater than the amount so
reserved, the resulting liability could have a material effect
on our financial condition, cash flows and results of operations.
On August 3, 2007, we were informed that the jury in a case
pending in the Superior Court of the State of California for the
County of Los Angeles (the Superior Court), had
issued, on August 2, 2007, a special verdict adverse to our
interests in a pending lawsuit against one of our insurance
companies. The Superior Court entered a formal judgment on
October 25, 2007 and we received notice of that formal
judgment on November 5, 2007. This matter, which
approximated a net exposure of $7.2 million, was vigorously
pursued on appeal and on December 30, 2009,
Californias Second Appellate District,
Division Eight, reversed the Superior Courts judgment
and remanded the case to that lower court with instructions to
enter judgment in our favor. This matter was resolved in a
manner that did not have a material adverse effect on our
consolidated financial position, results of operations or cash
flows.
26
PART II
|
|
ITEM 5
|
Market
for Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
|
Please refer to Forward-Looking Statements
following the Index in front of this
Form 10-K.
Market
Information
Our common shares are listed and traded on the Nasdaq Global
Select Market under the symbol NATL. The information presented
in the table below represents the high and low sales prices per
share reported on the NASDAQ for the periods indicated.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
2008
|
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
First Quarter
|
|
$
|
19.89
|
|
|
$
|
12.95
|
|
|
$
|
33.24
|
|
|
$
|
21.00
|
|
Second Quarter
|
|
|
18.19
|
|
|
|
13.03
|
|
|
|
25.59
|
|
|
|
18.26
|
|
Third Quarter
|
|
|
21.20
|
|
|
|
14.51
|
|
|
|
24.98
|
|
|
|
16.13
|
|
Fourth Quarter
|
|
|
21.72
|
|
|
|
16.06
|
|
|
|
23.90
|
|
|
|
13.57
|
|
There were approximately 51 shareholders of record of our
common shares at March 1, 2010.
Dividend
Policy
The Board has instituted a policy authorizing us to pay
quarterly dividends on our common shares in an amount to be
determined at each quarterly Board of Directors meeting. The
Board recently announced its intention to increase the quarterly
dividend to $0.08 per share for 2010. The Board intends to
continue to review our dividend policy annually during each
regularly scheduled first quarter meeting, with the anticipation
of considering annual dividend increases. We declared and paid
quarterly dividends of $0.07 and $0.06 per common share in 2009
and 2008, respectively.
The declaration and payment of dividends remains subject to the
discretion of the Board, and will depend on, among other things,
our financial condition, results of operations, capital and cash
requirements, future prospects, regulatory and contractual
restrictions on the payment of dividends by insurance company
subsidiaries and other factors deemed relevant by the Board. In
addition, our ability to pay dividends would be restricted in
the event of a default on our unsecured Credit Agreement, our
failure to make payment obligations with respect to such
agreement or our election to defer interest payments on the
agreement.
We are a holding company without significant operations of our
own. Our principal sources of funds are dividends and other
distributions from our subsidiaries including our insurance
company subsidiaries. Our ability to receive dividends from our
insurance company subsidiaries is also subject to limits under
applicable state insurance laws.
Equity
Compensation Plan Information
The table below shows information regarding awards outstanding
and common shares available for issuance (as of
December 31, 2009) under the National Interstate
Corporation Long Term Incentive Plan, as amended.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities
|
|
|
|
|
|
|
Available for
|
|
|
|
|
|
|
Future Issuance
|
|
|
Number of Securities
|
|
|
|
Under Equity
|
|
|
to be Issued upon
|
|
Weighted-Average
|
|
Compensation Plans
|
|
|
Exercise of
|
|
Exercise Price of
|
|
(Excluding Securities
|
Equity Compensation Plans
|
|
Outstanding Options
|
|
Outstanding Options
|
|
Reflected in Column (a))
|
|
|
(a)
|
|
(b)
|
|
(c)
|
|
Approved by shareholders
|
|
|
647,050
|
|
|
$
|
18.08
|
|
|
|
825,139
|
|
Not approved by shareholders
|
|
|
none
|
|
|
|
N/A
|
|
|
|
none
|
|
27
Performance
Graph
The following graph shows the percentage change in cumulative
total shareholder return on our common shares since the initial
public offering measured by dividing (i) the sum of
(A) the cumulative amount of dividends, assuming dividend
reinvestment during the periods presented and (B) the
difference between our share price at the end and the beginning
of the periods presented by (ii) the share price at the
beginning of the periods presented. The graph demonstrates our
cumulative total returns compared to those of the Center for
Research in Security Prices (CSRP) Total Return
Index for NASDAQ and the CSRP Total Return Index for NASDAQ
Insurance Stocks from the date of our initial public offering
January 28, 2005 ($13.50) through December 31, 2009
($16.96.)
Cumulative
Total Return as of December 31, 2009
(Assumes a $100 investment at the close of trading on
January 27, 2005)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Company/ Index
|
|
1/28/05
|
|
6/30/05
|
|
12/31/05
|
|
6/30/06
|
|
12/31/06
|
|
6/30/07
|
|
12/31/07
|
|
6/30/08
|
|
12/31/08
|
|
6/30/09
|
|
12/31/09
|
|
NATL Common Stock
|
|
$
|
100
|
|
|
$
|
147
|
|
|
$
|
142
|
|
|
$
|
202
|
|
|
$
|
182
|
|
|
$
|
196
|
|
|
$
|
249
|
|
|
$
|
139
|
|
|
$
|
136
|
|
|
$
|
117
|
|
|
$
|
132
|
|
Nasdaq Insurance Stocks
|
|
|
100
|
|
|
|
108
|
|
|
|
117
|
|
|
|
121
|
|
|
|
132
|
|
|
|
138
|
|
|
|
132
|
|
|
|
113
|
|
|
|
123
|
|
|
|
105
|
|
|
|
128
|
|
Nasdaq Index
|
|
|
100
|
|
|
|
101
|
|
|
|
109
|
|
|
|
107
|
|
|
|
119
|
|
|
|
128
|
|
|
|
129
|
|
|
|
112
|
|
|
|
62
|
|
|
|
72
|
|
|
|
90
|
|
28
|
|
ITEM 6
|
Selected
Financial Data
|
The following table sets forth selected consolidated financial
information for the periods ended and as of the dates indicated.
These historical results are not necessarily indicative of the
results to be expected from any future period. You should read
this selected consolidated financial data together with our
consolidated financial statements and the related notes and the
section of the
Form 10-K
entitled Managements Discussion and Analysis of
Financial Condition and Results of Operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At and for the Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(Dollars in thousands, except per share data)
|
|
|
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums written(1)
|
|
$
|
344,877
|
|
|
$
|
380,296
|
|
|
$
|
346,006
|
|
|
$
|
305,504
|
|
|
$
|
270,036
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written(2)
|
|
$
|
275,046
|
|
|
$
|
298,081
|
|
|
$
|
272,142
|
|
|
$
|
241,916
|
|
|
$
|
211,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
279,079
|
|
|
$
|
290,741
|
|
|
$
|
257,561
|
|
|
$
|
217,319
|
|
|
$
|
194,397
|
|
Net investment income
|
|
|
19,324
|
|
|
|
22,501
|
|
|
|
22,141
|
|
|
|
17,579
|
|
|
|
12,527
|
|
Net realized gains (losses) on investments
|
|
|
2,561
|
|
|
|
(22,394
|
)
|
|
|
(653
|
)
|
|
|
1,193
|
|
|
|
278
|
|
Other income
|
|
|
3,488
|
|
|
|
2,868
|
|
|
|
4,137
|
|
|
|
2,387
|
|
|
|
1,974
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
304,452
|
|
|
|
293,716
|
|
|
|
283,186
|
|
|
|
238,478
|
|
|
|
209,176
|
|
Losses and loss adjustment expenses
|
|
|
169,755
|
|
|
|
188,131
|
|
|
|
149,501
|
|
|
|
129,491
|
|
|
|
117,449
|
|
Commissions and other underwriting expense
|
|
|
57,245
|
|
|
|
62,130
|
|
|
|
50,922
|
|
|
|
42,671
|
|
|
|
35,741
|
|
Other operating and general expenses
|
|
|
13,076
|
|
|
|
12,605
|
|
|
|
12,140
|
|
|
|
9,472
|
|
|
|
8,436
|
|
Expense on amounts withheld(3)
|
|
|
3,535
|
|
|
|
4,299
|
|
|
|
3,708
|
|
|
|
2,147
|
|
|
|
992
|
|
Interest expense
|
|
|
717
|
|
|
|
833
|
|
|
|
1,550
|
|
|
|
1,522
|
|
|
|
1,421
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
244,328
|
|
|
|
267,998
|
|
|
|
217,821
|
|
|
|
185,303
|
|
|
|
164,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
60,124
|
|
|
|
25,718
|
|
|
|
65,365
|
|
|
|
53,175
|
|
|
|
45,137
|
|
Provision for income taxes
|
|
|
13,675
|
|
|
|
15,058
|
|
|
|
21,763
|
|
|
|
17,475
|
|
|
|
14,857
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
46,449
|
|
|
$
|
10,660
|
|
|
$
|
43,602
|
|
|
$
|
35,700
|
|
|
$
|
30,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected GAAP Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expense ratio(4)
|
|
|
60.8
|
%
|
|
|
64.7
|
%
|
|
|
58.0
|
%
|
|
|
59.6
|
%
|
|
|
60.4
|
%
|
Underwriting expense ratio(5)
|
|
|
24.0
|
%
|
|
|
24.7
|
%
|
|
|
22.9
|
%
|
|
|
22.9
|
%
|
|
|
21.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio(6)
|
|
|
84.8
|
%
|
|
|
89.4
|
%
|
|
|
80.9
|
%
|
|
|
82.5
|
%
|
|
|
82.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on equity(7)
|
|
|
19.1
|
%
|
|
|
5.0
|
%
|
|
|
22.6
|
%
|
|
|
22.8
|
%
|
|
|
28.5
|
%
|
Per Share Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share, basic
|
|
$
|
2.41
|
|
|
$
|
0.55
|
|
|
$
|
2.27
|
|
|
$
|
1.87
|
|
|
$
|
1.62
|
|
Earnings per common share, assuming dilution
|
|
|
2.40
|
|
|
|
0.55
|
|
|
|
2.25
|
|
|
|
1.85
|
|
|
|
1.60
|
|
Book value per common share,
basic (at year end)(8)
|
|
$
|
14.06
|
|
|
$
|
11.20
|
|
|
$
|
11.08
|
|
|
$
|
9.07
|
|
|
$
|
7.32
|
|
Weighted average number of common shares outstanding, basic
|
|
|
19,301
|
|
|
|
19,285
|
|
|
|
19,193
|
|
|
|
19,136
|
|
|
|
18,737
|
|
Weighted average number of common shares outstanding, diluted
|
|
|
19,366
|
|
|
|
19,366
|
|
|
|
19,348
|
|
|
|
19,302
|
|
|
|
18,975
|
|
Common shares outstanding (at year end)
|
|
|
19,302
|
|
|
|
19,295
|
|
|
|
19,312
|
|
|
|
19,159
|
|
|
|
19,055
|
|
Cash dividends per common share
|
|
$
|
0.28
|
|
|
$
|
0.24
|
|
|
$
|
0.20
|
|
|
$
|
0.16
|
|
|
$
|
0.08
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31,
|
|
|
2009
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and investments
|
|
$
|
614,974
|
|
|
$
|
563,714
|
|
|
$
|
492,916
|
|
|
$
|
406,454
|
|
|
$
|
320,220
|
|
Securities lending collateral
|
|
|
|
|
|
|
84,670
|
|
|
|
139,305
|
|
|
|
158,928
|
|
|
|
|
|
Reinsurance recoverables
|
|
|
149,949
|
|
|
|
150,791
|
|
|
|
98,091
|
|
|
|
90,070
|
|
|
|
77,834
|
|
Total assets
|
|
|
955,753
|
|
|
|
990,812
|
|
|
|
898,634
|
|
|
|
806,248
|
|
|
|
523,003
|
|
Unpaid losses and loss adjustment expenses
|
|
|
417,260
|
|
|
|
400,001
|
|
|
|
302,088
|
|
|
|
265,966
|
|
|
|
223,207
|
|
Long-term debt
|
|
|
15,000
|
|
|
|
15,000
|
|
|
|
15,464
|
|
|
|
15,464
|
|
|
|
16,297
|
|
Total shareholders equity
|
|
|
271,317
|
|
|
|
216,074
|
|
|
|
212,806
|
|
|
|
173,763
|
|
|
|
139,533
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At and for the Year Ended December 31,
|
|
|
2009
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
Selected Statutory Data(9):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policyholder surplus(10)
|
|
$
|
238,390
|
|
|
$
|
190,134
|
|
|
$
|
182,302
|
|
|
$
|
148,266
|
|
|
$
|
122,825
|
|
Combined ratio(11)
|
|
|
85.8
|
%
|
|
|
89.0
|
%
|
|
|
78.3
|
%
|
|
|
82.4
|
%
|
|
|
77.1
|
%
|
|
|
|
(1) |
|
The sum of premiums written on insurance policies issued by us
and premiums assumed by us on policies written by other
insurance companies. |
|
(2) |
|
Gross premiums written less premiums ceded to reinsurance
companies. |
|
(3) |
|
We invest funds in the participant loss layer for several of the
alternative risk transfer programs. We receive investment income
and incur an equal expense on the amounts owed to alternative
risk transfer participants. Expense on amounts
withheld represents investment income that we remit back
to alternative risk transfer participants. The related
investment income is included in our Net investment
income line on our Consolidated Statements of Income. |
|
(4) |
|
The ratio of losses and LAE to premiums earned. |
|
(5) |
|
The ratio of the net of the sum of commissions and other
underwriting expenses, other operating and general expenses less
other income to premiums earned. |
|
(6) |
|
The sum of the loss and LAE ratio and the underwriting expense
ratio. |
|
(7) |
|
The ratio of net income to the average of the shareholders
equity at the beginning and end of the year. |
|
(8) |
|
Book value per common share is computed using only unrestricted
outstanding common shares. As of December 31, 2009 and 2008
total unrestricted common shares were 19,302,000 and 19,295,000,
respectively. There were no unvested restricted shares prior to
2007. |
|
(9) |
|
While financial data is reported in accordance with GAAP for
shareholder and other investment purposes, it is reported on a
statutory basis for insurance regulatory purposes. Certain
statutory expenses differ from amounts reported under GAAP.
Specifically, under GAAP, premium taxes and other variable costs
incurred in connection with writing new and renewal business are
capitalized and amortized on a pro rata basis over the period in
which the related premiums are earned. On a statutory basis,
these items are expensed as incurred. In addition, certain other
expenses, such as those related to the expensing or amortization
of computer software, are accounted for differently for
statutory purposes than the treatment accorded under GAAP. |
|
(10) |
|
The statutory policyholder surplus of NIIC, which includes the
statutory policyholder surplus of its subsidiaries, NIIC-HI and
TCC. |
|
(11) |
|
Statutory combined ratio of NIIC represents the sum of the
following ratios: (1) losses and LAE incurred as a
percentage of net earned premium and (2) underwriting
expenses incurred as a percentage of net written premiums. |
30
|
|
ITEM 7
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Please refer to Forward-Looking Statements
following the Index in front of this
Form 10-K.
The following discussion and analysis of our historical
consolidated financial statements should be read in conjunction
with our audited consolidated financial statements and the
related notes included elsewhere in this
Form 10-K.
Overview
We are a holding company with operations being conducted by our
subsidiaries.
Our specialty property and casualty insurance companies are
licensed in all 50 states, the District of Columbia and the
Cayman Islands. We generate underwriting profits by providing
what we view as specialized insurance products, services and
programs not generally available in the marketplace. While many
companies write property and casualty insurance for
transportation companies, we believe that few write passenger
transportation coverage nationwide and very few write coverage
for several of the classes of passenger transportation insurance
written by us and our subsidiaries. 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. These niche markets
typically possess what we view as barriers to entry, such as
being too small, too remote or too difficult to attract or
sustain most competitors. Examples of products that we write for
these markets include captive programs for transportation
companies that we refer to as our alternative risk transfer
programs (55.9% of 2009 gross premiums written), property
and casualty insurance for transportation companies (19.3%),
specialty personal lines, primarily recreational vehicle and
commercial vehicle coverage (17.8%) and transportation and
general commercial insurance in Hawaii and Alaska (5.5%). We
strive to become a market leader in the specialty markets that
we choose and serve by offering what we believe are specialized
products, excellent customer service and superior claims
response.
We write commercial insurance for various sizes of
transportation fleets. Because of the amount of smaller fleets
nationwide, we have more opportunities to write smaller risks
than larger ones. When general economic conditions improve,
entrepreneurs are encouraged to start new transportation
companies, which typically commence operations as a smaller risk
and a potential traditional insurance customer for us. During
periods of economic downturn, smaller risks are more prone to
failure due to a decrease in leisure travel and consolidation in
the industry. An increase in the number of larger risks results
in more prospective captive insurance customers. We typically do
not believe that smaller fleets that generate annual premiums of
less than $100,000 are large enough to retain the risks
associated with participation in one of the captive programs we
currently offer.
By offering insurance products to all sizes of risks, we believe
we have hedged against the possibility that there will be a
reduction in demand for the products we offer. We believe that
we will continue to have opportunities to grow and profit with
both traditional and alternative risk transfer customers based
on our assumptions regarding future economic and competitive
conditions. We generally incur low
start-up
costs for new businesses, typically less than $500,000 incurred
over several quarters. We believe our flexible processes and
scalable systems, along with controlled increase of businesses,
allow us to manage costs and match them with the revenue flow.
The factors that impact our growth rate are consistent across
all products. However, the trends impacting each of these
factors may vary from time to time for individual products.
Those factors are as follows:
Submissions
|
|
|
|
|
The increase or decrease in the number of new applications we
receive. This is influenced by the effectiveness of our
marketing activities compared to the marketing activities of our
competitors in each market.
|
|
|
|
The change in the number of current policyholders that are
available for a renewal quote. The number of policyholders
available for renewal changes based upon the economic conditions
impacting our customer groups and the extent of consolidation
that may be taking place within the industries we support.
|
31
Quotes
|
|
|
|
|
The change in the percentage of the new applications received
that do not receive a quote from us. We do not quote risks that
do not meet our risk selection criteria or for which we have not
been provided complete application data. We refer to this ratio
as the declination ratio and an increasing
declination ratio usually results in reduced opportunities to
write new business.
|
Sales
|
|
|
|
|
The change in percentage of the quotes we issue that are
actually sold. We refer to this ratio as the hit
ratio. Hit ratios are affected by the number of
competitors, the prices quoted by these competitors and the
degree of difference between the competitors pricing,
terms and conditions and ours.
|
Rates
|
|
|
|
|
The change in our rate structure from period to period. The
rates we file and quote are impacted by several factors
including: the cost and extent of the reinsurance we purchase;
our operating efficiencies; our average loss costs, which
reflect the effectiveness of our underwriting; our underwriting
profit expectations; and our claims adjusting processes. The
difference between our rates and the rates of our competitors is
the primary factor impacting the revenue growth of our
established product lines.
|
Product
Offerings and Distribution
|
|
|
|
|
We operate in multiple markets with multiple distribution
approaches to attempt to reduce the probability that an adverse
competitive response in any single market will have a
significant impact on our overall business. We also attempt to
maintain several new products, product line extensions or
product distribution approaches in active development status so
we are able to take advantage of market opportunities. We select
from potential new product ideas based on our stated new
business criteria and the anticipated competitive response.
|
Industry
and Trends
The property/casualty (P/C) insurance industry is
cyclical, with periods of rising premium rates and shortages of
underwriting capacity (hard market) followed by
periods of substantial price competition and excess capacity
(soft market). The P/C insurance industry
experienced a continued soft market in 2009, resulting in an
anticipated industry wide decrease in premiums written for the
third consecutive year, which would mark the first time in
A.M. Bests recorded history that this has occurred.
Despite the decline in premiums written, the industrys
underwriting results benefited from a quiet 2009 hurricane
season and significant favorable development on prior-year loss
reserves according to available industry data compiled by A.M
Best through the first nine months of 2009. The industry faces
several unfavorable trends in the coming year such as, but not
limited to, prolonged recession-driven pricing instability,
uncertainty in the federal and state regulatory environments and
expense control.
Despite relatively flat pricing since 2004, improved risk
selection and an overall improvement in the risk quality of our
book of business have contributed to us attaining combined
ratios better than our corporate objective of 96.0% or lower.
Since our inception in 1989 we have placed a consistent emphasis
on underwriting profit. Though our combined ratio may fluctuate
from year to year, over the past five years we have exceeded our
underwriting profit objective by achieving an average GAAP
combined ratio of 83.9%. We believe the following factors
contribute to our performance which is consistently above
industry standards:
|
|
|
|
|
Our business model and bottom line orientation have resulted in
disciplined and consistent risk assessment and pricing adequacy.
|
|
|
|
Our ability to attract and retain some of the best
transportation companies in the industries we serve and insure
them directly or through our captive programs.
|
|
|
|
Our stable operating expenses which have historically been at or
below the revenue growth rate.
|
32
During 2009, like most of the P/C insurance industry, we
benefited from stabilization in the investment markets as we
recorded net realized gains from investments, which included
write-downs required by the
other-than-temporary
impairment accounting guidelines. We have historically
maintained a high quality investment portfolio, focusing
primarily on investment grade fixed income investments. Our 2009
purchases have been concentrated in U.S. Government and
government agencies, state and local government obligations
(muni bonds), agency backed collateralized mortgage
obligations and corporate obligations. Although we cannot
provide any assurances, at December 31, 2009, with over 90%
of our investment portfolio comprised of investment grade fixed
income, investment grade preferred stock and cash and cash
equivalents, we believe we remain properly positioned as we head
into 2010.
As noted above, the P/C insurance industry experienced few
significant weather-related losses in 2009. For weather-related
events such as hurricanes, tornados and hailstorms, we conduct
an analysis at least annually pursuant to which we input our
in-force exposures (vehicle values in all states and property
limits in Hawaii) into an independent catastrophe model that
predicts our probable maximum loss at various statistical
confidence levels. Our estimated probable maximum loss is
impacted by changes in our in-force exposures as well as changes
to the assumptions inherent in the catastrophe model. Hurricane
and other weather-related events have not had a material
negative impact on our past results.
Our transportation insurance business in particular is also
affected by cost trends that negatively impact profitability
such as inflation in vehicle repair costs, vehicle replacement
parts costs, used vehicle prices, fuel costs and medical care
costs. We routinely obtain independent data for vehicle repair
inflation, vehicle replacement parts costs, used vehicle prices,
fuel costs and medical care costs and adjust our pricing
routines to attempt to more accurately project the future costs
associated with insurance claims. Historically, these increased
costs have not had a material adverse impact on our results. Of
course, we would expect a negative impact on our future results
if we fail to properly account for and project for these
inflationary trends. Increased litigation of claims may also
negatively impact our profitability.
As described below, the average revenue dollar per personal
lines policy is significantly lower than typical commercial
policies. Profitability in the specialty personal lines
component is dependent on proper pricing and the efficiency of
underwriting and policy administration. We have continued to
monitor rate levels and have adjusted them throughout 2009, as
warranted. We continuously strive to improve our underwriting
and policy issuance functions to keep this cost element as low
as possible by utilizing current technology advances.
To succeed as a transportation underwriter and personal lines
underwriter, we must understand and be able to quantify the
different risk characteristics of the risks we consider quoting.
Certain coverages are more stable and predictable than others
and we must recognize the various components of the risks we
assume when we write any specific class of insurance business.
Examples of trends that can change and, therefore, impact our
profitability are loss frequency, loss severity, geographic loss
cost differentials, societal and legal factors impacting loss
costs (such as tort reform, punitive damage inflation and
increasing jury awards) and changes in regulation impacting the
insurance relationship. Any changes in these factors that are
not recognized and priced for accordingly will affect our future
profitability. We believe our product management organization
provides the focus on a specific risk class needed to stay
current with the trends affecting each specific class of
business we write.
Revenues
We derive our revenues primarily from premiums from our
insurance policies and income from our investment portfolio. Our
underwriting approach is to price our products to achieve an
underwriting profit even if it requires us to forego volume. As
with all P/C companies, the impact of price changes is reflected
in our financial results over time. Price changes on our
in-force policies occur as they are renewed, which generally
takes twelve months for our entire book of business and up to an
additional twelve months to earn a full year of premium at the
renewal rate. Insurance rates charged on renewing policies have
decreased slightly in 2009 compared to 2008.
There are distinct differences in the timing of premiums written
in traditional transportation insurance compared to the majority
of our alternative risk transfer (captive) insurance component.
We write traditional transportation insurance policies
throughout all twelve months of the year and commence new annual
policies at the expiration of the old policy. Under most captive
programs, all members of the group share a common renewal date.
33
These common renewal dates are scheduled throughout the calendar
year. Any new captive program participant that joins after the
common date will be written for other than a full annual term so
its next renewal date coincides with the common expiration date
of the captive program it has joined. Historically, most of our
group captives had common renewal dates in the first six months
of the year, but with the growth from new captive programs, we
are now experiencing renewal dates throughout the calendar year.
The alternative risk transfer component of our business grew to
55.9% of total gross premiums written during 2009 as compared to
54.3% in 2008.
The projected profitability from the traditional transportation
and transportation captive businesses are substantially
comparable. Increased investment income opportunities generally
are available with traditional insurance but the lower
acquisition expenses and persistence of the captive programs
generally provide for lower operating expenses from these
programs. The lower expenses associated with our captives
generally offset the projected reductions in investment income
potential. From a projected profitability perspective, we are
ambivalent as to whether a transportation operator elects to
purchase traditional insurance or one of our captive program
options.
All of our transportation products, traditional or alternative
risk transfer, are priced to achieve targeted underwriting
margins. Because traditional insurance tends to have a higher
operating expense structure, the portion of the premiums
available to pay losses tends to be lower for a traditional
insurance quote versus an alternative risk transfer insurance
quote. We use a cost plus pricing approach that projects future
losses based upon the insureds historic losses and other
factors. Operating expenses, premium taxes and a profit margin
are then added to the projected loss component to achieve the
total premium to be quoted. The lower the projected losses,
expenses and taxes, the lower the total quoted premiums
regardless of whether it is a traditional or alternative risk
transfer program quotation. Quoted premiums are computed in
accordance with our approved insurance department filings in
each state.
Our specialty personal lines products are also priced to achieve
targeted underwriting margins. The average premium per policy
for this business component is significantly less than
transportation lines.
We approach investment and capital management with the intention
of supporting insurance operations by providing a stable source
of income to supplement underwriting income. The goals of our
investment policy are to protect capital while optimizing
investment income and capital appreciation and maintaining
appropriate liquidity. We follow a formal investment policy and
the Board reviews the portfolio performance at least quarterly
for compliance with the established guidelines. In 2009, our
investment portfolio was positioned to benefit from
stabilization in the investment markets. In 2009, we recorded a
$2.6 million pre-tax net realized gain on investments as
compared to the $22.4 million pre-tax net realized loss
recorded in 2008. Included in the 2008 pre-tax net realized
losses are impairment adjustments of $20.2 million.
Expenses
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 record losses and LAE based on an actuarial
analysis of the estimated losses we expect to be reported on
contracts written. We seek to establish case reserves at the
maximum probable exposure based on our historical claims
experience. Our ability to estimate losses and LAE accurately 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 the value of the reserves for unpaid losses and LAE
between the beginning and the end of the period.
Commissions and other underwriting expenses consist principally
of brokerage and agent commissions and to a lesser extent
premium taxes. The brokerage and agent commissions are reduced
by ceding commissions received from assuming reinsurers that
represent a percentage of the premiums on insurance policies and
reinsurance contracts written and vary depending upon the amount
and types of contracts written.
Other operating and general expenses consist primarily of
personnel expenses (including salaries, benefits and certain
costs associated with awards under our equity compensation
plans, such as stock compensation expense) and other general
operating expenses. Our personnel expenses are primarily fixed
in nature and do not vary with the amount of premiums written.
Interest expenses associated with outstanding debt and
Expense on amounts
34
withheld are disclosed separately from operating and
general expenses. We invest funds in the participant loss layer
for several of our alternative risk programs. We receive
investment income and incur an equal expense on the amounts owed
to alternative risk transfer participants. Expense on
amounts withheld represents investment income that we
remit back to alternative risk transfer participants. The
related investment income is included in the Net
investment income line on our Consolidated Statements of
Income.
Results
of Operations
Overview
Our December 31, 2009, 2008 and 2007 net earnings from
operations, net realized gains (losses) from investments and net
income are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
Amount
|
|
|
Per Share
|
|
|
Amount
|
|
|
Per Share
|
|
|
Amount
|
|
|
Per Share
|
|
|
|
(Dollars in thousands, except per share data)
|
|
|
Net income from operations
|
|
$
|
38,050
|
|
|
$
|
1.96
|
|
|
$
|
32,761
|
|
|
$
|
1.69
|
|
|
$
|
44,027
|
|
|
$
|
2.27
|
|
Change in valuation allowance related to net capital losses
|
|
|
6,735
|
|
|
|
0.35
|
|
|
|
(7,545
|
)
|
|
|
(0.39
|
)
|
|
|
|
|
|
|
|
|
After-tax net realized gains (losses) from investments
|
|
|
1,664
|
|
|
|
0.09
|
|
|
|
(14,556
|
)
|
|
|
(0.75
|
)
|
|
|
(425
|
)
|
|
|
(0.02
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
46,449
|
|
|
$
|
2.40
|
|
|
$
|
10,660
|
|
|
$
|
0.55
|
|
|
$
|
43,602
|
|
|
$
|
2.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our net earnings from operations for 2009 were
$38.1 million ($1.96 per share diluted) compared to
$32.8 million ($1.69 per share diluted) in 2008, primarily
driven by a lower loss and LAE ratio of 60.8%, as compared to
64.7% in 2008. During 2008, we experienced an unusual number of
large claims, whereas in 2009, we experienced more favorable
large claims activity levels. This improvement in our
underwriting results is largely attributable to the risk
selection and pricing adequacy initiatives that began during the
third quarter of 2008 and continued into 2009. In addition to
lower losses, we also maintained a relatively constant expense
ratio of 24.0% for the year ended December 31, 2009 as
compared to 24.7% for the year ended December 31, 2008.
In 2008, we established a valuation allowance on deferred tax
assets related to net realized losses, primarily impairment
charges, which increased income tax expense by
$7.5 million. In 2009, income tax expense was positively
impacted by a $6.7 million reduction in the deferred tax
valuation allowance due to both available tax strategies and the
future realizability of previously impaired securities.
We had after-tax net realized gains from investments of
$1.7 million ($0.09 per share diluted) in 2009 compared to
after-tax net realized losses from investments of
$14.6 million ($0.75 per share diluted) in 2008. Included
in the 2009 after-tax net realized gains are $2.7 million
in net realized gains or losses associated with an equity
partnership investment and $2.6 million related to sales of
securities. Also included in the after-tax net realized gains
are
other-than-temporary
impairment adjustments of $2.5 million and
$13.1 million for the years ended December 31, 2009
and December 31, 2008, respectively.
35
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
|
(Dollars in thousands)
|
|
|
Alternative Risk Transfer
|
|
$
|
192,953
|
|
|
|
55.9
|
%
|
|
$
|
206,342
|
|
|
|
54.3
|
%
|
|
$
|
167,717
|
|
|
|
48.5
|
%
|
Transportation
|
|
|
66,537
|
|
|
|
19.3
|
%
|
|
|
87,246
|
|
|
|
22.9
|
%
|
|
|
90,984
|
|
|
|
26.3
|
%
|
Specialty Personal Lines
|
|
|
61,523
|
|
|
|
17.8
|
%
|
|
|
59,065
|
|
|
|
15.5
|
%
|
|
|
55,169
|
|
|
|
15.9
|
%
|
Hawaii and Alaska
|
|
|
18,576
|
|
|
|
5.5
|
%
|
|
|
22,489
|
|
|
|
5.9
|
%
|
|
|
25,126
|
|
|
|
7.3
|
%
|
Other
|
|
|
5,288
|
|
|
|
1.5
|
%
|
|
|
5,154
|
|
|
|
1.4
|
%
|
|
|
7,010
|
|
|
|
2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums written
|
|
$
|
344,877
|
|
|
|
100.0
|
%
|
|
$
|
380,296
|
|
|
|
100.0
|
%
|
|
$
|
346,006
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums written includes both direct premium and assumed
premium. During 2009, our gross premiums written decreased
$35.4 million, or 9.3%, compared to 2008. This decrease is
primarily attributable to our transportation, alternative risk
transfer and Hawaii and Alaska components, which decreased by
$20.7 million, $13.4 million and $3.9 million,
respectively. The decrease in gross premiums written in these
components is due to several factors, including the impact that
the current economic environment has had on our commercial
customers, particularly through reductions in vehicle counts and
mileage-based exposures, the effects of risk selection and
pricing adequacy initiatives specific to a few of our products
that we put in place in 2008 and the first half of 2009 and the
continued overly aggressive pricing from competition in the
insurance marketplace. In spite of the obstacles posed by the
current economic environment, we have renewed nearly 100% of our
captive members at the common renewal dates, maintained our
disciplined underwriting approach and have continued to generate
new business leads and add new programs and accounts to our
existing book of business. This was demonstrated in our
alternative risk transfer component, where we added seven new
captive programs during 2009, contributing approximately
$25.3 million in gross premiums written.
The captive 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 captive programs, we have analyzed, on a
quarterly basis, captive 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 written premium (assessments increase written
premium; returns of premium reduce written premium). For the
years ended December 31, 2009, 2008 and 2007, we recorded
return of premium of $4.5 million, $5.7 million and
$1.9 million, respectively.
Our specialty personal lines component increased
$2.5 million, or 4.2%, in 2009 compared to 2008, primarily
due to additional policies in force in our commercial vehicle
product from expanded marketing initiatives and product
enhancements. The growth in our commercial vehicle product was
offset by a decrease in our recreational vehicle product, as the
economic downturn has created a decline in the demand for
recreational vehicles.
36
Premiums
Earned
2009 compared to 2008. The following table
shows premiums earned for the years ended December 31, 2009
and 2008 summarized by the broader business component
description, which were determined based primarily on similar
economic characteristics, products and services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
Change
|
|
|
|
2009
|
|
|
2008
|
|
|
Amount
|
|
|
Percent
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alternative Risk Transfer
|
|
$
|
141,525
|
|
|
$
|
137,298
|
|
|
$
|
4,227
|
|
|
|
3.1
|
%
|
Transportation
|
|
|
60,344
|
|
|
|
75,495
|
|
|
|
(15,151
|
)
|
|
|
(20.1
|
%)
|
Specialty Personal Lines
|
|
|
56,385
|
|
|
|
54,862
|
|
|
|
1,523
|
|
|
|
2.8
|
%
|
Hawaii and Alaska
|
|
|
15,272
|
|
|
|
17,591
|
|
|
|
(2,319
|
)
|
|
|
(13.2
|
%)
|
Other
|
|
|
5,553
|
|
|
|
5,495
|
|
|
|
58
|
|
|
|
1.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums earned
|
|
$
|
279,079
|
|
|
$
|
290,741
|
|
|
$
|
(11,662
|
)
|
|
|
(4.0
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our premiums earned decreased $11.6 million, or 4.0%, to
$279.1 million during the year ended December 31, 2009
compared to $290.7 million for the year ended
December 31, 2008. This decrease is primarily attributable
to the transportation and Hawaii and Alaska components, which
decreased 20.1% and 13.2%, respectively, during 2009 compared to
the same period in 2008, due to reductions in gross premiums
written in these components during 2009. These reductions
related to the effect that the current economic environment has
had on our customers and the effects of risk selection and
pricing adequacy initiatives undertaken in 2008. Partially
offsetting these decreases were increases in our alternative
risk transfer and specialty personal lines components. Our
alternative risk transfer component increased 3.1% in 2009
compared to 2008, mainly due to new captive programs introduced
throughout 2009. Our specialty personal lines component
increased 2.8% during 2009 compared to the same period in 2008,
due to continued gross premiums written growth in our commercial
vehicle product.
2008 compared to 2007. The following table
shows premiums earned for the years ended December 31, 2008
and 2007 summarized by the broader business component
description, which were determined based primarily on similar
economic characteristics, products and services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
Change
|
|
|
|
2008
|
|
|
2007
|
|
|
Amount
|
|
|
Percent
|
|
|
|
(Dollars in thousands)
|
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alternative Risk Transfer
|
|
$
|
137,298
|
|
|
$
|
107,303
|
|
|
$
|
29,995
|
|
|
|
28.0
|
%
|
Transportation
|
|
|
75,495
|
|
|
|
74,112
|
|
|
|
1,383
|
|
|
|
1.9
|
%
|
Specialty Personal Lines
|
|
|
54,862
|
|
|
|
51,852
|
|
|
|
3,010
|
|
|
|
5.8
|
%
|
Hawaii and Alaska
|
|
|
17,591
|
|
|
|
17,625
|
|
|
|
(34
|
)
|
|
|
(0.2
|
%)
|
Other
|
|
|
5,495
|
|
|
|
6,669
|
|
|
|
(1,174
|
)
|
|
|
(17.6
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums earned
|
|
$
|
290,741
|
|
|
$
|
257,561
|
|
|
$
|
33,180
|
|
|
|
12.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our premiums earned increased $33.2 million, or 12.9%, to
$290.7 million during the year ended December 31, 2008
compared to $257.5 million for the year ended
December 31, 2007. Our alternative risk transfer component
increased 28.0% during 2008 compared to the same period in 2007,
primarily due to expanded insurance offerings in one of our
larger captives, new participants in existing captive programs
and the addition of new truck captive programs in 2008. Our
specialty personal lines component increased 5.8% in 2008
compared to 2007, due to growth in our commercial vehicle
product. The transportation component remained relatively
constant in 2008 compared to 2007, as we experienced a slight
decline in renewal rate increases due to the soft market. Our
Other component, which is comprised primarily of premium from
assigned risk plans from the states in which our insurance
company subsidiaries operate and over which we have no control,
decreased $1.2 million, or 17.6%, to $5.5 million in
2008.
37
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.
Our underwriting approach is to price our products to achieve an
underwriting profit even if we forego volume as a result. From
2000 through 2006, our insurance subsidiaries increased their
premium rates to offset rising losses and reinsurance costs. In
2009, 2008 and 2007, we experienced a slight decline in rate
levels on renewal business due to the continued softening market.
The table below presents our premiums earned and combined ratios
for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands)
|
|
|
Gross premiums written
|
|
$
|
344,877
|
|
|
$
|
380,296
|
|
|
$
|
346,006
|
|
Ceded reinsurance
|
|
|
(69,831
|
)
|
|
|
(82,215
|
)
|
|
|
(73,864
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written
|
|
|
275,046
|
|
|
|
298,081
|
|
|
|
272,142
|
|
Change in unearned premiums, net of ceded
|
|
|
4,033
|
|
|
|
(7,340
|
)
|
|
|
(14,581
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
279,079
|
|
|
$
|
290,741
|
|
|
$
|
257,561
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and LAE ratio(1)
|
|
|
60.8
|
%
|
|
|
64.7
|
%
|
|
|
58.0
|
%
|
Underwriting expense ratio(2)
|
|
|
24.0
|
%
|
|
|
24.7
|
%
|
|
|
22.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
84.8
|
%
|
|
|
89.4
|
%
|
|
|
80.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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. |
2009 compared to 2008. Losses and LAE
decreased $18.4 million, or 9.8%, for 2009 compared to
2008. The loss and LAE ratio for the year ended
December 31, 2009 was 60.8% compared to 64.7% for the year
ended December 31, 2008. The decrease in the loss and LAE
ratio in 2009 of 3.9 percentage points is primarily due to
the greater loss severity experienced in 2008, partially offset
by higher claims frequency in 2009. During the first three
quarters of 2008, we experienced an unusual number of severe
claims, primarily concentrated in our charter passenger
transportation products. These claims contributed approximately
5.8 percentage points to the loss and LAE ratio during
2008, whereas we experienced significantly lower large claim
activity throughout 2009, which reduced our loss and LAE ratio
by 1.4 percentage points. The large claims levels
experienced during 2009 are not considered to be unusual and are
in line with our historical results. We attribute this
improvement to the review of our underwriting standards that we
began in the third quarter of 2008 and continued into 2009, as
well as other risk selection and pricing adequacy initiatives
and lower vehicle usage by our customers in 2009. Partially
offsetting the decrease in severity was an increase in claim
frequency related to higher vehicle usage particularly within
our specialty personal lines component, primarily commercial
vehicle, during 2009.
For the years ended December 31, 2009 and 2008, we had
favorable development from prior years loss reserves of
$1.3 million and $0.9 million, respectively. The
favorable development for both years was primarily related to
settlements below the established case reserves and revisions to
our estimated future settlements on an individual case by case
basis. This development represents only 0.5% and 0.4% for 2009
and 2008, respectively, of the prior year reserves.
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. The underwriting expense ratio was 24.0% and
24.7% for the years ended December 31, 2009 and 2008,
respectively. The 0.7 percentage point decrease to our 2009
expense
38
ratio is primarily due to a change in our overall mix of
business, as many of the new captive programs written in 2009
have lower commission rates compared to the programs where we
had high premium growth in 2008.
2008 compared to 2007. Losses and LAE
increased $38.6 million, or 25.8%, for 2008 compared to
2007. The loss and LAE ratio for the year ended
December 31, 2008 was 64.7% compared to 58.0% for the year
ended December 31, 2007. The increase in the loss and LAE
ratio in 2008 of 6.7 percentage points is primarily due to
an increase in large loss severity in our charter passenger
transportation products that we experienced during the first
three quarters of 2008. These large losses contributed
approximately 5.8 percentage points to our 2008 loss and
LAE ratio. During the third quarter of 2008, we began the
process of reviewing most of our large fleet charter
transportation book and our entire in-force small fleet book of
charter transportation business to ensure that our high
underwriting standards were in place and identified specific
accounts that required action. We also implemented other
initiatives, centered on risk selection and pricing adequacy
relative to the entire charter transportation product.
For the years ended December 31, 2008 and 2007, we had
favorable development from prior years loss reserves of
$0.9 million and $5.7 million, respectively. The
favorable development for both years was primarily related to
settlements below the established case reserves and revisions to
our estimated future settlements on an individual case by case
basis. This development represents 0.4% and 3.1% for 2008 and
2007, respectively, of the prior year reserves. The increase in
the loss and LAE ratio from 2007 to 2008 also reflects the
impact of modestly lower renewal rates that we experienced from
the softening market.
The underwriting expense ratio was 24.7% and 22.9% for the years
ended December 31, 2008 and 2007, respectively. The
1.8 percentage point increase to our 2008 expense ratio is
primarily due to a change in our overall mix of business,
including high premium growth in products that tend to have
higher commission rates.
Net
Investment Income
2009 compared to 2008. Net investment income
decreased $3.2 million, or 14.1%, to $19.3 million in
2009 compared to 2008, reflecting lower yields on our cash,
short-term and fixed income portfolios due to a prolonged low
interest rate environment and a focus on high quality
investments during the financial crisis, as well as a high
allocation to tax exempt state and local government investments.
The decrease in yields, which we initially experienced in 2008,
continued in 2009 and remained at lower levels, offsetting the
portfolio growth that occurred during the year.
2008 compared to 2007. Net investment income
remained relatively constant at $22.5 million for 2008
compared to $22.1 million in 2007, reflecting portfolio
growth that was offset by lower yields. Yields declined
throughout 2008 for most investment categories in which we are
active.
Net
Realized Gains (Losses) on Investments
2009 compared to 2008. In 2009, we had pre-tax
net realized gains of $2.6 million compared to pre-tax net
realized losses of $22.4 million for 2008. The pre-tax net
realized gains for the year ended December 31, 2009 were
primarily generated from net realized gains associated with an
equity partnership investment of $4.2 million and realized
gains associated with the sales of securities of
$4.0 million. Offsetting these gains were
other-than-temporary
impairment charges recognized in earnings of $3.9 million
and realized losses of $1.7 million on disposals, including
a $1.0 million realized loss on the conversion of a
perpetual preferred stock to common stock on a financial
institution holding. The two largest components of the
$3.9 million impairment charge were $1.8 million on
three corporate notes and credit only impairments of
$1.9 million related to four mortgage-backed securities. In
2008, turmoil in the investment markets resulted in market
declines in our portfolio, particularly in our financial and
real estate related holdings. This had an adverse impact on our
investment portfolio in 2008, as we recognized
other-than-temporary
impairment charges on investments of $20.2 million for the
year ended December 31, 2008. The two largest components of
the $20.2 million impairment charge were write-offs of
$7.0 million related to securities issued by Fannie Mae,
Freddie Mac and Lehman Brothers Holdings Inc. and
$8.7 million related to exchange traded funds.
2008 compared to 2007. In 2008, we had pre-tax
net realized losses of $22.4 million compared to
$0.7 million for 2007. The turmoil in investment markets
caused market declines in our investment portfolio
39
during 2008, as we recognized
other-than-temporary
impairment charges on investments of $20.2 million. We
recorded $1.0 million of impairment adjustments during 2007.
Other
Income
2009 compared to 2008. Other income increased
$0.6 million, or 21.6%, to $3.5 million for 2009
compared to $2.9 million in 2008. This increase is
primarily attributable to growth in the policy-based fee income
generated by our personal lines component throughout 2009.
2008 compared to 2007. Other income decreased
$1.2 million, or 30.7%, to $2.9 million for 2008
compared to $4.1 million in 2007. This decrease is
primarily attributable to a decline in rental income directly
resulting from a lease termination agreement executed with a
former tenant in the third quarter of 2007.
Commissions
and Other Underwriting Expenses
2009 compared to 2008. Commissions and other
underwriting expenses for the year ended December 31, 2009
decreased $4.9 million, or 7.9%, to $57.2 million from
$62.1 million in the comparable period in 2008. The
decrease relates to a decline in net commission expense due to a
change in our overall mix of business. Our various products have
different commission rates; therefore, commission expense can
vary based on the product mix written during the period.
Additionally, our 2008 commissions and other underwriting
expenses included an approximate $1.3 million charge for a
one-time state guaranty fund.
2008 compared to 2007. Commissions and other
underwriting expenses for the year ended December 31, 2008
increased $11.2 million, or 22.0%, to $62.1 million
from $50.9 million in the comparable period in 2007. The
increases relate to an increase in net commission expense due to
growth and a change in our business mix as well as a decrease in
ceding commission. Our various products have different
commission rates; therefore, commission expense can vary based
on the product mix written during the period. During 2008, our
premium growth was typically in products with higher commission
rates. In addition to a change in our overall mix of business,
we recorded an approximate $1.3 million charge for a
one-time state guarantee fund in the third quarter of 2008,
which was also a contributing factor to the increase in our
commissions and other underwriting expenses.
Other
Operating and General Expenses
2009 compared to 2008. Other operating and
general expenses increased $0.5 million, or 3.7%, to
$13.1 million during the year ended December 31, 2009
compared to $12.6 million for the same period in 2008. The
increase was primarily due to an increase in our employee wages
over prior year.
2008 compared to 2007. Other operating and
general expenses increased $0.5 million, or 3.8%, to
$12.6 million during the year ended December 31, 2008
compared to $12.1 million for the same period in 2007. This
increase was primarily due to an increase in employee headcount
that increased our employee wages over prior year.
Expense
on Amounts Withheld
2009 compared to 2008. We invest funds in the
participant loss layer for several of the alternative risk
transfer programs. We receive investment income and incur an
equal expense on the amounts owed to alternative risk transfer
participants. Expense on amounts withheld represents
investment income that we remit back to alternative risk
transfer participants. The related investment income is included
in our Net investment income line on our
Consolidated Statements of Income. For the year ended
December 31, 2009, the expense on amounts withheld
decreased $0.8 million over the same period in 2008. The
decrease is primarily attributable to lower interest rate yields
experienced during 2009 compared to 2008.
2008 compared to 2007. For the year ended
December 31, 2008, the expense on amounts withheld
increased $0.6 million over the same period in 2007. The
increase is directly attributable to the growth in our
alternative risk transfer component.
40
Income
Taxes
2009 compared to 2008. The 2009 effective tax
rate was 22.7%, decreasing 35.9% from a rate of 58.6% in 2008.
The decrease in our 2009 effective tax rate was favorably
impacted by a decrease in our valuation allowance related to net
realized losses. In 2008, the provision for income taxes was
negatively impacted by the recording of a $7.5 million
valuation allowance related to our realized losses, primarily
impairment charges, which increased the 2008 effective tax rate
by 29.3 percentage points. In 2009, income tax expense was
positively impacted by a $6.7 million reduction in the
deferred tax valuation allowance due to both available tax
strategies and the future realizability of previously impaired
securities, thereby decreasing our effective tax rate by
11.2 percentage points.
2008 compared to 2007. The 2008 effective tax
rate was 58.6%, increasing 25.3% from a rate of 33.3% in 2007.
The change in the effective tax rate was primarily due to a
valuation allowance of $7.5 million that was recorded on
our realized losses, primarily impairment charges which
increased the 2008 effective tax rate 29.3 percentage
points.
At December 31, 2008, we had gross deferred tax assets of
$13.6 million related to investment securities. This gross
deferred tax asset was reduced by a valuation allowance related
to unrealized losses on equity investments of $0.1 million
and a valuation allowance related to realized losses on
investments of $7.5 million.
Financial
Condition
Investments
and Securities Lending Collateral
During the second quarter of 2009, we terminated our securities
lending program and transferred fixed maturities with a fair
market value of $35.8 million, primarily residential
mortgage-backed securities and corporate obligations, into our
fixed maturities portfolio.
At December 31, 2009, our investment portfolio contained
$566.9 million in fixed maturity securities and
$28.7 million in equity securities, all carried at fair
value with unrealized gains and losses reported as a separate
component of shareholders equity on an after-tax basis. At
December 31, 2009, we had pretax net unrealized gains of
$1.1 million on fixed maturities and $2.5 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.
Fixed maturity investments are focused on securities with short
and intermediate-term maturities. At December 31, 2009, the
weighted average maturity of our fixed maturity investments was
approximately 4.8 years. At December 31, 2009, 94.6%
of the fixed maturities in our portfolio were rated
investment grade (credit rating of AAA to BBB-) by
Standard & Poors Corporation. Investment grade
securities generally bear lower yields and lower degrees of risk
than those that are unrated or non-investment grade. Although we
cannot provide any assurances, we believe that, in normal market
conditions, our high quality investment portfolio should
generate a stable and predictable investment return.
Included in the fixed maturities at December 31, 2009 were
$116.7 million of residential mortgage-backed securities
(MBS). We do not have a significant exposure to the
subprime lending sector as 93.1% of our residential MBS are
backed by US government agencies. MBS are subject to prepayment
risk due to the fact that, in periods of declining interest
rates, mortgages may be prepaid more rapidly than scheduled as
buyers refinance higher rate mortgages to take advantage of
declining interest rates. Also included in fixed maturities at
December 31, 2009 were $155.0 million of state and
local government obligations (muni bonds).
Approximately 93.0% of our muni bonds are rated
A− or better giving no effect to credit
enhancement.
41
Summary information for securities with unrealized gains or
losses at December 31, 2009 is shown in the following
table. Approximately $0.2 million of fixed maturities and
$13.5 million of equity securities had no unrealized gains
or losses at December 31, 2009.
|
|
|
|
|
|
|
|
|
|
|
Securities with
|
|
Securities with
|
|
|
Unrealized
|
|
Unrealized
|
|
|
Gains
|
|
Losses
|
|
|
(Dollars in thousands)
|
|
Fixed Maturities:
|
|
|
|
|
|
|
|
|
Fair value of securities
|
|
$
|
368,831
|
|
|
$
|
197,850
|
|
Amortized cost of securities
|
|
|
357,881
|
|
|
|
207,652
|
|
Gross unrealized gain or (loss)
|
|
$
|
10,950
|
|
|
$
|
(9,802
|
)
|
Fair value as a % of amortized cost
|
|
|
103.1
|
%
|
|
|
95.3
|
%
|
Number of security positions held
|
|
|
369
|
|
|
|
168
|
|
Number individually exceeding $50,000 gain or (loss)
|
|
|
75
|
|
|
|
30
|
|
Concentration of gains or losses by type or industry:
|
|
|
|
|
|
|
|
|
US Government and government agencies
|
|
$
|
1,736
|
|
|
$
|
(349
|
)
|
State, municipalities and political subdivisions
|
|
|
5,436
|
|
|
|
(1,612
|
)
|
Residential mortgage-backed securities
|
|
|
2,224
|
|
|
|
(4,478
|
)
|
Commercial mortgage-backed securities
|
|
|
|
|
|
|
(547
|
)
|
Banks, insurance and brokers
|
|
|
891
|
|
|
|
(2,429
|
)
|
Industrial and other
|
|
|
663
|
|
|
|
(387
|
)
|
Percentage rated investment grade(1)
|
|
|
97.3
|
%
|
|
|
89.7
|
%
|
Equity Securities:
|
|
|
|
|
|
|
|
|
Fair value of securities
|
|
$
|
15,037
|
|
|
$
|
94
|
|
Cost of securities
|
|
|
12,558
|
|
|
|
103
|
|
Gross unrealized gain or (loss)
|
|
$
|
2,479
|
|
|
$
|
(9
|
)
|
Fair value as a % of cost
|
|
|
119.7
|
%
|
|
|
91.3
|
%
|
Number individually exceeding $50,000 gain or (loss)
|
|
|
7
|
|
|
|
|
|
|
|
|
(1) |
|
Investment grade of AAA to BBB- by Standard &
Poors Corporation. |
The table below sets forth the scheduled maturities of available
for sale fixed maturity securities at December 31, 2009,
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
|
|
|
Unrealized
|
|
|
|
Gains
|
|
|
Losses
|
|
|
Maturity:
|
|
|
|
|
|
|
|
|
One year or less
|
|
|
5.3
|
%
|
|
|
5.0
|
%
|
After one year through five years
|
|
|
39.4
|
%
|
|
|
32.2
|
%
|
After five years through ten years
|
|
|
29.7
|
%
|
|
|
28.5
|
%
|
After ten years
|
|
|
5.8
|
%
|
|
|
10.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
80.2
|
%
|
|
|
75.9
|
%
|
Mortgage-backed securities
|
|
|
19.8
|
%
|
|
|
24.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
42
The table below summarizes the unrealized gains and losses on
fixed maturities and equity securities by dollar amount:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2009
|
|
|
|
Aggregate
|
|
|
Aggregate
|
|
|
Fair Value
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
as % of
|
|
|
|
Value
|
|
|
Gain (Loss)
|
|
|
Cost Basis
|
|
|
|
(Dollars in thousands)
|
|
|
Fixed Maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with unrealized gains:
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year (56 issues)
|
|
$
|
84,043
|
|
|
$
|
4,375
|
|
|
|
105.5
|
%
|
More than one year (19 issues)
|
|
|
25,108
|
|
|
|
1,627
|
|
|
|
106.9
|
%
|
Less than $50,000 (294 issues)
|
|
|
259,680
|
|
|
|
4,948
|
|
|
|
101.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
368,831
|
|
|
$
|
10,950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with unrealized losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year (3 issues)
|
|
$
|
9,749
|
|
|
$
|
(316
|
)
|
|
|
96.9
|
%
|
More than one year (27 issues)
|
|
|
30,016
|
|
|
|
(8,373
|
)
|
|
|
78.2
|
%
|
Less than $50,000 (138 issues)
|
|
|
158,085
|
|
|
|
(1,113
|
)
|
|
|
99.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
197,850
|
|
|
$
|
(9,802
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with unrealized gains:
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year (7 issues)
|
|
$
|
13,130
|
|
|
$
|
2,283
|
|
|
|
121.0
|
%
|
More than one year (0 issues)
|
|
|
|
|
|
|
|
|
|
|
0.0
|
%
|
Less than $50,000 (18 issues)
|
|
|
1,907
|
|
|
|
196
|
|
|
|
111.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
15,037
|
|
|
$
|
2,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with unrealized losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year (0 issues)
|
|
$
|
|
|
|
$
|
|
|
|
|
0.0
|
%
|
More than one year (0 issues)
|
|
|
|
|
|
|
|
|
|
|
0.0
|
%
|
Less than $50,000 (1 issue)
|
|
|
94
|
|
|
|
(9
|
)
|
|
|
91.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
94
|
|
|
$
|
(9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 Managements Discussion
and Analysis of Financial Condition and Results of
Operations
Other-Than-Temporary
Impairment.
43
Net realized gains (losses) on securities sold and charges for
other-than-temporary
impairment on securities held were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Realized
|
|
|
|
Net Realized
|
|
|
Gains (Losses)
|
|
Charges for
|
|
Gains (Losses)
|
|
|
on Sales
|
|
Impairment
|
|
on Investments
|
|
|
(Dollars in thousands)
|
|
Year ended:
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
$
|
6,449
|
|
|
$
|
(3,888
|
)
|
|
$
|
2,561
|
|
2008
|
|
|
(2,230
|
)
|
|
|
(20,164
|
)
|
|
|
(22,394
|
)
|
2007
|
|
|
321
|
|
|
|
(974
|
)
|
|
|
(653
|
)
|
Fair
Value Measurements
Under fair value accounting, we must determine the appropriate
level in the fair value hierarchy for each applicable
measurement. The fair value hierarchy prioritizes the inputs,
which refer broadly to assumptions market participants would use
in pricing an asset or liability, into three levels. It gives
the highest priority to quoted prices (unadjusted) in active
markets for identical assets or liabilities and the lowest
priority to unobservable inputs. The level in the fair value
hierarchy within which a fair value measurement in its entirety
falls is determined based on the lowest level input that is
significant to the fair value measurement in its entirety. Fair
values for our investment portfolio are reviewed by company
personnel using data from nationally recognized pricing services
as well as non-binding broker quotes.
The pricing services use a variety of observable inputs to
estimate the fair value of fixed maturities that do not trade on
a daily basis. These inputs include, but are not limited to,
recent reported trades, benchmark yields, issuer spreads, bids
or offers, reference data and measures of volatility. Included
in the pricing of mortgage-backed securities are estimates of
the rate of future prepayments and defaults of principal over
the remaining life of the underlying collateral. Valuation
techniques utilized by pricing services and prices obtained from
independent financial institutions are reviewed by company
personnel who are familiar with the securities being priced and
the markets in which they trade to ensure that the fair value
determination is representative of an exit price, as defined by
fair value accounting.
Effective April 1, 2009, we adopted revised accounting
guidance on estimating the fair value of an asset or liability
when there is no active market and on identifying transactions
that are not orderly. This did not change the objective of fair
value measurements. Adoption of this change in the accounting
guidance did not have a material impact on our consolidated
financial position or results of operations.
Level 1 inputs are quoted prices (unadjusted) in active
markets for identical securities that the reporting entity has
the ability to access at the measurement date. Level 2
inputs are inputs other than quoted prices within Level 1
that are observable for the security, either directly or
indirectly. Level 2 inputs include quoted prices for
similar securities in active markets, quoted prices for
identical or similar securities that are not active and
observable inputs other than quoted prices, such as interest
rate and yield curves. Level 3 inputs are unobservable
inputs for the asset or liability.
Level 1 consists of publicly traded equity securities whose
fair value is based on quoted prices that are readily and
regularly available in an active market. Level 2 primarily
consists of financial instruments whose fair value is based on
quoted prices in markets that are not active and include
U.S. government and government agency securities, fixed
maturity investments, perpetual preferred stock and certain
publicly traded common stocks that are not actively traded.
Included in Level 2 are $6.6 million of securities,
which are valued based upon a non-binding broker quote and
validated by management by observable market data. Level 3
consists of financial instruments that are not traded in an
active market, whose fair value is estimated by management based
on inputs from independent financial institutions, which include
non-binding broker quotes, for which we believe reflects fair
value, but are unable to verify inputs to the valuation
methodology. We obtained one quote or price per instrument from
its brokers and pricing services and did not adjust any quotes
or prices that it obtained. Management reviews these broker
quotes using information such as the market prices of similar
investments.
44
Liquidity
and Capital Resources
Capital Ratios. The NAICs model law for
RBC provides formulas to determine the amount of capital and
surplus that an insurance company needs to ensure that it has an
acceptable expectation of not becoming financially impaired. At
December 31, 2009 and 2008, the capital and surplus of all
our insurance companies substantially exceeded the RBC
requirements.
Sources of Funds. 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, 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 or an increase in claims paid or operating expenses, 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 has
enabled us to extend slightly 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, cash equivalents and short-term investments were
$19.4 million at December 31, 2009, a
$57.8 million decrease from December 31, 2008. For
2009, 2008 and 2007, we generated consolidated cash flow from
operations of $51.3 million, $101.3 million and
$93.2 million, respectively. The decrease of
$50.0 million in cash flow from operations in 2009 from
2008 is primarily attributable to a large amount of claims
payments made during 2009. Cash flow from operations increased
$8.1 million in 2008 from 2007 due to an increase in our
loss and LAE reserves stemming from an increase in large claim
severity that we experienced during the first three quarters of
2008.
Net cash used in investing activities was $57.9 million,
$63.3 million and $69.1 million for the years ended
December 31, 2009, 2008 and 2007, respectively. This
$5.4 million decrease in cash used in investing activities
in 2009, as compared to 2008, was primarily related to a
$65.3 million increase in the proceeds from the sale of
fixed maturity securities and an $11.2 million decrease in
the purchase of fixed maturity investments in 2009, which were
offset by a $68.6 million decrease in the proceeds from
maturities and redemptions of investments. The decrease in both
purchases and redemptions of fixed maturity investments in 2009,
compared to the prior period was primarily due to a shift in
asset allocation from callable U.S. government agency bonds
into longer duration state and local government bonds,
residential collateralized mortgage-backed securities and
corporate obligations. The increase in proceeds from the sale of
fixed maturity securities was the result of taking advantage of
improving market conditions to realize gains on portions of our
fixed maturity portfolio. The $5.8 million decrease in cash
used in investing activities in 2008 compared to 2007 was
primarily related to a $176.4 million increase in the
proceeds from sales and maturities of investments and a decline
of $42.1 million in the purchase of equity securities,
which was partially offset by a $212.4 million increase in
the purchase of fixed maturity investments in 2008. The increase
in both purchases and redemptions of fixed maturities during
2008, compared to the prior period was directly influenced by
market conditions. As interest rates declined throughout 2008,
many of our high yielding U.S. government agency bonds were
called and replaced with purchases of lower yielding agency
bonds. Additionally, the decrease in the purchases of equity
securities is directly related to the market turmoil experienced
during 2008.
Net cash used in financing activities of $52.0 million,
$3.9 million and $3.2 million, respectively, for the
years ended December 31, 2009, 2008 and 2007. The
$48.1 million increase in net cash used in financing
activities was primarily driven by the termination of our
securities lending program in June 2009. During 2009 and prior
to the programs termination, approximately
$22.1 million of investments within our securities lending
collateral matured and were used to pay down a corresponding
amount of our securities lending obligation. Upon the
programs termination, cash on hand and securities lending
collateral were used to pay off the remaining $73.7 million
securities lending obligation. Securities lending collateral
that had an original cost of $46.5 million at the
45
termination date were retained by us and are included in our
fixed maturities portfolio through a non-cash transaction. The
increase in cash used from financing activities in 2008 from
2007 of $0.7 million is primarily attributable to a
$0.8 million increase in dividends paid to shareholders.
We will 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 and from our line of
credit. Under the state insurance laws, dividends and capital
distributions from our insurance companies are subject to
restrictions relating to statutory surplus and earnings. The
maximum amount of dividends that our insurance companies could
pay to us without seeking regulatory approval in 2009 is
$33.1 million. Our insurance subsidiaries paid no dividends
in 2009 or 2008.
Under tax allocation and cost sharing agreements among the
Company and its subsidiaries, taxes and expenses are allocated
among the entities. The federal income tax provision of our
individual subsidiaries is computed as if the subsidiary filed a
separate tax return. The resulting provision (or credit) is
currently payable to (or receivable from) us.
We have a $50 million unsecured Credit Agreement (the
Credit Agreement) that terminates in December 2012,
which includes a sublimit of $10 million for letters of
credit. At December 31, 2009 there was $15 million
drawn on this credit facility. We have the ability to increase
the line of credit to $75 million subject to the Credit
Agreements accordion feature. Amounts borrowed bear
interest at either (1) a rate per annum equal to the
greater of the administrative agents 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
December 31, 2009. Commitment fees on the average daily
unused portion of the Credit Agreement also vary with our
A.M. Best insurance group rating and range from 0.090% to
0.175%, or 0.125% at December 31, 2009.
In 2008, we drew $15 million from its Credit Agreement to
redeem in full its outstanding junior subordinated debentures,
replacing higher variable rate debt of LIBOR plus 420 basis
points with lower variable rate debt. As of December 31,
2009, the interest rate on this debt is equal to the six-month
LIBOR (0.5% at November 27, 2009) plus 65 basis
points, with interest payments due quarterly.
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 December 31, 2009, we
were in compliance with all financial covenants.
We believe that funds generated from operations, including
dividends from insurance subsidiaries, parent company cash and
funds available under our Credit Agreement 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 additional borrowings, 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. If we were forced to borrow
additional funds in order to meet liquidity needs, we would
incur additional interest expense, which could have a negative
impact on our earnings. 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 operating needs.
Off-Balance Sheet Items. We do not have any
off-balance sheet arrangements as such term is defined in
applicable SEC rules.
46
We do not currently 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.
Contractual Obligations. The following table
summarizes our long-term contractual obligations as of
December 31, 2009:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period
|
|
|
|
|
|
|
Within 1
|
|
|
|
|
|
|
|
|
More than
|
|
|
|
Total
|
|
|
Year
|
|
|
2-3 Years
|
|
|
4-5 Years
|
|
|
5 Years
|
|
|
|
(Dollars in thousands)
|
|
|
Gross unpaid losses and LAE(1)
|
|
$
|
417,260
|
|
|
$
|
170,404
|
|
|
$
|
155,344
|
|
|
$
|
59,066
|
|
|
$
|
32,446
|
|
Long term debt obligations
|
|
|
15,000
|
|
|
|
|
|
|
|
15,000
|
|
|
|
|
|
|
|
|
|
Operating lease obligations
|
|
|
822
|
|
|
|
307
|
|
|
|
412
|
|
|
|
103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
433,082
|
|
|
$
|
170,711
|
|
|
$
|
170,756
|
|
|
$
|
59,169
|
|
|
$
|
32,446
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Dollar amounts and time periods are estimates based on
historical net payment patterns applied to the gross reserves
and do not represent actual contractual obligations. Actual
payments and their timing could differ significantly from these
estimates, and the estimates provided do not reflect potential
recoveries under reinsurance treaties. |
Critical
Accounting Policies
The preparation of financial statements in conformity with 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 impact amounts reported in the future. Management
believes that the establishment of loss and LAE reserves and the
determination of
other-than-temporary
impairment on investments are two areas where by the degree of
judgment required to determine amounts recorded in the financial
statements make the accounting policies critical. We discuss
these two policies below. Our other significant accounting
policies are described in Note 2 to our consolidated
financial statements.
Loss
and Loss Adjustment Expenses 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 December 31, 2009 and 2008, we had
$417.3 million and $400.0 million, respectively, of
gross loss and LAE reserves, representing managements 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,
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 NIICs, NIIC-HIs and TCCs
net reserves as of December 31, 2009 and 2008 reflected
point estimates that were within 2% of managements
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 managements
best estimates of the liability as of each year end.
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):
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|
|
the Case Incurred Development Method;
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|
|
the Paid Development Method;
|
|
|
|
the Bornhuetter-Ferguson Method; and
|
|
|
|
the Incremental Paid LAE to Paid Loss Methods.
|
47
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:
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|
|
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;
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|
|
|
average closed claim severity;
|
|
|
|
ultimate claim severity;
|
|
|
|
reported loss ratios;
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|
|
|
projected ultimate loss ratios; and
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|
|
|
loss payment patterns.
|
Following is a discussion of certain critical variables
affecting the estimation of loss reserves in our more
significant lines of business. Many other variables may also
impact ultimate claim costs. An important assumption underlying
reserve estimates is that the cost trends implicitly built into
development patterns will continue into the future. An
unexpected change in cost trends could arise from a variety of
sources including a general increase in economic inflation,
inflation from social programs, new medical technologies or
other factors such as those listed below in connection with our
largest lines of business. It is not possible to isolate and
measure the potential impact of just one of these variables and
future cost trends could be partially impacted by several such
variables. However, it is reasonable to address the sensitivity
of the reserves to a potential impact from changes in these
variables by measuring the effect of a possible overall 1%
change in future cost trends that may be caused by one or more
variables. The sensitivity of recorded reserves to a potential
change of 1% in the future cost trends is shown below. Utilizing
the effect of a 1% change in overall cost trends enables changes
greater than 1% to be estimated by extrapolation. The estimated
cumulative unfavorable impact that this 1% change would have on
our 2009 net income is shown below:
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|
|
|
|
|
|
Cumulative
|
Line of Business
|
|
Impact
|
|
Commercial Auto Liability
|
|
$
|
2.0 million
|
|
Workers Compensation
|
|
$
|
0.6 million
|
|
The judgments and uncertainties surrounding managements
reserve estimation process and the potential for reasonably
possible variability in managements most recent reserve
estimates may also be viewed by looking at how recent historical
estimates of reserves for all lines of business have developed.
If our December 31, 2009, reserves (net of reinsurance)
developed at the same rate as the average development of the
most recent five years, the effect on net earnings would be an
increase of $4.9 million.
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|
|
|
|
|
|
|
|
|
|
5-yr. Average
|
|
Net Reserves
|
|
Effect on Net
|
Development (*)
|
|
December 31, 2009
|
|
Earnings
|
|
|
(1.8
|
)%
|
|
$
|
276.4 million
|
|
|
$
|
4.9 million
|
|
48
The following discussion describes key assumptions and important
variables that materially affect the estimate of the reserve for
loss and LAE of our two most significant lines of business,
which represent 88.4% of our total reserves and explains what
caused them to change from assumptions used in the preceding
period. Management has not made changes in key assumptions used
in calculating current year reserves based on historical changes
or current trends observed.
Commercial Auto Liability. In this line of
business, we provide coverage protecting buses, limousines,
other public transportation vehicles and trucks for accidents
causing property damage or personal injury to others. Property
damage liability and medical payments exposures are typically
short-tail lines of business with relatively quick reporting and
settlement of claims. Bodily injury exposure is long-tail
because although the claim reporting of this line of business is
relatively quick, the final settlement can take longer to
achieve.
Some of the important variables affecting our estimation of loss
reserves for commercial auto liability include:
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|
litigious climate;
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|
|
unpredictability of judicial decisions regarding coverage issues;
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|
|
|
magnitude of jury awards;
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|
|
|
outside counsel costs; and
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|
|
|
frequency and timing of claims reporting.
|
We recorded favorable development of $0.7 million in 2009
for this line of business as actual claim severity, driven by
favorable negotiated settlements and jury awards, was lower than
previously anticipated. We recorded unfavorable development of
$1.3 million in 2008 as actual claim severity was
significantly higher than previously anticipated and favorable
development of $1.4 million in 2007 as actual claim
severity was significantly lower than previously anticipated. We
continually monitor development trends in each line of business
as a component of estimating future ultimate loss and related
LAE liabilities. Management has not made any changes to the key
assumptions used in calculating current year reserves in the
commercial auto liability line of business.
Workers Compensation. In this long-tail
line of business, we provide coverage for employees who may be
injured in the course of employment. Some of the important
variables affecting our estimation of loss reserves for
workers compensation include:
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|
|
|
|
legislative actions and regulatory interpretations;
|
|
|
|
future medical cost inflation; and
|
|
|
|
timing of claims reporting.
|
A significant portion of our workers compensation business
is written in California. Significant reforms passed by the
California state legislature in 2003 and in 2004 reduced
employer premiums and set treatment standards for injured
workers. However, recent judicial decisions are moderating the
benefits of these reforms. We recorded unfavorable prior year
loss development of $2.3 million in 2009. We recorded
favorable prior year loss development of $0.5 million in
2008 and $3.0 million in 2007 due primarily to the impact
of the legislation on medical claim costs being more favorable
than previously anticipated.
Future costs depend on the implementation and interpretation of
the reforms and judicial decisions throughout the workers
compensation system over the next several years. Due to the
long-tail nature of this business and the uncertainty
surrounding recent judicial decisions, it is difficult to
predict ultimate liabilities until a higher percentage of claims
have been paid and the ultimate impact of these decisions can be
estimated with more precision.
Within each line, Great American actuaries review the results of
individual tests, supplementary statistical information and
input from management to select their point estimate of the
ultimate liability. This estimate may be one test, a weighted
average of several tests or a judgmental selection as the
actuaries determine is appropriate. The actuarial review is
performed each quarter as a test of the reasonableness of
managements point estimate and to
49
provide management with a consulting opinion regarding the
advisability of modifying its reserve setting assumptions for
future periods. The Great American actuaries do not develop
ranges of losses.
The level of detail at which data is analyzed varies among the
different lines of business. We generally analyze data by major
product or coverage, using countrywide data. We determine the
appropriate segmentation of the data based on data volume, data
credibility, mix of business and other actuarial considerations.
Point estimates are selected based on test indications and
judgment.
Claims we view as potentially significant are subject to a
rigorous review process involving the adjuster, claims
management and executive management. We seek to establish
reserves at the maximum probable exposure based on our historic
claims experience. Incurred but not yet reported
(IBNR) reserves are determined separate from the
case reserving process and include estimates for potential
adverse development of the recorded case reserves. We monitor
IBNR reserves monthly with financial management and quarterly
with an actuary from Great American. IBNR reserves are adjusted
monthly based on historic patterns and current trends and
exposures. When a claim is reported, claims personnel establish
a case reserve for the estimated amount of ultimate
payment. The amount of the reserve is based upon an evaluation
of the type of claim involved, the circumstances surrounding
each claim and the policy provisions relating to the loss. The
estimate reflects informed judgment of our claims personnel
based on general insurance reserving practices and on the
experience and knowledge of the claims personnel. During the
loss adjustment period, these estimates are revised as deemed
necessary by our claims department based on developments and
periodic reviews of the cases. Individual case reserves are
reviewed for adequacy at least quarterly by senior claims
management.
When establishing and reviewing reserves, we analyze historic
data and estimate the impact of various loss development
factors, such as our historic loss experience and that of the
industry, trends in claims frequency and severity, our mix of
business, our claims processing procedures, legislative
enactments, judicial decisions, legal developments in imposition
of damages and changes and trends in general economic
conditions, including the effects of inflation. As of
December 31, 2009, management has not made any key
assumptions that are inconsistent with historical loss reserve
development patterns. A change in any of these aforementioned
factors from the assumptions implicit in our estimate can cause
our actual loss experience to be better or worse than our
reserves and the difference can be material. There is no precise
method, however, for evaluating the impact of any specific
factor on the adequacy of reserves. Currently established
reserves may not prove adequate in light of subsequent actual
occurrences. To the extent that reserves are inadequate and are
increased or strengthened, the amount of such
increase is treated as a charge to income in the period that the
deficiency is recognized. To the extent that reserves are
redundant and are released, the amount of the release is a
benefit to income in the period that redundancy is recognized.
The changes we have recorded in our reserves in the past three
years illustrate the potential for revisions inherent in
estimating reserves. In 2009, we experienced favorable
development of $1.3 million (0.5% of total net reserves)
from claims incurred prior to 2008. In 2008, we experienced
favorable development of $0.9 million (0.4% of total net
reserves) from claims incurred prior to 2008. In 2007, we
experienced favorable development of $5.7 million (3.1% of
total net reserves) from claims incurred prior to 2007. We did
not significantly change our reserving methodology or our claims
settlement process in any of these years. The development
reflected settlements that differed from the established case
reserves, changes in the case reserves based on new information
for that specific claim or the differences in the timing of
actual settlements compared to the payout patterns assumed in
our accident year IBNR reductions. The types of coverages we
offer and risk levels we retain have a direct influence on the
development of claims. Specifically, short duration claims and
lower risk retention levels generally are more predictable and
normally have less development. Future favorable or unfavorable
development of reserves from this past development experience
should not be assumed or estimated. The reserves reported in the
financial statements are our best estimate.
50
The following table shows the breakdown of our gross loss
reserves between case reserves (estimated amounts required to
settle claims that have already been reported), IBNR reserves
(estimated amounts that will be needed to settle claims that
have already occurred but have not yet been reported to us, as
well as reserves for possible development on known claims) and
LAE reserves (estimated amounts required to adjust, record and
settle claims, other than the claim payments themselves):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2009
|
|
Statutory Lines of Business:
|
|
Case
|
|
|
IBNR
|
|
|
LAE
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
Commercial auto liability
|
|
$
|
99,975
|
|
|
$
|
142,699
|
|
|
$
|
40,547
|
|
|
$
|
283,221
|
|
Workers compensation
|
|
|
22,973
|
|
|
|
52,505
|
|
|
|
10,300
|
|
|
|
85,778
|
|
Auto physical damage
|
|
|
7,341
|
|
|
|
9,619
|
|
|
|
2,301
|
|
|
|
19,261
|
|
General liability
|
|
|
3,831
|
|
|
|
8,005
|
|
|
|
3,687
|
|
|
|
15,523
|
|
Inland marine
|
|
|
1,089
|
|
|
|
5,148
|
|
|
|
636
|
|
|
|
6,873
|
|
Private passenger
|
|
|
2,389
|
|
|
|
1,407
|
|
|
|
971
|
|
|
|
4,767
|
|
Commercial multiple peril
|
|
|
783
|
|
|
|
291
|
|
|
|
247
|
|
|
|
1,321
|
|
Other lines
|
|
|
76
|
|
|
|
376
|
|
|
|
64
|
|
|
|
516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
138,457
|
|
|
$
|
220,050
|
|
|
$
|
58,753
|
|
|
$
|
417,260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance Recoverables. We are also subject
to credit risks with respect to our third party reinsurers.
Although reinsurers are liable to us to the extent we cede risks
to them, we are ultimately liable to our policyholders on all
these risks. As a result, reinsurance does not limit our
ultimate obligation to pay claims to policyholders and we may
not be able to recover claims made to our reinsurers. We manage
this credit risk by selecting what we believe to be quality
reinsurers, closely monitoring their financial condition, timely
billing and collecting amounts due and obtaining sufficient
collateral when necessary.
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 managements 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.
|
51
In April 2009, we adopted new accounting guidance relating to
the recognition and presentation of
other-than-temporary
impairments. Under the 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 securitys 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 5 Investments.
We closely monitor each investment that has a market value that
is below its amortized cost and make a determination each
quarter for
other-than-temporary
impairment for each of those investments. During the year ended
December 31, 2009, we recorded $7.0 million in total
losses on securities with impairment charges, which consisted of
$3.9 million in credit
other-than-temporary
impairments recognized in earnings and $3.1 million of
non-credit impairments recognized in other comprehensive income.
The
other-than-temporary
charges primarily consist of four residential mortgage-backed
securities with total impairment charges of $5.0 million,
consisting of $1.9 million in credit impairments recognized
in earnings and $3.1 million in non-credit impairments. The
impairment on these mortgage-backed securities was recorded as
the full principal is not expected to be collected and these
securities were written down to the present value of the
expected cash flows. In addition, we recorded $1.8 million
in
other-than-temporary
impairment on three corporate notes that had experienced credit
issues that, in our estimation, made recovery of the cost of our
investments unlikely. During the year ended December 31,
2008, we recorded $20.2 million in
other-than-temporary
impairments. Of the $20.2 million of
other-than-temporary
impairments taken during 2008, $7.0 million related to
securities issued by Fannie Mae, Freddie Mac and Lehman Brothers
Holdings Inc. and $8.7 million related to exchange traded
funds. The
other-than-temporary
impairment charge on the exchange traded funds was based on the
length of time and the extent to which the market value was
below cost and the uncertainty in the equity markets related to
any anticipated recovery period, which is unpredictable. The
remaining
other-than-temporary
impairment charge of $4.5 million is related to investments
that had experienced credit issues that in our estimation made
recovery of the cost of our investments unlikely. We recorded a
$1.0 million impairment for the year ended
December 31, 2007. In all instances of calculating an
other-than-temporary
impairment loss we adjusted the cost or amortized cost of the
investment down to its fair market value. 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 Managements Discussions and Analysis
of Financial Condition and Results of Operations
Investments.
52
|
|
ITEM 7A
|
Quantitative
and Qualitative Disclosures About Market Risk
|
Market risk represents the potential economic loss arising from
adverse changes in the fair value of financial instruments. Our
exposures to market risk relate primarily to our investment
portfolio, which is also exposed to interest rate risk and
credit risk. We have not entered and do not plan to enter, into
any derivative financial instruments for trading or speculative
purposes.
During 2009, the financial markets began to stabilize from the
significant disruptions and market declines that were
experienced in 2008. As liquidity moved back into the financial
markets, investors returned to more diversified credit holdings
and the equity markets experienced a rally during the year from
their March 2009 lows. As a result of these effects, we had a
pre-tax unrealized gain of $1.1 million in our fixed
maturities portfolio at December 31, 2009, which is
inclusive of investments remaining from the securities lending
program, which terminated in June 2009, compared to a pre-tax
unrealized loss of $13.3 million at December 31, 2008.
Our equity securities had a pre-tax unrealized gain of
$2.5 million at December 31, 2009 compared to a
pre-tax unrealized loss of $2.9 million at
December 31, 2008.
The fair value of our fixed maturities portfolio is directly
impacted by changes in interest rates, in addition to credit
risk. Our fixed maturities portfolio is comprised of primarily
fixed rate investments with primarily short-term and
intermediate-term maturities. We believe this practice allows us
to be flexible in reacting to fluctuations of interest rates. We
manage the portfolios of our insurance companies to attempt to
achieve an adequate risk-adjusted return while maintaining
sufficient liquidity to meet policyholder obligations. We invest
in a diverse allocation of fixed income securities to capture
what we believe are adequate risk-adjusted returns in an
evolving investment environment.
The following table provides information about our
available for sale fixed maturity investments that
are sensitive to interest rate risk. The table shows expected
principal cash flows and related weighted average interest rates
by expected maturity date for each of the five subsequent years
and collectively for all years thereafter. We include callable
bonds and notes based on call date or maturity date depending
upon which date produces the most conservative yield. MBS are
included based on maturity year adjusted for expected payment
patterns. Actual cash flows may differ from those expected.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
|
December 31, 2008
|
|
|
|
Principal
|
|
|
|
|
|
Principal
|
|
|
|
|
|
|
Cash Flows
|
|
|
Rate
|
|
|
Cash Flows
|
|
|
Rate
|
|
|
|
(Dollars in thousands)
|
|
|
Subsequent calendar year
|
|
$
|
149,602
|
|
|
|
3.8
|
%
|
|
$
|
194,172
|
|
|
|
4.7
|
%
|
2nd Subsequent calendar year
|
|
|
52,332
|
|
|
|
4.3
|
%
|
|
|
64,532
|
|
|
|
5.0
|
%
|
3rd Subsequent calendar year
|
|
|
48,983
|
|
|
|
4.4
|
%
|
|
|
27,441
|
|
|
|
5.0
|
%
|
4th Subsequent calendar year
|
|
|
49,124
|
|
|
|
4.4
|
%
|
|
|
20,948
|
|
|
|
5.1
|
%
|
5th Subsequent calendar year
|
|
|
77,296
|
|
|
|
4.2
|
%
|
|
|
26,804
|
|
|
|
5.1
|
%
|
Thereafter
|
|
|
183,325
|
|
|
|
4.3
|
%
|
|
|
121,973
|
|
|
|
5.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
560,662
|
|
|
|
4.2
|
%
|
|
$
|
455,870
|
|
|
|
4.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$
|
566,901
|
|
|
|
|
|
|
$
|
459,237
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Risk. Equity risk is potential economic
losses due to adverse changes in equity security prices. As of
December 31, 2009, approximately 4.8% of the fair value of
our investment portfolio (excluding cash and cash equivalents)
was invested in equity securities. We manage equity price risk
primarily through industry and issuer diversification and asset
allocation techniques such as investing in exchange traded funds.
53
|
|
ITEM 8
|
Financial
Statements and Supplementary Data
|
|
|
|
|
|
|
|
Page
|
|
Index to Financial Statements
|
|
|
|
|
|
|
|
55
|
|
|
|
|
56
|
|
|
|
|
|
|
December 31, 2009 and 2008
|
|
|
58
|
|
|
|
|
|
|
Years ended December 31, 2009, 2008 and 2007
|
|
|
59
|
|
|
|
|
|
|
Years ended December 31, 2009, 2008 and 2007
|
|
|
60
|
|
|
|
|
|
|
Years ended December 31, 2009, 2008 and 2007
|
|
|
61
|
|
|
|
|
62
|
|
Selected Quarterly Financial Data has been included
in Note 18 to the consolidated financial statements.
54
MANAGEMENTS
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We, as management of National Interstate Corporation and its
subsidiaries (the Company), are responsible for
establishing and maintaining adequate internal control over
financial reporting. Pursuant to the rules and regulations of
the Securities and Exchange Commission, internal control over
financial reporting is a process designed by, or under the
supervision of, the Companys principal executive and
principal financial officers or persons performing similar
functions and effected by the Companys board of directors,
management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles and
includes those policies and procedures that:
|
|
|
|
|
Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions
of the assets of the Company;
|
|
|
|
Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles and
that receipts and expenditures of the Company are being made
only in accordance with authorizations of management and
directors of the Company; and
|
|
|
|
Provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the
Companys assets that could have a material effect on the
financial statements.
|
Management has evaluated the effectiveness of the Companys
internal control over financial reporting as of
December 31, 2009, based on the control criteria
established in a report entitled Internal Control
Integrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on such
evaluation, we have concluded that the Companys internal
control over financial reporting is effective as of
December 31, 2009.
The independent registered public accounting firm of
Ernst & Young LLP, as auditors of the Companys
consolidated financial statements, has issued an attestation
report on the effectiveness of the Companys internal
control over financial reporting.
|
|
|
|
|
|
|
|
|
|
|
|
/s/ David
W.
Michelson David
W. Michelson
|
|
/s/ Julie
A.
McGraw Julie
A. McGraw
|
President and Chief Executive Officer
|
|
Vice President and Chief Financial Officer
|
55
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board of Directors and Shareholders of
National Interstate Corporation
We have audited National Interstate Corporation and subsidiaries
internal control over financial reporting as of
December 31, 2009, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). National Interstate Corporation
subsidiaries management is responsible for maintaining effective
internal control over financial reporting, and for its
assessment of the effectiveness of internal control over
financial reporting included in the accompanying
Managements Report on Internal Control over Financial
Reporting. Our responsibility is to express an opinion on the
Companys internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk,
that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk and performing such other procedures as we
considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
U.S. generally accepted accounting principles. A
companys internal control over financial reporting
includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with
U.S. generally accepted accounting principles and that
receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use
or disposition of the companys assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, National Interstate Corporation and subsidiaries
maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2009, based on
the COSO criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of National Interstate Corporation
and subsidiaries as of December 31, 2009 and 2008 and the
related consolidated statements of income, shareholders
equity and cash flows for each of the three years in the period
ended December 31, 2009 of National Interstate Corporation
and subsidiaries and our report dated March 8, 2010
expressed an unqualified opinion thereon.
Cleveland, Ohio
March 8, 2010
56
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
National Interstate Corporation
We have audited the accompanying consolidated balance sheets of
National Interstate Corporation and subsidiaries as of
December 31, 2009 and 2008, and the related consolidated
statements of income, shareholders equity and cash flows
for each of the three years in the period ended
December 31, 2009. Our audits also included the financial
statement schedules listed in the Index at Item 15(a).
These financial statements and schedules are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these financial statements and schedules
based on our audits.
We conducted our audits in accordance with standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of National Interstate Corporation and
subsidiaries at December 31, 2009 and 2008, and the
consolidated results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2009, in conformity with U.S. generally
accepted accounting principles. Also, in our opinion, the
related financial statement schedules, when considered in
relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set
forth therein.
As discussed in Note 2 to the consolidated financial
statements, in 2009 the Company changed its method of accounting
for recognizing
other-than-temporary
impairment charges for its debt securities in connection with
the adoption of the revised Financial Accounting Standards
Boards
other-than-temporary
impairment model.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
National Interstate Corporations internal control over
financial reporting as of December 31, 2009, based on
criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated
March 8, 2010 expressed an unqualified opinion thereon.
Cleveland, Ohio
March 8, 2010
57
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(In thousands, except per share data)
|
|
|
ASSETS
|
Investments:
|
|
|
|
|
|
|
|
|
Fixed maturities
available-for-sale,
at fair value (amortized cost $565,753 and $462,562,
respectively)
|
|
$
|
566,901
|
|
|
$
|
459,237
|
|
Equity securities
available-for-sale,
at fair value (cost $26,203 and $30,143,
respectively)
|
|
|
28,673
|
|
|
|
27,233
|
|
Short-term investments, at cost which approximates fair value
|
|
|
811
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
|
596,385
|
|
|
|
486,555
|
|
Cash and cash equivalents
|
|
|
18,589
|
|
|
|
77,159
|
|
Securities lending collateral (cost $0 and $94,655,
respectively)
|
|
|
|
|
|
|
84,670
|
|
Accrued investment income
|
|
|
4,926
|
|
|
|
5,161
|
|
Premiums receivable, net of allowance for doubtful accounts of
$963 and $587, respectively
|
|
|
98,679
|
|
|
|
95,610
|
|
Reinsurance recoverables on paid and unpaid losses
|
|
|
149,949
|
|
|
|
150,791
|
|
Prepaid reinsurance premiums
|
|
|
25,163
|
|
|
|
28,404
|
|
Deferred policy acquisition costs
|
|
|
17,833
|
|
|
|
19,245
|
|
Deferred federal income taxes
|
|
|
18,178
|
|
|
|
18,324
|
|
Property and equipment, net
|
|
|
21,747
|
|
|
|
20,406
|
|
Funds held by reinsurer
|
|
|
3,441
|
|
|
|
3,073
|
|
Prepaid expenses and other assets
|
|
|
863
|
|
|
|
1,414
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
955,753
|
|
|
$
|
990,812
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY
|
Liabilities:
|
|
|
|
|
|
|
|
|
Unpaid losses and loss adjustment expenses
|
|
$
|
417,260
|
|
|
$
|
400,001
|
|
Unearned premiums and service fees
|
|
|
149,509
|
|
|
|
156,598
|
|
Long-term debt
|
|
|
15,000
|
|
|
|
15,000
|
|
Amounts withheld or retained for account of others
|
|
|
51,359
|
|
|
|
48,357
|
|
Reinsurance balances payable
|
|
|
10,540
|
|
|
|
10,267
|
|
Securities lending obligation
|
|
|
|
|
|
|
95,828
|
|
Accounts payable and other liabilities
|
|
|
29,371
|
|
|
|
35,813
|
|
Commissions payable
|
|
|
8,164
|
|
|
|
9,274
|
|
Assessments and fees payable
|
|
|
3,233
|
|
|
|
3,600
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
684,436
|
|
|
|
774,738
|
|
Shareholders equity:
|
|
|
|
|
|
|
|
|
Preferred shares no par value
|
|
|
|
|
|
|
|
|
Authorized 10,000 shares
|
|
|
|
|
|
|
|
|
Issued 0 shares
|
|
|
|
|
|
|
|
|
Common shares $0.01 par value
|
|
|
|
|
|
|
|
|
Authorized 50,000 shares
|
|
|
|
|
|
|
|
|
Issued 23,350 shares, including 4,048 and
4,055 shares, respectively, in treasury
|
|
|
234
|
|
|
|
234
|
|
Additional paid-in capital
|
|
|
49,264
|
|
|
|
48,004
|
|
Retained earnings
|
|
|
225,195
|
|
|
|
184,187
|
|
Accumulated other comprehensive income (loss)
|
|
|
2,353
|
|
|
|
(10,613
|
)
|
Treasury shares
|
|
|
(5,729
|
)
|
|
|
(5,738
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
271,317
|
|
|
|
216,074
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
955,753
|
|
|
$
|
990,812
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands, except per share data)
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
279,079
|
|
|
$
|
290,741
|
|
|
$
|
257,561
|
|
Net investment income
|
|
|
19,324
|
|
|
|
22,501
|
|
|
|
22,141
|
|
Net realized gains (losses) on investments(*)
|
|
|
2,561
|
|
|
|
(22,394
|
)
|
|
|
(653
|
)
|
Other
|
|
|
3,488
|
|
|
|
2,868
|
|
|
|
4,137
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
304,452
|
|
|
|
293,716
|
|
|
|
283,186
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses
|
|
|
169,755
|
|
|
|
188,131
|
|
|
|
149,501
|
|
Commissions and other underwriting expenses
|
|
|
57,245
|
|
|
|
62,130
|
|
|
|
50,922
|
|
Other operating and general expenses
|
|
|
13,076
|
|
|
|
12,605
|
|
|
|
12,140
|
|
Expense on amounts withheld
|
|
|
3,535
|
|
|
|
4,299
|
|
|
|
3,708
|
|
Interest expense
|
|
|
717
|
|
|
|
833
|
|
|
|
1,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
244,328
|
|
|
|
267,998
|
|
|
|
217,821
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
60,124
|
|
|
|
25,718
|
|
|
|
65,365
|
|
Provision for income taxes
|
|
|
13,675
|
|
|
|
15,058
|
|
|
|
21,763
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
46,449
|
|
|
$
|
10,660
|
|
|
$
|
43,602
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share basic
|
|
$
|
2.41
|
|
|
$
|
0.55
|
|
|
$
|
2.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share diluted
|
|
$
|
2.40
|
|
|
$
|
0.55
|
|
|
$
|
2.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average of common shares outstanding basic
|
|
|
19,301
|
|
|
|
19,285
|
|
|
|
19,193
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average of common shares outstanding diluted
|
|
|
19,366
|
|
|
|
19,366
|
|
|
|
19,348
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends per common share
|
|
$
|
0.28
|
|
|
$
|
0.24
|
|
|
$
|
0.20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(*) Consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized gains (losses) before impairment losses
|
|
$
|
6,448
|
|
|
$
|
(2,230
|
)
|
|
$
|
321
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total losses on securities with impairment charges
|
|
|
(6,955
|
)
|
|
|
(20,164
|
)
|
|
|
(974
|
)
|
Non-credit portion in other comprehensive income
|
|
|
3,068
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net impairment charges recognized in earnings
|
|
|
(3,887
|
)
|
|
|
(20,164
|
)
|
|
|
(974
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains (losses) on investments
|
|
$
|
2,561
|
|
|
$
|
(22,394
|
)
|
|
$
|
(653
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
Comprehensive
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
Paid-In
|
|
|
Retained
|
|
|
Income
|
|
|
Treasury
|
|
|
|
|
|
|
Stock
|
|
|
Capital
|
|
|
Earnings
|
|
|
(Loss)
|
|
|
Stock
|
|
|
Total
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
Balance at January 1, 2007
|
|
$
|
234
|
|
|
$
|
43,921
|
|
|
$
|
138,450
|
|
|
$
|
(2,915
|
)
|
|
$
|
(5,927
|
)
|
|
$
|
173,763
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
43,602
|
|
|
|
|
|
|
|
|
|
|
|
43,602
|
|
Unrealized depreciation of investment securities, no related tax
benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,406
|
)
|
|
|
|
|
|
|
(2,406
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41,196
|
|
Dividends on common stock
|
|
|
|
|
|
|
|
|
|
|
(3,862
|
)
|
|
|
|
|
|
|
|
|
|
|
(3,862
|
)
|
Issuance of 46,009 treasury shares upon exercise of options and
stock award grants
|
|
|
|
|
|
|
392
|
|
|
|
|
|
|
|
|
|
|
|
64
|
|
|
|
456
|
|
Tax benefit realized from exercise of stock options
|
|
|
|
|
|
|
218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
218
|
|
Stock compensation expense
|
|
|
|
|
|
|
1,035
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,035
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
|
234
|
|
|
|
45,566
|
|
|
|
178,190
|
|
|
|
(5,321
|
)
|
|
|
(5,863
|
)
|
|
|
212,806
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
10,660
|
|
|
|
|
|
|
|
|
|
|
|
10,660
|
|
Unrealized depreciation of investment securities, net of tax
benefit of $4.0 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,292
|
)
|
|
|
|
|
|
|
(5,292
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,368
|
|
Dividends on common stock
|
|
|
|
|
|
|
|
|
|
|
(4,663
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,663
|
)
|
Issuance of 90,035 treasury shares upon exercise of options and
restricted stock issued, net of forfeitures
|
|
|
|
|
|
|
713
|
|
|
|
|
|
|
|
|
|
|
|
125
|
|
|
|
838
|
|
Tax benefit realized from exercise of stock options
|
|
|
|
|
|
|
396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
396
|
|
Stock compensation expense
|
|
|
|
|
|
|
1,329
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,329
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2008
|
|
|
234
|
|
|
|
48,004
|
|
|
|
184,187
|
|
|
|
(10,613
|
)
|
|
|
(5,738
|
)
|
|
|
216,074
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
46,449
|
|
|
|
|
|
|
|
|
|
|
|
46,449
|
|
Unrealized appreciation of investment securities, net of tax
expense of $6.9 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,966
|
|
|
|
|
|
|
|
12,966
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59,415
|
|
Dividends on common stock
|
|
|
|
|
|
|
|
|
|
|
(5,441
|
)
|
|
|
|
|
|
|
|
|
|
|
(5,441
|
)
|
Issuance of 6,517 treasury shares from restricted stock issued,
net of forfeitures
|
|
|
|
|
|
|
(49
|
)
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
|
(40
|
)
|
Stock compensation expense
|
|
|
|
|
|
|
1,309
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,309
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2009
|
|
$
|
234
|
|
|
$
|
49,264
|
|
|
$
|
225,195
|
|
|
$
|
2,353
|
|
|
$
|
(5,729
|
)
|
|
$
|
271,317
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(Dollars in thousands)
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
46,449
|
|
|
$
|
10,660
|
|
|
$
|
43,602
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net amortization of bond premiums and discounts
|
|
|
2,713
|
|
|
|
1,673
|
|
|
|
382
|
|
Provision for depreciation and amortization
|
|
|
1,841
|
|
|
|
1,470
|
|
|
|
1,266
|
|
Net realized (gains) losses on investment securities
|
|
|
(2,561
|
)
|
|
|
22,394
|
|
|
|
653
|
|
Deferred federal income taxes
|
|
|
(6,727
|
)
|
|
|
(2,294
|
)
|
|
|
(1,262
|
)
|
Stock compensation expense
|
|
|
1,309
|
|
|
|
1,329
|
|
|
|
1,035
|
|
Decrease (increase) in deferred policy acquisition costs, net
|
|
|
1,412
|
|
|
|
(1,667
|
)
|
|
|
(2,543
|
)
|
Increase in reserves for losses and loss adjustment expenses
|
|
|
17,259
|
|
|
|
97,913
|
|
|
|
36,122
|
|
Increase in premiums receivable
|
|
|
(3,069
|
)
|
|
|
(10,902
|
)
|
|
|
(7,632
|
)
|
(Decrease) increase in unearned premiums and service fees
|
|
|
(7,089
|
)
|
|
|
11,302
|
|
|
|
17,573
|
|
Decrease (increase) in interest receivable and other assets
|
|
|
418
|
|
|
|
539
|
|
|
|
(2,210
|
)
|
Decrease (increase) in prepaid reinsurance premiums
|
|
|
3,241
|
|
|
|
(4,079
|
)
|
|
|
(3,053
|
)
|
(Decrease) increase in accounts payable, commissions and other
liabilities and assessments and fees payable
|
|
|
(7,919
|
)
|
|
|
13,358
|
|
|
|
5,966
|
|
Increase in amounts withheld or retained for account of others
|
|
|
3,002
|
|
|
|
9,618
|
|
|
|
10,854
|
|
Decrease (increase) in reinsurance recoverable
|
|
|
842
|
|
|
|
(52,700
|
)
|
|
|
(8,021
|
)
|
Increase in reinsurance balances payable
|
|
|
273
|
|
|
|
2,671
|
|
|
|
440
|
|
Other
|
|
|
(45
|
)
|
|
|
23
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
51,349
|
|
|
|
101,308
|
|
|
|
93,169
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of fixed maturities
|
|
|
(401,140
|
)
|
|
|
(412,313
|
)
|
|
|
(199,918
|
)
|
Purchases of equity securities
|
|
|
(4,772
|
)
|
|
|
(3,386
|
)
|
|
|
(45,460
|
)
|
Proceeds from sale of fixed maturities
|
|
|
67,558
|
|
|
|
2,234
|
|
|
|
|
|
Proceeds from sale of equity securities
|
|
|
11,653
|
|
|
|
11,948
|
|
|
|
21,921
|
|
Proceeds from maturities and redemptions of investments
|
|
|
271,914
|
|
|
|
340,561
|
|
|
|
156,466
|
|
Capital expenditures
|
|
|
(3,137
|
)
|
|
|
(2,369
|
)
|
|
|
(2,087
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(57,924
|
)
|
|
|
(63,325
|
)
|
|
|
(69,078
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in securities lending collateral
|
|
|
49,314
|
|
|
|
45,488
|
|
|
|
17,612
|
|
Decrease in securities lending obligation
|
|
|
(95,828
|
)
|
|
|
(45,488
|
)
|
|
|
(17,612
|
)
|
Additional long-term borrowings
|
|
|
|
|
|
|
15,000
|
|
|
|
|
|
Reductions of long-term debt
|
|
|
|
|
|
|
(15,464
|
)
|
|
|
|
|
Tax benefit realized from exercise of stock options
|
|
|
|
|
|
|
396
|
|
|
|
218
|
|
Issuance of common shares from treasury upon exercise of stock
options or stock award grants
|
|
|
(40
|
)
|
|
|
838
|
|
|
|
456
|
|
Cash dividends paid on common shares
|
|
|
(5,441
|
)
|
|
|
(4,663
|
)
|
|
|
(3,862
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(51,995
|
)
|
|
|
(3,893
|
)
|
|
|
(3,188
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and cash equivalents
|
|
|
(58,570
|
)
|
|
|
34,090
|
|
|
|
20,903
|
|
Cash and cash equivalents at beginning of year
|
|
|
77,159
|
|
|
|
43,069
|
|
|
|
22,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$
|
18,589
|
|
|
$
|
77,159
|
|
|
$
|
43,069
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
61
NATIONAL
INTERSTATE CORPORATION AND SUBSIDIARIES
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1.
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Background,
Basis of Presentation and Principals of Consolidation
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National Interstate Corporation (the Company) and
its subsidiaries operate as an insurance holding company group
that underwrites and sells traditional and alternative risk
transfer property and casualty insurance products primarily to
the passenger transportation industry and the trucking industry,
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.
The Company is a 52.6% owned subsidiary of Great American
Insurance Company (Great American), a wholly-owned
subsidiary of American Financial Group, Inc.
The Company has four property and casualty insurance
subsidiaries, National Interstate Insurance Company
(NIIC), National Interstate Insurance Company of
Hawaii, Inc. (NIIC-HI), Triumphe Casualty Company
(TCC), Hudson Indemnity, Ltd. (HIL) and
six other agency and service subsidiaries. The Company writes
its insurance policies on a direct basis through NIIC, NIIC-HI
and TCC. NIIC is licensed in all 50 states and the District
of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and
New Jersey. TCC, a Pennsylvania domiciled company, holds
licenses for multiple lines of authority, including auto-related
lines, in 24 states and the District of Columbia. HIL is
domiciled in the Cayman Islands and provides reinsurance for
NIIC, NIIC-HI and TCC primarily for the Companys
alternative risk transfer product. Insurance products are
marketed through multiple distribution channels including,
independent agents and brokers, program administrators,
affiliated agencies and agent internet initiatives. The Company
uses its six agency and service subsidiaries to sell and service
the Companys insurance business. Approximately 12.0% of
the Companys premiums are written in the state of
California, and an additional 40.9%, collectively, in the states
of Texas, New York, Hawaii, Florida, North Carolina,
Massachusetts and Pennsylvania.
A summary of the significant accounting policies applied in the
preparation of the consolidated financial statements follows.
Basis of
Presentation
The accompanying consolidated financial statements of the
Company and its subsidiaries have been prepared in accordance
with U.S. generally accepted accounting principles
(GAAP), which differ in some respects from statutory
accounting principles (SAP) permitted by state
regulatory agencies (see Note 15).
Certain reclassifications have been made to financial
information presented for prior years to conform to the current
years presentation.
Principles
of Consolidation
The consolidated financial statements include the accounts of
the Company and its subsidiaries, NIIC, NIIC-HI, HIL, TCC,
Hudson Management Group, National Interstate Insurance Agency,
Inc. (NIIA), American Highways Insurance Agency,
Inc., Safety, Claims, and Litigation Services, Inc., Explorer RV
Insurance Agency, Inc. and Safety, Claims, Litigation Services,
LLC. Significant intercompany transactions have been eliminated.
Use of
Estimates
The preparation of financial statements in accordance with GAAP
requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from the
estimates and assumptions used.
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NATIONAL
INTERSTATE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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2.
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Significant
Accounting Policies
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Cash
Equivalents
The Company considers all highly liquid investments with a
maturity date of three months or less at the date of acquisition
to be cash equivalents.
Premium,
Commissions and Service Fee Recognition
Insurance premiums, commissions and service fees generally are
recognized over the terms of the policies on a daily pro rata
basis. Unearned premiums, commissions and service fees are
related to the unexpired terms of the policies in force.
Investments
The Company classifies all investment securities as available
for sale, which are recorded at fair value, with unrealized
gains and losses (net of tax) on such securities reported as a
separate component of shareholders equity as accumulated
other comprehensive income (loss).
Net investment income is adjusted for amortization of premiums
to the earliest of the call date or maturity date and accretion
of discounts to maturity. Realized gains and losses credited or
charged to income are determined by the specific identification
method. Estimated fair values for investments are determined
based on published market quotations or where not available,
based on other observable market data, broker quotations or
other independent sources. When a decline in fair market value
is deemed to be
other-than-temporary,
a provision for impairment is charged to earnings (included in
realized gains (losses)) and the cost basis of that investment
is reduced. Interest income is recognized when earned and
dividend income is recognized when declared.
In April 2009, the Company adopted new accounting guidance
relating to the recognition and presentation of
other-than-temporary
impairments. Under the 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 securitys 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 5 Investments.
Deferred
Policy Acquisition Costs
The costs of acquiring new business, principally commissions and
premium taxes and certain underwriting expenses directly related
to the production of new business, are deferred and amortized
over the period in which the related premiums are earned. Policy
acquisition costs are limited based upon recoverability without
any consideration for anticipated investment income and are
charged to operations ratably over the terms of the related
policies. The Company accelerates the amortization of these
costs for premium deficiencies. The amount of deferred policy
acquisition costs amortized during the years ended
December 31, 2009, 2008 and 2007 were $49.1 million,
$54.3 million and $44.6 million, respectively. There
were no premium deficiencies for the years ended
December 31, 2009, 2008 and 2007.
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NATIONAL
INTERSTATE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Property
and Equipment
Property and equipment are reported at cost less accumulated
depreciation and amortization. Property and equipment are
depreciated or amortized over the estimated useful lives on a
straight-line basis. The useful lives range from 3 to
5 years for computer equipment, 20 to 40 years for
buildings and improvements and 5 to 7 years for all other
property and equipment. Property and equipment include
capitalized software developed or acquired for internal use.
Upon sale or retirement, the cost of the asset and related
accumulated depreciation are eliminated from their respective
accounts and the resulting gain or loss is included in
operations. Repairs and maintenance are charged to operations
when incurred. The Company recorded depreciation expense of
$1.9 million, $1.5 million and $1.2 million for
the years ended December 31, 2009, 2008 and 2007,
respectively.
Unpaid
Losses and Loss Adjustment Expenses (LAE)
The liabilities for unpaid losses and LAE are determined on the
basis of estimates of policy claims reported and estimates of
unreported claims based on historical and industry data. The
estimates of policy claim amounts are continuously reviewed and
any resulting adjustments are reflected in operations currently.
Although considerable variability is inherent in such estimates,
management believes that the liabilities for unpaid losses and
LAE are adequate. These liabilities are reported net of amounts
recoverable from salvage and subrogation.
Assessments
The Company has provided for estimated assessments anticipated
for reported insolvencies of other insurers and other charges
from regulatory organizations. Management accrues for these
liabilities as assessments are imposed or the probability of
such assessments being imposed has been determined, the event
obligating the Company to pay an imposed or probable assessment
has occurred and the amount of the assessment can be reasonably
estimated.
Premiums
Receivable
Premiums receivable are carried at cost, which approximate fair
value. Management provides an allowance for doubtful accounts in
the period that collectability is deemed impaired.
Reinsurance
Reinsurance premiums, commissions, expense reimbursements and
reserves related to reinsured business are accounted for on a
basis consistent with those used in accounting for the original
policies issued and the terms of the reinsurance contracts. A
significant portion of the reinsurance is related to excess of
loss reinsurance contracts. Premiums ceded are reported as a
reduction of premiums earned.
Segment
Information
The Company offers a range of products and services, but
operates as one reportable property and casualty insurance
segment.
Federal
Income Taxes
Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the periods in which those temporary
differences are expected to be recovered or settled. A valuation
allowance is provided if it is more likely than not that some or
all of the deferred tax assets will not be realized. Management
evaluates the realizability of the deferred tax assets and
assesses the need for additional valuation allowance quarterly.
64
NATIONAL
INTERSTATE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Comprehensive
Income
Comprehensive income includes the Companys net income plus
the changes in the unrealized gains or losses (net of income
taxes) on the Companys
available-for-sale
securities. The details of the comprehensive income are reported
in the Consolidated Statements of Shareholders Equity.
Earnings
Per Common Share
Basic earnings per common share have been computed based on the
weighted average number of common shares outstanding during the
period. Diluted earnings per share are based on the weighted
average number of common shares and dilutive potential common
shares outstanding during the period using the treasury stock
method.
Stock-Based
Compensation
The Company grants stock options to officers under the Long Term
Incentive Plan (LTIP). The LTIP and stock-based
compensation are more fully described in Note 8,
Shareholders Equity and Stock-Based
Compensation. The Company uses the Black-Scholes pricing
model to measure the fair value of employee stock options.
Awards issued prior to the initial public offering were valued
for disclosure purposes using the minimum value method. No
compensation cost will be recognized for future vesting of these
awards.
Recent
Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board
(FASB) issued Accounting Standards Update
No. 2010-06,
Improving Disclosures about Fair Value Measurements (ASU
2010-06).
The ASU amends Accounting Standard Codification
(ASC) 820, Fair Value Measurements and
Disclosures. ASU
2010-06
requires expanded disclosures around significant transfers
between levels of the fair value hierarchy and valuation
techniques and inputs used in estimates. ASU
2010-06 is
effective for interim and annual reporting periods beginning
after December 15, 2009. The Company will adopt the
expanded disclosure required by ASU
2010-06 for
the quarter ended March 31, 2010.
In June 2009, the FASB updated ASC 810, Consolidation,
that amended the guidance for determining whether an
enterprise is the primary beneficiary of a variable interest
entity (VIE) by requiring a qualitative analysis to determine if
an enterprises variable interest results in a controlling
financial interest. ASC 810 is effective for annual reporting
periods beginning after November 15, 2009 and interim and
annual periods thereafter. The Company will adopt ASC 810 on
January 1, 2010 and such adoption will not have a material
impact on financial condition, results of operations or
liquidity.