Attached files
file | filename |
---|---|
EXCEL - IDEA: XBRL DOCUMENT - National Interstate CORP | Financial_Report.xls |
EX-32.1 - EX-32.1 - National Interstate CORP | l43021exv32w1.htm |
EX-31.2 - EX-31.2 - National Interstate CORP | l43021exv31w2.htm |
EX-32.2 - EX-32.2 - National Interstate CORP | l43021exv32w2.htm |
EX-31.1 - EX-31.1 - National Interstate CORP | l43021exv31w1.htm |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended June 30, 2011
OR
o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to .
Commission File Number 000-51130
National Interstate Corporation
(Exact name of registrant as specified in its charter)
Ohio | 34-1607394 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
3250 Interstate Drive
Richfield, Ohio 44286-9000
(330) 659-8900
(Address and telephone number of principal executive offices)
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. þ Yes o No
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).
þ Yes o No
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):
Large Accelerated Filer o | Accelerated Filer þ | Non-Accelerated Filer o (Do not check if a smaller reporting company) | Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). oYes þ No
The number of shares outstanding of the registrants sole class of common shares as of August 3,
2011 was 19,442,191.
National Interstate Corporation
Table of Contents
Table of Contents
Page | ||||
3 | ||||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
7 | ||||
18 | ||||
30 | ||||
30 | ||||
31 | ||||
31 | ||||
31 | ||||
31 | ||||
31 | ||||
31 | ||||
31 |
2
PART I FINANCIAL INFORMATION
ITEM 1. | Financial Statements |
National Interstate Corporation and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share data)
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Investments: |
||||||||
Fixed maturities available-for-sale, at fair value (amortized cost $897,887 and $901,209, respectively) |
$ | 914,698 | $ | 907,575 | ||||
Equity securities available-for-sale, at fair value (amortized cost $20,351 and $13,424, respectively) |
22,829 | 16,675 | ||||||
Other investments |
27,362 | 13,833 | ||||||
Short-term investments, at cost which approximates fair value |
68 | 67 | ||||||
Total investments |
964,957 | 938,150 | ||||||
Cash and cash equivalents |
39,427 | 27,054 | ||||||
Accrued investment income |
9,330 | 8,650 | ||||||
Premiums receivable, net of allowance for doubtful accounts of $1,785 and $1,435, respectively |
202,929 | 162,906 | ||||||
Reinsurance recoverable on paid and unpaid losses |
201,351 | 208,590 | ||||||
Prepaid reinsurance premiums |
39,996 | 35,065 | ||||||
Deferred policy acquisition costs |
30,453 | 23,488 | ||||||
Deferred federal income taxes |
24,452 | 27,333 | ||||||
Property and equipment, net |
23,827 | 24,469 | ||||||
Funds held by reinsurer |
3,847 | 3,788 | ||||||
Intangible assets, net |
8,816 | 8,972 | ||||||
Amounts refundable on estimated purchase price of Vanliner |
| 14,256 | ||||||
Prepaid expenses and other assets |
3,405 | 5,884 | ||||||
Total assets |
$ | 1,552,790 | $ | 1,488,605 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Liabilities: |
||||||||
Unpaid losses and loss adjustment expenses |
$ | 795,396 | $ | 798,645 | ||||
Unearned premiums and service fees |
259,257 | 221,903 | ||||||
Long-term debt |
22,000 | 20,000 | ||||||
Amounts withheld or retained for accounts of others |
60,561 | 58,691 | ||||||
Reinsurance balances payable |
28,135 | 16,180 | ||||||
Accounts payable and other liabilities |
40,040 | 49,605 | ||||||
Commissions payable |
11,914 | 9,295 | ||||||
Assessments and fees payable |
5,046 | 4,708 | ||||||
Total liabilities |
1,222,349 | 1,179,027 | ||||||
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 3,982 and 3,993 shares, respectively, in treasury |
234 | 234 | ||||||
Additional paid-in capital |
50,604 | 50,273 | ||||||
Retained earnings |
272,702 | 258,473 | ||||||
Accumulated other comprehensive income |
12,538 | 6,251 | ||||||
Treasury shares |
(5,637 | ) | (5,653 | ) | ||||
Total shareholders equity |
330,441 | 309,578 | ||||||
Total liabilities and shareholders equity |
$ | 1,552,790 | $ | 1,488,605 | ||||
See notes to consolidated financial statements.
3
National Interstate Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
(Unaudited)
(In thousands, except per share data)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenues: |
||||||||||||||||
Premiums earned |
$ | 106,464 | $ | 69,233 | $ | 211,603 | $ | 139,414 | ||||||||
Net investment income |
7,796 | 5,012 | 14,698 | 9,971 | ||||||||||||
Net realized gains on investments (*) |
1,316 | 1,669 | 2,516 | 2,551 | ||||||||||||
Other |
854 | 976 | 1,970 | 1,794 | ||||||||||||
Total revenues |
116,430 | 76,890 | 230,787 | 153,730 | ||||||||||||
Expenses: |
||||||||||||||||
Losses and loss adjustment expenses |
78,570 | 46,032 | 153,229 | 89,136 | ||||||||||||
Commissions and other underwriting expenses |
21,196 | 14,735 | 41,521 | 29,571 | ||||||||||||
Other operating and general expenses |
4,095 | 3,996 | 8,636 | 7,622 | ||||||||||||
Expense on amounts withheld |
979 | 926 | 1,819 | 1,735 | ||||||||||||
Interest expense |
55 | 92 | 109 | 104 | ||||||||||||
Total expenses |
104,895 | 65,781 | 205,314 | 128,168 | ||||||||||||
Income before income taxes |
11,535 | 11,109 | 25,473 | 25,562 | ||||||||||||
Provision for income taxes |
3,332 | 3,491 | 7,742 | 7,358 | ||||||||||||
Net income |
$ | 8,203 | $ | 7,618 | $ | 17,731 | $ | 18,204 | ||||||||
Net income per share basic |
$ | 0.42 | $ | 0.39 | $ | 0.92 | $ | 0.94 | ||||||||
Net income per share diluted |
$ | 0.42 | $ | 0.39 | $ | 0.91 | $ | 0.94 | ||||||||
Weighted average of common shares outstanding basic |
19,368 | 19,343 | 19,367 | 19,336 | ||||||||||||
Weighted
average of common shares outstanding diluted |
19,482 | 19,456 | 19,479 | 19,424 | ||||||||||||
Cash dividends per common share |
$ | 0.09 | $ | 0.08 | $ | 0.18 | $ | 0.16 | ||||||||
(*) | Consists of the following: |
Net realized gains before impairment losses |
$ | 1,316 | $ | 1,770 | $ | 2,516 | $ | 2,652 | ||||||||
Total losses on securities with impairment charges |
| | | | ||||||||||||
Non-credit portion in other comprehensive income |
| (101 | ) | | (101 | ) | ||||||||||
Net impairment charges recognized in earnings |
| (101 | ) | | (101 | ) | ||||||||||
Net realized gains on investments |
$ | 1,316 | $ | 1,669 | $ | 2,516 | $ | 2,551 | ||||||||
See notes to consolidated financial statements.
4
National Interstate Corporation and Subsidiaries
Consolidated Statements of Shareholders Equity
(Unaudited)
(Unaudited)
(Dollars in thousands)
Accumulated Other | ||||||||||||||||||||||||
Additional Paid-In | Comprehensive | |||||||||||||||||||||||
Common Stock | Capital | Retained Earnings | Income (Loss) | Treasury Stock | Total | |||||||||||||||||||
Balance at January 1, 2011 |
$ | 234 | $ | 50,273 | $ | 258,473 | $ | 6,251 | $ | (5,653 | ) | $ | 309,578 | |||||||||||
Net income |
17,731 | 17,731 | ||||||||||||||||||||||
Unrealized appreciation of investment securities,
net of tax of $3.4 million |
6,287 | 6,287 | ||||||||||||||||||||||
Comprehensive income |
24,018 | |||||||||||||||||||||||
Dividends on common stock |
(3,502 | ) | (3,502 | ) | ||||||||||||||||||||
Issuance of 11,502 treasury shares upon exercise of
options and restricted stock issued, net of
forfeitures |
(136 | ) | 16 | (120 | ) | |||||||||||||||||||
Net tax effect from exercise/vesting of stock-based
compensation |
54 | 54 | ||||||||||||||||||||||
Stock compensation expense |
413 | 413 | ||||||||||||||||||||||
Balance at June 30, 2011 |
$ | 234 | $ | 50,604 | $ | 272,702 | $ | 12,538 | $ | (5,637 | ) | $ | 330,441 | |||||||||||
Balance at January 1, 2010 |
$ | 234 | $ | 49,264 | $ | 225,195 | $ | 2,353 | $ | (5,729 | ) | $ | 271,317 | |||||||||||
Net income |
18,204 | 18,204 | ||||||||||||||||||||||
Unrealized appreciation of investment securities,
net
of tax of $2.4 million |
4,375 | 4,375 | ||||||||||||||||||||||
Comprehensive income |
22,579 | |||||||||||||||||||||||
Dividends on common stock |
(3,115 | ) | (3,115 | ) | ||||||||||||||||||||
Issuance of 41,579 treasury shares upon exercise
of
options, stock award grants and restricted stock
issued, net of forfeitures |
387 | 57 | 444 | |||||||||||||||||||||
Net tax effect from exercise/vesting of stock-based
compensation |
(50 | ) | (50 | ) | ||||||||||||||||||||
Stock compensation expense |
485 | 485 | ||||||||||||||||||||||
Balance at June 30, 2010 |
$ | 234 | $ | 50,086 | $ | 240,284 | $ | 6,728 | $ | (5,672 | ) | $ | 291,660 | |||||||||||
See notes to consolidated financial statements.
5
National Interstate Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(Unaudited)
(Dollars in thousands)
Six Months Ended June 30, | ||||||||
2011 | 2010 | |||||||
Operating activities |
||||||||
Net income |
$ | 17,731 | $ | 18,204 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Net amortization of bond premiums and discounts |
4,999 | 1,368 | ||||||
Provision for depreciation and amortization |
1,806 | 1,112 | ||||||
Net realized gains on investment securities |
(2,516 | ) | (2,551 | ) | ||||
Deferred federal income taxes |
(504 | ) | (1,522 | ) | ||||
Stock compensation expense |
413 | 485 | ||||||
Increase in deferred policy acquisition costs, net |
(6,965 | ) | (4,669 | ) | ||||
(Decrease) increase in reserves for losses and loss adjustment expenses |
(3,249 | ) | 5,858 | |||||
Increase in premiums receivable |
(40,023 | ) | (41,315 | ) | ||||
Increase in unearned premiums and service fees |
37,354 | 42,413 | ||||||
Decrease in interest receivable and other assets |
1,740 | 981 | ||||||
Increase in prepaid reinsurance premiums |
(4,931 | ) | (14,325 | ) | ||||
(Decrease) increase in accounts payable, commissions and other liabilities and assessments and fees payable |
(6,608 | ) | 6,005 | |||||
Increase in amounts withheld or retained for accounts of others |
1,870 | 647 | ||||||
Decrease in reinsurance recoverable |
7,239 | 4,919 | ||||||
Increase in reinsurance balances payable |
11,955 | 11,786 | ||||||
Other |
(69 | ) | (58 | ) | ||||
Net cash provided by operating activities |
20,242 | 29,338 | ||||||
Investing activities |
||||||||
Purchases of fixed maturities |
(158,400 | ) | (191,247 | ) | ||||
Purchases of equity securities |
(10,814 | ) | | |||||
Proceeds from sale of fixed maturities |
10,022 | 70,911 | ||||||
Proceeds from sale of equity securities |
5,164 | 156 | ||||||
Proceeds from maturities and redemptions of investments |
147,410 | 216,940 | ||||||
Change in other investments, net |
(13,000 | ) | | |||||
Collection of amounts refundable on purchase price of Vanliner |
14,256 | | ||||||
Deposit in advance of acquisition |
| (128,059 | ) | |||||
Capital expenditures |
(939 | ) | (1,131 | ) | ||||
Net cash used in investing activities |
(6,301 | ) | (32,430 | ) | ||||
Financing activities |
||||||||
Excess tax benefit realized from vesting of restricted stock |
54 | | ||||||
Additional long-term borrowings |
2,000 | 30,000 | ||||||
Issuance of common shares from treasury upon exercise of stock options or stock award grants |
(120 | ) | 444 | |||||
Cash dividends paid on common shares |
(3,502 | ) | (3,115 | ) | ||||
Net cash (used in) provided by financing activities |
(1,568 | ) | 27,329 | |||||
Net increase in cash and cash equivalents |
12,373 | 24,237 | ||||||
Cash and cash equivalents at beginning of period |
27,054 | 18,589 | ||||||
Cash and cash equivalents at end of period |
$ | 39,427 | $ | 42,826 | ||||
See notes to consolidated financial statements.
6
NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of National Interstate Corporation
(the Company) and its subsidiaries have been prepared in accordance with the instructions to Form
10-Q, which differ in some respects from statutory accounting principles permitted by state
regulatory agencies.
The unaudited consolidated financial statements include the accounts of the Company and its
subsidiaries, National Interstate Insurance Company (NIIC), Hudson Indemnity, Ltd. (HIL),
National Interstate Insurance Company of Hawaii, Inc. (NIIC-HI), Triumphe Casualty Company
(TCC), National Interstate Insurance Agency, Inc. (NIIA), Hudson Management Group, Ltd.
(HMG), Vanliner Group Inc. (Vanliner), Vanliner Insurance Company (VIC), Vanliner Reinsurance
Company (VRC), American Highways Insurance Agency, Inc., Safety, Claims and Litigation Services,
Inc., Explorer RV Insurance Agency, Inc., Safety, Claims and Litigation Services, LLC and
TransProtection Service Company. Significant intercompany transactions have been eliminated.
These interim unaudited consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Companys Annual Report on Form
10-K for the year ended December 31, 2010. The interim financial statements reflect all
adjustments which are, in the opinion of management, necessary for the fair presentation of the
results for the periods presented. Such adjustments are of a normal recurring nature. Operating
results for the three and six month periods ended June 30, 2011 are not necessarily indicative of
the results that may be expected for the full year ending December 31, 2011.
The unaudited consolidated financial statements include the results of operations and cash flows of
Vanliner and its subsidiaries for the three and six months ended June 30, 2011, as Vanliner was
acquired on July 1, 2010. As such, Vanliner and its subsidiaries are not included in the results
of operations and cash flows for the three and six months ended June 30, 2010.
The preparation of the financial statements requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying notes. Changes in
circumstances could cause actual results to differ materially from those estimates. Certain
reclassifications have been made to financial information presented for prior years to conform to
the current years presentation.
2. Recent Accounting Pronouncements
In October 2010, the FASB issued Accounting Standards Update No. 2010-26, Financial Services -
Insurance (ASU 2010-26). ASU 2010-26 amends ASC 944, Financial Services Insurance, limiting the
capitalization of costs incurred in the acquisition of new and renewal contracts to incremental
direct costs of contract acquisition and certain costs related directly to certain acquisition
activities performed by the insurer of the contract. ASU 2010-26 is effective for interim and
annual reporting periods beginning after December 15, 2011, with retrospective application
permitted, but not required. The Company will adopt ASU 2010-26 on January 1, 2012. This guidance
will result in fewer acquisition costs being capitalized by the Company. Management is still in
the process of evaluating the impact such adoption will have on financial condition, results of
operations and liquidity.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic
220): Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 eliminates the option to
report other comprehensive income and its components in the statement of shareholders equity. ASU
2011-05 requires that all non-owner changes in shareholders equity be presented in either a single
continuous statement of comprehensive income which contains two sections, net income and other
comprehensive income, or in two separate but consecutive statements. ASU 2011-05 is effective for
interim and annual reporting periods beginning after December 15, 2011. The Company will adopt ASU
2011-05 on January 1, 2012. The updated guidance only requires a change in the format of
information already disclosed; the adoption will not impact our cash flows, financial condition, or
net income.
3. Fair Value Measurements
The Company must determine the appropriate level in the fair value hierarchy for each applicable
fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to
assumptions market participants would use in pricing an asset or
7
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 the Companys investment portfolio are reviewed by company personnel
using data from nationally recognized pricing services as well as non-binding broker quotes on a
limited basis.
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.
Inputs from brokers and independent financial institutions include, but are not limited to, yields
or spreads of comparable investments which have recent trading activity, credit quality, duration,
credit enhancements, collateral value and estimated cash flows based on inputs including
delinquency rates, estimated defaults and losses, and estimates of the rate of future prepayments.
Valuation techniques utilized by pricing services and values obtained from brokers and 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 accounting standards.
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 $6.0 million of securities, which are valued based upon a non-binding broker quote and
validated with other observable market data by management. 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 the Company believes reflects fair value, but for which the Company is unable to verify
inputs to the valuation methodology. The Company obtained at least one quote or price per
instrument from its brokers and pricing services for all Level 3 securities and did not adjust any
quotes or prices that it obtained. Management reviews these broker quotes using any recent trades,
if such information is available, or market prices of similar investments. The Company primarily
uses the market approach valuation technique for all investments.
The following table presents the Companys investment portfolio, categorized by the level within
the fair value hierarchy in which the fair value measurements fall as of June 30, 2011:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Fixed maturities: |
||||||||||||||||
U.S. Government and government agency obligations |
$ | | $ | 130,943 | $ | | $ | 130,943 | ||||||||
Foreign government obligations |
| 5,713 | | 5,713 | ||||||||||||
State and local government obligations |
| 287,152 | 4,301 | 291,453 | ||||||||||||
Residential mortgage-backed securities |
| 198,911 | | 198,911 | ||||||||||||
Commercial mortgage-backed securities |
| 7,724 | | 7,724 | ||||||||||||
Corporate obligations |
| 267,510 | 2,216 | 269,726 | ||||||||||||
Redeemable preferred stocks |
9,638 | 143 | 447 | 10,228 | ||||||||||||
Total fixed maturities |
9,638 | 898,096 | 6,964 | 914,698 | ||||||||||||
Equity securities: |
||||||||||||||||
Common stocks |
21,195 | 16 | | 21,211 | ||||||||||||
Perpetual preferred stocks |
325 | 897 | 396 | 1,618 | ||||||||||||
Total equity securities |
21,520 | 913 | 396 | 22,829 | ||||||||||||
Short-term investments |
| 68 | | 68 | ||||||||||||
Total investments |
31,158 | 899,077 | 7,360 | 937,595 | ||||||||||||
Cash and cash equivalents |
39,427 | | | 39,427 | ||||||||||||
Total investments and cash and cash equivalents at fair value |
$ | 70,585 | $ | 899,077 | $ | 7,360 | $ | 977,022 | ||||||||
8
The following table presents the Companys investment portfolio, categorized by the level
within the fair value hierarchy in which the fair value measurements fall as of December 31, 2010:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Fixed maturities: |
||||||||||||||||
U.S. Government and government agency obligations |
$ | | $ | 184,857 | $ | | $ | 184,857 | ||||||||
Foreign government obligations |
| 5,676 | | 5,676 | ||||||||||||
State and local government obligations |
| 266,023 | 3,992 | 270,015 | ||||||||||||
Residential mortgage-backed securities |
| 196,738 | | 196,738 | ||||||||||||
Commercial mortgage-backed securities |
| 5,570 | | 5,570 | ||||||||||||
Corporate obligations |
| 230,287 | 2,290 | 232,577 | ||||||||||||
Redeemable preferred stocks |
9,238 | 475 | 2,429 | 12,142 | ||||||||||||
Total fixed maturities |
9,238 | 889,626 | 8,711 | 907,575 | ||||||||||||
Equity securities: |
||||||||||||||||
Common stocks |
15,275 | 37 | | 15,312 | ||||||||||||
Perpetual preferred stocks |
840 | 127 | 396 | 1,363 | ||||||||||||
Total equity securities |
16,115 | 164 | 396 | 16,675 | ||||||||||||
Short-term investments |
| 67 | | 67 | ||||||||||||
Total investments |
25,353 | 889,857 | 9,107 | 924,317 | ||||||||||||
Cash and cash equivalents |
27,054 | | | 27,054 | ||||||||||||
Total investments and cash and cash equivalents at fair value |
$ | 52,407 | $ | 889,857 | $ | 9,107 | $ | 951,371 | ||||||||
The tables above exclude investments in limited partnerships accounted for under the equity
method of $27.4 million and $13.8 million (included in other investments) at June 30, 2011 and
December 31, 2010, respectively. As such, they are not reported at fair value.
9
The Company uses the end of the reporting period as its policy for determining transfers into and
out of each level. There were no significant transfers between Level 1 and Level 2 during the
three and six months ended June 30, 2011. The following table presents a reconciliation of the
beginning and ending balances for all investments measured at fair value on a recurring basis using
Level 3 inputs for the three and six months ended June 30, 2011:
Three Months Ended June 30, 2011 | ||||||||||||||||
State and Local | ||||||||||||||||
Government | Corporate | Redeemable | Perpetual Preferred | |||||||||||||
Obligations | Obligations | Preferred Stock | Stock | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Beginning balance at April 1, 2011 |
$ | 4,210 | $ | 2,268 | $ | 2,423 | $ | 396 | ||||||||
Total gains or (losses): |
||||||||||||||||
Included in earnings |
| | | | ||||||||||||
Included in other comprehensive income |
91 | 11 | 24 | | ||||||||||||
Purchases and issuances |
| | | | ||||||||||||
Sales, settlements and redemptions |
| (63 | ) | (2,000 | ) | | ||||||||||
Transfers in and/or (out) of Level 3 |
| | | | ||||||||||||
Ending balance at June 30, 2011 |
$ | 4,301 | $ | 2,216 | $ | 447 | $ | 396 | ||||||||
The amount of total gains or (losses) for the period
included in earnings and attributable to the change
in unrealized gains or (losses) relating to assets still
held at the reporting date |
$ | | $ | | $ | | $ | | ||||||||
Six Months Ended June 30, 2011 | ||||||||||||||||
State and Local | ||||||||||||||||
Government | Corporate | Redeemable | Perpetual Preferred | |||||||||||||
Obligations | Obligations | Preferred Stock | Stock | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Beginning balance at January 1, 2011 |
$ | 3,992 | $ | 2,290 | $ | 2,429 | $ | 396 | ||||||||
Total gains or (losses): |
||||||||||||||||
Included in earnings |
| | | | ||||||||||||
Included in other comprehensive income |
309 | 61 | 18 | | ||||||||||||
Purchases and issuances, sales and settlements: |
| | | | ||||||||||||
Sales, settlements and redemptions |
| (135 | ) | (2,000 | ) | | ||||||||||
Transfers in and/or (out) of Level 3 |
| | | | ||||||||||||
Ending balance at June 30, 2011 |
$ | 4,301 | $ | 2,216 | $ | 447 | $ | 396 | ||||||||
The amount of total gains or (losses) for the period
included in earnings and attributable to the change
in unrealized gains or (losses) relating to assets still
held at the reporting date |
$ | | $ | | $ | | $ | | ||||||||
The following table presents a reconciliation of the beginning and ending balances for all
investments measured at fair value on a recurring basis using Level 3 inputs for the three and six
months ended June 30, 2010:
Three Months Ended June 30, 2010 | ||||||||||||||||||||
State and Local | Residential | |||||||||||||||||||
Government | Corporate | Mortgage-Backed | Redeemable | Perpetual Preferred | ||||||||||||||||
Obligations | Obligations | Securities | Preferred Stock | Stock | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Beginning balance at April 1, 2010 |
$ | 6,387 | $ | 5,840 | $ | 2,367 | $ | 2,368 | $ | 396 | ||||||||||
Total gains or (losses): |
||||||||||||||||||||
Included in earnings |
| | | | | |||||||||||||||
Included in other comprehensive income |
577 | (101 | ) | 54 | 39 | | ||||||||||||||
Purchases, issuances, sales and settlements: |
||||||||||||||||||||
Sales |
(3,000 | ) | (178 | ) | (354 | ) | | | ||||||||||||
Transfers in and/or (out) of Level 3 |
| | | | | |||||||||||||||
Ending balance at June 30, 2010 |
$ | 3,964 | $ | 5,561 | $ | 2,067 | $ | 2,407 | $ | 396 | ||||||||||
The amount of total gains or (losses) for the period
included in earnings and attributable to the change
in unrealized gains or (losses) relating to assets still
held at the reporting date |
$ | | $ | | $ | | $ | | $ | | ||||||||||
10
Six Months Ended June 30, 2010 | ||||||||||||||||||||
State and Local | Residential | |||||||||||||||||||
Government | Corporate | Mortgage-Backed | Redeemable | Perpetual Preferred | ||||||||||||||||
Obligations | Obligations | Securities | Preferred Stock | Stock | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Beginning balance at January 1, 2010 |
$ | 6,369 | $ | 5,842 | $ | 2,384 | $ | 2,353 | $ | 396 | ||||||||||
Total gains or (losses): |
||||||||||||||||||||
Included in earnings |
| | | | | |||||||||||||||
Included in other comprehensive income |
595 | 12 | 201 | 54 | | |||||||||||||||
Purchases and issuances |
||||||||||||||||||||
Sales, settlements and redemptions |
(3,000 | ) | (293 | ) | (518 | ) | | | ||||||||||||
Transfers in and/or (out) of Level 3 |
| | | | | |||||||||||||||
Ending balance at June 30, 2010 |
$ | 3,964 | $ | 5,561 | $ | 2,067 | $ | 2,407 | $ | 396 | ||||||||||
The amount of total gains or (losses) for the period
included in earnings and attributable to the change
in unrealized gains or (losses) relating to assets still
held at the reporting date |
$ | | $ | | $ | | $ | | $ | | ||||||||||
4. Investments
Under current other-than-temporary impairment accounting guidance, if management can assert that it
does not intend to sell an impaired fixed maturity security and it is not more likely than not that
it will have to sell the security before recovery of its amortized cost basis, then an entity may
separate the other-than-temporary impairments into two components: 1) the amount related to credit
losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other
comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is
measured by comparing a securitys amortized cost to the present value of its current expected cash
flows discounted at its effective yield prior to the impairment charge. 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 recorded in earnings is required to reduce the
amortized cost of that security to fair value.
11
The cost or amortized cost and fair value of investments in fixed maturities and equity securities
are as follows:
Cost or | Gross Unrealized | Gross Unrealized | ||||||||||||||
Amortized Cost | Gains | Losses | Fair Value | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
June 30, 2011: |
||||||||||||||||
Fixed Maturities: |
||||||||||||||||
U.S. Government and government agency obligations |
$ | 128,185 | $ | 3,046 | $ | (288 | ) | $ | 130,943 | |||||||
Foreign government obligations |
5,702 | 11 | | 5,713 | ||||||||||||
State and local government obligations |
285,008 | 7,337 | (892 | ) | 291,453 | |||||||||||
Residential mortgage-backed securities |
198,105 | 3,722 | (2,916 | ) | 198,911 | |||||||||||
Commercial mortgage-backed securities |
7,799 | 10 | (85 | ) | 7,724 | |||||||||||
Corporate obligations |
262,834 | 7,314 | (422 | ) | 269,726 | |||||||||||
Redeemable preferred stocks |
10,254 | 179 | (205 | ) | 10,228 | |||||||||||
Total fixed maturities |
897,887 | 21,619 | (4,808 | ) | 914,698 | |||||||||||
Equity securities: |
||||||||||||||||
Common stocks |
19,042 | 2,575 | (406 | ) | 21,211 | |||||||||||
Perpetual preferred stocks |
1,309 | 309 | | 1,618 | ||||||||||||
Total equity securities |
20,351 | 2,884 | (406 | ) | 22,829 | |||||||||||
Short-term investments |
68 | | | 68 | ||||||||||||
Total investments |
$ | 918,306 | $ | 24,503 | $ | (5,214 | ) | $ | 937,595 | |||||||
December 31, 2010: |
||||||||||||||||
Fixed Maturities: |
||||||||||||||||
U.S. Government and government agency obligations |
$ | 183,370 | $ | 2,463 | $ | (976 | ) | $ | 184,857 | |||||||
Foreign government obligations |
5,741 | | (65 | ) | 5,676 | |||||||||||
State and local government obligations |
267,966 | 4,611 | (2,562 | ) | 270,015 | |||||||||||
Residential mortgage-backed securities |
196,644 | 3,126 | (3,032 | ) | 196,738 | |||||||||||
Commercial mortgage-backed securities |
5,798 | | (228 | ) | 5,570 | |||||||||||
Corporate obligations |
229,263 | 4,400 | (1,086 | ) | 232,577 | |||||||||||
Redeemable preferred stocks |
12,427 | 126 | (411 | ) | 12,142 | |||||||||||
Total fixed maturities |
901,209 | 14,726 | (8,360 | ) | 907,575 | |||||||||||
Equity securities: |
||||||||||||||||
Common stocks |
12,115 | 3,197 | | 15,312 | ||||||||||||
Perpetual preferred stocks |
1,309 | 88 | (34 | ) | 1,363 | |||||||||||
Total equity securities |
13,424 | 3,285 | (34 | ) | 16,675 | |||||||||||
Short-term investments |
67 | | | 67 | ||||||||||||
Total investments |
$ | 914,700 | $ | 18,011 | $ | (8,394 | ) | $ | 924,317 | |||||||
The table above excludes investments in limited partnerships accounted for under the equity
method of $27.4 million and $13.8 million (included in other investments) at June 30, 2011 and
December 31, 2010, respectively. As such, they are not reported at fair value.
The amortized cost and fair value of fixed maturities at June 30, 2011, by contractual maturity,
are shown below. Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment penalties. The
average life of mortgage-backed securities is 3.8 years in the Companys investment portfolio.
Amortized cost and fair value of the fixed maturities in the Companys investment portfolio were as
follows:
Amortized Cost | Fair Value | |||||||
(Dollars in thousands) | ||||||||
Due in one year or less |
$ | 27,399 | $ | 28,023 | ||||
Due after one year through five years |
246,622 | 253,350 | ||||||
Due after five years through ten years |
302,150 | 310,386 | ||||||
Due after ten years |
115,812 | 116,304 | ||||||
691,983 | 708,063 | |||||||
Mortgage-backed securities |
205,904 | 206,635 | ||||||
Total |
$ | 897,887 | $ | 914,698 | ||||
12
Gains and losses on the sale of investments, including other-than-temporary impairment charges
and other investments gains or losses, were as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Fixed maturity gains |
$ | 275 | $ | 1,949 | $ | 708 | $ | 2,408 | ||||||||
Fixed maturity losses |
| (102 | ) | | (102 | ) | ||||||||||
Equity security gains |
706 | | 1,278 | 30 | ||||||||||||
Equity security losses |
| | | | ||||||||||||
Other investments, net gains (losses) |
335 | (178 | ) | 530 | 215 | |||||||||||
Net realized gains on investments |
$ | 1,316 | $ | 1,669 | $ | 2,516 | $ | 2,551 | ||||||||
Pre-tax net realized gains were $1.3 million and $2.5 million for the three and six months
ended June 30, 2011, respectively. The net realized gains for both the three and six months ended
June 30, 2011 were generated from realized gains associated with the sales or calls of securities
of $1.0 million and $2.0 million, respectively, which were primarily from common stocks and
corporate obligations, and net gains associated with equity in earnings of limited partnerships
(included in other investments) of $0.3 million and $0.5 million, respectively. There were no
impairment charges taken during the three and six months ended June 30, 2011.
Pre-tax net realized gains were $1.7 million and $2.6 million for the three and six months ended
June 30, 2010, respectively. The net realized gains for both the three and six month periods ended
June 30, 2010 were primarily generated from net realized gains associated with the sales of
securities of $2.0 million and $2.5 million, respectively. The gains on sales of equity and fixed
maturity securities were primarily due to favorable market conditions that increased the value of
the securities over book value, and the Company sold these securities in order to generate funds
for the July 1, 2010 purchase of Vanliner. Included in the six months ended June 30, 2010 were
gains associated with other investments of $0.4 million, which occurred during the first three
months of 2010. Partially offsetting these gains were losses on other investments of $0.2 million
during the three months ended June 30, 2011 and an other-than-temporary impairment charge of $0.1
million for both the three and six months ended June 30, 2010.
13
The following table summarizes the Companys gross unrealized losses on fixed maturities and equity
securities and the length of time that individual securities have been in a continuous unrealized
loss position:
Less than Twelve Months | Twelve Months or More | |||||||||||||||||||||||||||||||
Fair | Fair | |||||||||||||||||||||||||||||||
Value | Number | Value | Number | |||||||||||||||||||||||||||||
Fair | Unrealized | as % of | of | Fair | Unrealized | as % of | of | |||||||||||||||||||||||||
Value | Losses | Cost | Holdings | Value | Losses | Cost | Holdings | |||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||||||
June 30, 2011: |
||||||||||||||||||||||||||||||||
Fixed maturities: |
||||||||||||||||||||||||||||||||
U.S. Government and government
agency obligations |
$ | 32,003 | $ | (288 | ) | 99.1 | % | 17 | $ | | $ | | | | ||||||||||||||||||
State and local government
obligations |
22,720 | (313 | ) | 98.6 | % | 20 | 5,569 | (579 | ) | 90.6 | % | 4 | ||||||||||||||||||||
Residential mortgage-backed
securities |
54,588 | (561 | ) | 99.0 | % | 20 | 6,361 | (2,355 | ) | 73.0 | % | 6 | ||||||||||||||||||||
Commercial mortgage-backed
securities |
2,064 | (11 | ) | 99.5 | % | 1 | 3,631 | (74 | ) | 98.0 | % | 1 | ||||||||||||||||||||
Corporate obligations |
37,019 | (389 | ) | 99.0 | % | 66 | 2,967 | (33 | ) | 98.9 | % | 2 | ||||||||||||||||||||
Redeemable preferred stocks |
3,731 | (125 | ) | 96.8 | % | 7 | 920 | (80 | ) | 92.0 | % | 2 | ||||||||||||||||||||
Total fixed maturities |
152,125 | (1,687 | ) | 98.9 | % | 131 | 19,448 | (3,121 | ) | 86.2 | % | 15 | ||||||||||||||||||||
Equity securities: |
||||||||||||||||||||||||||||||||
Common stocks |
3,142 | (406 | ) | 88.6 | % | 4 | | | | | ||||||||||||||||||||||
Total equity securities |
3,142 | (406 | ) | 88.6 | % | 4 | | | | | ||||||||||||||||||||||
Total fixed maturities and equity
securities |
$ | 155,267 | $ | (2,093 | ) | 98.7 | % | 135 | $ | 19,448 | $ | (3,121 | ) | 86.2 | % | 15 | ||||||||||||||||
December 31, 2010: |
||||||||||||||||||||||||||||||||
Fixed maturities: |
||||||||||||||||||||||||||||||||
U.S. Government and government
agency obligations |
$ | 76,781 | $ | (976 | ) | 98.7 | % | 35 | $ | | $ | | | | ||||||||||||||||||
Foreign government obligations |
5,676 | (65 | ) | 98.9 | % | 3 | | | | | ||||||||||||||||||||||
State and local government
obligations |
124,938 | (1,599 | ) | 98.7 | % | 108 | 5,194 | (963 | ) | 84.4 | % | 4 | ||||||||||||||||||||
Residential mortgage-backed
securities |
78,332 | (1,056 | ) | 98.7 | % | 25 | 7,317 | (1,976 | ) | 78.7 | % | 5 | ||||||||||||||||||||
Commercial mortgage-backed
securities |
2,034 | (48 | ) | 97.7 | % | 1 | 3,536 | (180 | ) | 95.2 | % | 1 | ||||||||||||||||||||
Corporate obligations |
62,158 | (652 | ) | 99.0 | % | 61 | 6,311 | (434 | ) | 93.6 | % | 7 | ||||||||||||||||||||
Redeemable preferred stocks |
3,326 | (266 | ) | 92.6 | % | 8 | 3,691 | (145 | ) | 96.2 | % | 5 | ||||||||||||||||||||
Total fixed maturities |
353,245 | (4,662 | ) | 98.7 | % | 241 | 26,049 | (3,698 | ) | 87.6 | % | 22 | ||||||||||||||||||||
Equity securities: |
||||||||||||||||||||||||||||||||
Perpetual preferred stocks |
605 | (34 | ) | 94.7 | % | 4 | | | | | ||||||||||||||||||||||
Total equity securities |
605 | (34 | ) | 94.7 | % | 4 | | | | | ||||||||||||||||||||||
Total fixed maturities and equity
securities |
$ | 353,850 | $ | (4,696 | ) | 98.7 | % | 245 | $ | 26,049 | $ | (3,698 | ) | 87.6 | % | 22 | ||||||||||||||||
The gross unrealized losses on the Companys fixed maturities and equity securities portfolios
decreased from $8.4 million at December 31, 2010 to $5.2 million at June 30, 2011. The improvement
in gross unrealized losses was driven by a decrease in market yields and a general tightening of
credit spreads from December 31, 2010. The $5.2 million in gross unrealized losses at June 30,
2011 was primarily on fixed maturity holdings in residential mortgage-backed securities, and to a
lesser extent, state and local government obligations and corporate obligations. The gross
unrealized losses on common stocks are minimal and are considered to be temporary. There were no
gross unrealized losses on perpetual preferred stocks. Investment grade securities (as determined
by nationally recognized rating agencies) represented 86.5% of all fixed maturity securities with
unrealized losses.
At June 30, 2011, gross unrealized losses on residential mortgage-backed securities were $2.9
million and represented 60.6% of the total gross unrealized losses on fixed maturities. There were
six securities with gross unrealized losses of $2.4 million that were in an unrealized loss
position for 12 months or more. Three of these securities previously had both credit and non-credit
other-than-temporary impairment charges and were in a gross unrealized loss position of $1.5
million at June 30, 2011. Based on historical payment data and analysis of expected future cash
flows of the underlying collateral, independent credit ratings and other facts and analysis,
including managements current intent and ability to hold these securities for a period of time
sufficient to allow for anticipated recovery, management believes that, based upon information
currently available, the Company will recover its cost basis in all these securities and no
additional charges for other-than-temporary impairments will be required.
At June 30, 2011, the state and local government obligations, with gross unrealized losses of $0.9
million, had 20 holdings that were in an unrealized loss position of $0.3 million for less than 12
months and four holdings that were in an unrealized loss position of $0.6 million for more than 12
months. Investment grade securities represented 86.5% of all state and local government obligations
with unrealized losses greater than 12 months. The corporate obligations had gross unrealized
losses totaling $0.4 million at June 30, 2011. The gross unrealized losses on corporate obligations
consisted of 66 holdings with gross unrealized
14
losses of $0.4 million that were in an unrealized loss position for less than 12 months. Investment
grade securities represented 66.7% of all corporate obligations with unrealized losses greater than
12 months.
Management concluded that no additional charges for other-than-temporary impairment were required
on the fixed maturity holdings based on many factors, including the Companys ability and current
intent to hold these investments for a period of time sufficient to allow for anticipated recovery
of its amortized cost, the length of time and the extent to which fair value has been below cost,
analysis of company-specific financial data and the outlook for industry sectors and credit
ratings. The Company believes these unrealized losses are primarily due to temporary market and
sector-related factors and does not consider these securities to be other-than-temporarily
impaired. If the Companys strategy was to change or these securities were determined to be
other-than-temporarily impaired, the Company would recognize a write-down in accordance with its
stated policy.
The following table is a progression of the amount related to credit losses on fixed maturity
securities for which the non-credit portion of an other-than-temporary impairment has been
recognized in other comprehensive income.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Beginning balance |
$ | 2,017 | $ | 1,910 | $ | 2,017 | $ | 1,910 | ||||||||
Additional credit impairments on: |
||||||||||||||||
Previously impaired securities |
| 101 | | 101 | ||||||||||||
Securities without prior impairments |
| | | | ||||||||||||
Reductions |
| (37 | ) | | (37 | ) | ||||||||||
Ending balance |
$ | 2,017 | $ | 1,974 | $ | 2,017 | $ | 1,974 | ||||||||
5. Income Taxes
A reconciliation of the provision for income taxes for financial reporting purposes and the
provision for income taxes calculated at the statutory rate of 35% is as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Federal income tax expense at statutory rate |
$ | 4,037 | $ | 3,888 | $ | 8,915 | $ | 8,947 | ||||||||
Effect of: |
||||||||||||||||
Tax-exempt investment income |
(756 | ) | (377 | ) | (1,389 | ) | (751 | ) | ||||||||
Change in valuation allowance on net capital losses |
| | | (810 | ) | |||||||||||
Other items, net |
51 | (20 | ) | 216 | (28 | ) | ||||||||||
$ | 3,332 | $ | 3,491 | $ | 7,742 | $ | 7,358 | |||||||||
The tax effects of temporary differences that give rise to significant portions of the net
deferred tax assets and liabilities in the Consolidated Balance Sheets were as follows:
June 30, 2011 | December 31, 2010 | |||||||
(Dollars in thousands) | ||||||||
Deferred Tax Assets: |
||||||||
Unearned premiums |
$ | 15,395 | $ | 13,103 | ||||
Unpaid losses and loss adjustment expenses |
18,869 | 18,700 | ||||||
Assignments and assessments |
1,568 | 1,474 | ||||||
Realized losses on investments, primarily impairments |
5,457 | 6,092 | ||||||
Accrued compensation |
2,601 | 3,156 | ||||||
Other, net |
3,803 | 2,129 | ||||||
47,693 | 44,654 | |||||||
Deferred Tax Liabilities: |
||||||||
Deferred policy acquisition costs |
(10,658 | ) | (8,221 | ) | ||||
Unrealized gains on investments |
(6,751 | ) | (3,366 | ) | ||||
Intangible assets |
(3,073 | ) | (3,122 | ) | ||||
Other, net |
(2,759 | ) | (2,612 | ) | ||||
Total deferred tax liabilities |
(23,241 | ) | (17,321 | ) | ||||
Net deferred income tax assets |
$ | 24,452 | $ | 27,333 | ||||
Management has reviewed the recoverability of the deferred tax assets and believes that the
amount will be recoverable against future earnings.
15
6. Shareholders Equity and Stock-Based Compensation
The Company grants options and other stock awards to officers and key employees of the Company
under the Long Term Incentive Plan (LTIP). At June 30, 2011, there were options for 620,550
shares outstanding and 776,536 of the Companys common shares reserved for issuance under the LTIP.
Treasury shares are used to fulfill the options exercised and other awards granted. Options and
restricted shares vest pursuant to the terms of a written grant agreement. Options must be
exercised no later than the tenth anniversary of the date of grant. As set forth in the LTIP, the
Compensation Committee of the Board of Directors may accelerate vesting and exercisability of
options.
For the three months ended June 30, 2011, the Company recognized stock-based compensation expense
of $0.1 million with related income tax benefits of approximately $32 thousand, as compared to
stock-based compensation expense of $0.1 million with related income tax benefits of approximately
$48 thousand for the same period in 2010. For both the six months ended June 30, 2011 and 2010, the
Company recognized stock-based compensation expense of $0.4 million and $0.5 million, respectively,
with related income tax benefits of approximately $0.1 million.
7. Earnings Per Common Share
The following table sets forth the computation of basic and diluted net income per share:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(In thousands, except per share data) | (In thousands, except per share data) | |||||||||||||||
Net income |
$ | 8,203 | $ | 7,618 | $ | 17,731 | $ | 18,204 | ||||||||
Weighted average shares outstanding during period |
19,368 | 19,343 | 19,367 | 19,336 | ||||||||||||
Additional shares issuable under employee common stock option plans
using treasury stock method |
114 | 113 | 112 | 88 | ||||||||||||
Weighted
average shares outstanding assuming exercise of stock options |
19,482 | 19,456 | 19,479 | 19,424 | ||||||||||||
Net income per share: |
||||||||||||||||
Basic |
$ | 0.42 | $ | 0.39 | $ | 0.92 | $ | 0.94 | ||||||||
Diluted |
$ | 0.42 | $ | 0.39 | $ | 0.91 | $ | 0.94 |
For the three months ended June 30, 2011 and 2010, there were 279,598 and 344,113,
respectively, outstanding options and restricted shares excluded from diluted earnings per share
because they were anti-dilutive. For the six months ended June 30, 2011 and 2010, there were
227,152 and 438,550, respectively, outstanding options and restricted shares excluded from diluted
earnings per share because they were anti-dilutive.
8. Transactions with Related Parties
The Companys principal insurance subsidiary, NIIC, is involved in both the cession and assumption
of reinsurance. NIIC is a party to a reinsurance agreement, and NIIA, a wholly-owned subsidiary of
the Company, is a party to an underwriting management agreement with Great American Insurance
Company (Great American). As of June 30, 2011, Great American owned 52.5% of the outstanding
shares of the Company. The reinsurance agreement calls for the assumption by NIIC of all of the
risk on Great Americans net premiums written for public transportation and recreational vehicle
risks underwritten pursuant to the reinsurance agreement. NIIA provides administrative services to
Great American in connection with Great Americans underwriting of these risks. The Company also
cedes premium through reinsurance agreements with Great American to reduce exposure in certain of
its property and casualty insurance programs.
The table below summarizes the reinsurance balance and activity with Great American:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Assumed premiums written |
$ | 1,350 | $ | 1,241 | $ | 2,558 | $ | 2,287 | ||||||||
Assumed premiums earned |
1,029 | 799 | 2,009 | 1,571 | ||||||||||||
Assumed losses and loss adjustment expense incurred |
932 | 544 | 2,019 | 649 | ||||||||||||
Ceded premiums written |
144 | 694 | 477 | 1,383 | ||||||||||||
Ceded premiums earned |
379 | 623 | 844 | 1,303 | ||||||||||||
Ceded losses and loss adjustment expense recoveries |
348 | 1,434 | 1,135 | 1,701 | ||||||||||||
Payable to Great American as of period end |
129 | 540 | 129 | 540 |
16
Great American or its parent, American Financial Group, Inc., perform certain services for the
Company without charge including, without limitation, actuarial services and on a consultative
basis, as needed, internal audit, legal, accounting and other support services. If Great American
no longer controlled a majority of the Companys common shares, it is possible that many of these
services would cease or, alternatively, be provided at an increased cost to the Company. This could
impact the Companys personnel resources, require the Company to hire additional professional staff
and generally increase the Companys operating expenses. Management believes, based on discussions
with Great American, that these services will continue to be provided by the affiliated entity in
future periods and the relative impact on operating results is not material.
9. Reinsurance
Premiums and reinsurance activity consisted of the following:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Direct premiums written |
$ | 153,473 | $ | 108,239 | $ | 285,323 | $ | 212,365 | ||||||||
Reinsurance assumed |
3,012 | 2,487 | 5,475 | 4,165 | ||||||||||||
Reinsurance ceded |
(22,742 | ) | (24,799 | ) | (46,804 | ) | (49,149 | ) | ||||||||
Net premiums written |
$ | 133,743 | $ | 85,927 | $ | 243,994 | $ | 167,381 | ||||||||
Direct premiums earned |
$ | 124,728 | $ | 85,103 | $ | 248,215 | $ | 170,821 | ||||||||
Reinsurance assumed |
2,526 | 1,884 | 5,010 | 3,417 | ||||||||||||
Reinsurance ceded |
(20,790 | ) | (17,754 | ) | (41,622 | ) | (34,824 | ) | ||||||||
Total premiums earned |
$ | 106,464 | $ | 69,233 | $ | 211,603 | $ | 139,414 | ||||||||
The Company cedes premiums through reinsurance agreements with reinsurers to reduce exposure
in certain of its property-casualty insurance programs. Ceded losses and loss adjustment expense
recoveries recorded for the three months ended June 30, 2011 and 2010 were $16.0 million and $15.9
million, respectively, and were $29.5 million and $25.0 million for the six months ended June 30,
2011 and 2010, respectively. The Company remains primarily liable as the direct insurer on all
risks reinsured and a contingent liability exists to the extent that the reinsurance companies are
unable to meet their obligations for losses assumed. To minimize its exposure to significant losses
from reinsurer insolvencies, the Company seeks to do business with only reinsurers rated
Excellent or better by A.M. Best Company and regularly evaluates the financial condition of its
reinsurers.
10. Commitments and Contingencies
The Company and its subsidiaries 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 loss adjustment
expense (LAE) reserves. In addition, regulatory bodies, such as state insurance departments, the
Securities and Exchange Commission (SEC), the Department of Labor and other regulatory bodies may
make inquiries and conduct examinations or investigations concerning the Companys compliance with
insurance laws, securities laws, labor laws and the Employee Retirement Income Security Act of
1974, as amended.
The Companys subsidiaries also have lawsuits pending in which the plaintiff seeks
extra-contractual damages from the Company 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 the Company is
vigorously defending these lawsuits, the outcomes of these cases cannot be determined at this time.
The Company has established loss and LAE reserves for lawsuits as to which the Company has
determined that a loss is both probable and estimable. In addition to these case reserves, the
Company also establishes reserves for claims incurred but not reported to cover unknown exposures
and adverse development on known exposures. Based on currently available information, the Company
believes that reserves for these lawsuits are reasonable and that the amounts reserved did not have
a material effect on the Companys financial condition or results of operations. However, if any
one or more of these cases results in a judgment against or settlement by the Company for an amount
that is significantly greater than the amount so reserved, the resulting liability could have a
material effect on the Companys financial condition, cash flows and results of operations.
As a direct writer of insurance, the Company receives assessments by state funds to cover losses to
policyholders of insolvent or rehabilitated companies and other authorized fees. These mandatory
assessments may be partially recovered through a reduction in future premium taxes in some states
over several years. At June 30, 2011 and December 31, 2010, the liability for such assessments was
$5.0 million and $4.7 million, respectively, and will be paid over several years as assessed by the
various state funds.
17
11. Segment Information
The Company operates its business as one segment, property and casualty insurance. The Company
manages this segment through a product management structure. The following table shows revenues
summarized by the broader business component description, which were determined based primarily on
similar economic characteristics, products and services. Vanliners premiums earned are included in
the table below as part of the Companys transportation component for the three and six months
ended June 30, 2011.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Revenue: |
||||||||||||||||
Premiums Earned: |
||||||||||||||||
Alternative Risk Transfer |
$ | 49,509 | $ | 35,003 | $ | 95,617 | $ | 72,373 | ||||||||
Transportation |
38,221 | 14,984 | 78,608 | 29,183 | ||||||||||||
Specialty Personal Lines |
13,551 | 14,538 | 27,413 | 28,684 | ||||||||||||
Hawaii and Alaska |
3,492 | 3,361 | 6,854 | 6,680 | ||||||||||||
Other |
1,691 | 1,347 | 3,111 | 2,494 | ||||||||||||
Total premiums earned |
106,464 | 69,233 | 211,603 | 139,414 | ||||||||||||
Net investment income |
7,796 | 5,012 | 14,698 | 9,971 | ||||||||||||
Net realized gains on investments |
1,316 | 1,669 | 2,516 | 2,551 | ||||||||||||
Other |
854 | 976 | 1,970 | 1,794 | ||||||||||||
Total revenues |
$ | 116,430 | $ | 76,890 | $ | 230,787 | $ | 153,730 | ||||||||
12. 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. There was total
comprehensive income for the three months ended June 30, 2011 and 2010 of $14.8 million and $8.7
million, respectively. Total comprehensive income for the six months ended June 30, 2011 and 2010
was $24.0 million and $22.6 million, respectively.
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
Forward-Looking Statements
This document, including information incorporated by reference, contains forward-looking
statements (within the meaning of the Private Securities Litigation Reform Act of 1995). All
statements, trend analyses and other information contained in this Form 10-Q relative to markets
for our products and trends in our operations or financial results, as well as other statements
including words such as may, target, anticipate, believe, plan, estimate, expect,
intend, project, and other similar expressions, constitute forward-looking statements. We made
these statements based on our plans and current analyses of our business and the insurance industry
as a whole. We caution that these statements may and often do vary from actual results and the
differences between these statements and actual results can be material. Factors that could
contribute to these differences include, among other things:
| general economic conditions, weakness of the financial markets and other factors, including prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value of our investments; |
| our ability to manage our growth strategy; |
| customer response to new products and marketing initiatives; |
| tax law and accounting changes; |
| increasing competition in the sale of our insurance products and services and the retention of existing customers; |
| changes in legal environment; |
| regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements; |
18
| levels of natural catastrophes, terrorist events, incidents of war and other major losses; |
| adequacy of insurance reserves; and |
| availability of reinsurance and ability of reinsurers to pay their obligations. |
The forward-looking statements herein are made only as of the date of this report. We assume no
obligation to publicly update any forward-looking statements.
General
We underwrite and sell traditional and alternative risk transfer (ART) property and casualty
insurance products primarily to the passenger transportation industry 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 also
underwrite and sell insurance products for moving and storage transportation companies.
Effective July 1, 2010, we and our principal insurance subsidiary, National Interstate Insurance
Company (NIIC), completed the acquisition of Vanliner Group, Inc. (Vanliner) from UniGroup,
Inc. (UniGroup) whereby NIIC acquired all of the issued and outstanding capital stock of Vanliner
and we acquired certain information technology assets. As part of this acquisition, UniGroup
agreed to provide us with comprehensive financial guarantees, including a four and a half-year
balance sheet guaranty whereby both favorable and unfavorable balance sheet developments inure to
UniGroup. Through the acquisition of Vanliner, NIIC acquired Vanliner Insurance Company (VIC), a
market leader in providing insurance for the moving and storage industry. Obtaining a presence in
this industry was our primary strategic objective associated with the acquisition. Beginning July
1, 2010, Vanliners results are included as part of our transportation component, with the
exception of VICs moving and storage group ART programs, which are part of our ART component.
Additional disclosures regarding the Vanliner acquisition are contained in Note 3 to the
Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31,
2010.
We have five property and casualty insurance subsidiaries: NIIC, VIC, National Interstate Insurance
Company of Hawaii, Inc. (NIIC-HI), Triumphe Casualty Company (TCC), Hudson Indemnity, Ltd.
(HIL) and six active agency and service subsidiaries. We write our insurance policies on a
direct basis through NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed in all 50 states and
the District of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New Jersey. TCC, a
Pennsylvania domiciled company, holds licenses for multiple lines of authority, including
auto-related lines, in 25 states and the District of Columbia. HIL is domiciled in the Cayman
Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC primarily for the ART component.
Insurance products are marketed through multiple distribution channels, including independent
agents and brokers, program administrators, affiliated agencies and agent internet initiatives. We
use our six active agency and service subsidiaries to sell and service our insurance business.
As of June 30, 2011, Great American Insurance Company (Great American) owned 52.5% of our
outstanding common shares. Great American is a wholly-owned subsidiary of American Financial Group,
Inc.
Results of Operations
Overview
Through the operations of our subsidiaries, we are engaged in property and casualty insurance
operations. We generate underwriting profits by providing what we view as specialized insurance
products, services and programs not generally available in the marketplace. We focus on niche
insurance markets where we offer insurance products designed to meet the unique needs of targeted
insurance buyers that we believe are underserved by the insurance industry.
We derive our revenues primarily from premiums generated by our insurance policies and income from
our investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses
(LAE), commissions and other underwriting expenses and other operating and general expenses.
19
The following table sets forth our June 30, 2011 and 2010 net income from operations, after-tax net
realized gains from investments, change in valuation allowance on deferred tax assets related to
net capital losses and the after-tax impact from the operating results of Vanliners guaranteed
runoff business, all of which are non-GAAP financial measures that we believe are useful tools for
investors and analysts in analyzing ongoing operating trends.
Three Months Ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Amount | Per Share | Amount | Per Share | |||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||
Net income from operations |
$ | 7,806 | $ | 0.40 | $ | 6,534 | $ | 0.33 | ||||||||
After-tax net realized gain from investments |
855 | 0.04 | 1,084 | 0.06 | ||||||||||||
Impact from balance sheet guaranty for Vanliner |
(458 | ) | (0.02 | ) | | | ||||||||||
Net income |
$ | 8,203 | $ | 0.42 | $ | 7,618 | $ | 0.39 | ||||||||
Six Months Ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Amount | Per Share | Amount | Per Share | |||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||
Net income from operations |
$ | 17,825 | $ | 0.92 | $ | 15,736 | $ | 0.81 | ||||||||
After-tax net realized gain from investments |
1,635 | 0.08 | 1,658 | 0.09 | ||||||||||||
Change in valuation allowance related to net capital losses |
| | 810 | 0.04 | ||||||||||||
Impact from balance sheet guaranty for Vanliner |
(1,729 | ) | (0.09 | ) | | | ||||||||||
Net income |
$ | 17,731 | $ | 0.91 | $ | 18,204 | $ | 0.94 | ||||||||
As discussed above, UniGroup provided us with comprehensive financial guarantees related to
the runoff of Vanliners final balance sheet whereby both favorable and unfavorable balance sheet
development inures to the seller. In accordance with purchase accounting requirements we were
required to determine the fair value of the future economic benefit of the financial guarantees and
acquired loss reserves as of the date of acquisition, despite the fact that certain gains and
losses related to the financial guaranty would be reflected in operations as they are incurred in
future periods. As a result, the recognition of the revenues and expenses associated with the
guaranteed runoff business will not occur in the same period and will result in combined ratios
which are inconsistent with the negotiated combined ratio which was to approximate 100% for the
Vanliner guaranteed business. As such, the after-tax impact from the runoff business guaranteed by
the seller for the three and six months ended June 30, 2011 of $0.5 million ($0.02 per share
diluted) and $1.7 million ($0.09 per share diluted), respectively, has been removed from the net
after-tax earnings from operations to reflect only those results of the ongoing business.
Our net income from operations for the three and six months ended June 30, 2011 was $7.8 million
($0.40 per share diluted) and $17.8 million ($0.92 per share diluted), respectively, compared to
$6.5 million ($0.33 per share diluted) and $15.7 million ($0.81 per share diluted) for the same
periods in 2010. These increases were primarily driven by the growth in net investment income,
which was attributable to the $300 million net increase to our investment portfolio associated with
the Vanliner acquisition and the reinvestment of cash flows from matured securities into
higher-yielding corporate obligations. Partially offsetting these increases were elevated loss and
LAE ratios from ongoing operations for the three and six months ended June 30, 2011 of 72.2% and
69.7%, respectively, which excludes the impact from the runoff of the guaranteed Vanliner business,
as compared to 66.5% and 63.9% for the same periods in 2010. These increases are primarily
concentrated in our specialty personal lines component, which experienced higher than expected
claims results in the second quarter and first half of 2011.
After-tax net realized gains from investments of $0.9 million ($0.04 per share diluted) and $1.6
million ($0.08 per share diluted) for the second quarter and first six months of 2011,
respectively, were relatively flat compared to the $1.1 million ($0.06 per share diluted) and $1.7
million ($0.09 per share diluted) reported for both comparative periods in 2010. During the first
quarter of 2010, we recorded a reduction of $0.8 million ($0.04 per share diluted) to our valuation
allowance related to net realized losses due to both available tax strategies and the future
realizability of previously impaired securities. No valuation allowance against deferred tax
assets was necessary subsequent to March 31, 2010.
20
Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We manage this segment
through a product management structure. The following table sets forth an analysis of gross
premiums written by business component during the periods indicated:
Three Months Ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Alternative Risk Transfer |
$ | 88,584 | 56.6 | % | $ | 68,217 | 61.6 | % | ||||||||
Transportation |
46,322 | 29.6 | % | 19,038 | 17.2 | % | ||||||||||
Specialty Personal Lines |
15,130 | 9.7 | % | 17,784 | 16.1 | % | ||||||||||
Hawaii and Alaska |
4,515 | 2.9 | % | 4,175 | 3.8 | % | ||||||||||
Other |
1,934 | 1.2 | % | 1,512 | 1.3 | % | ||||||||||
Gross premiums written |
$ | 156,485 | 100.0 | % | $ | 110,726 | 100.0 | % | ||||||||
Six Months Ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Alternative Risk Transfer |
$ | 169,445 | 58.3 | % | $ | 134,162 | 62.0 | % | ||||||||
Transportation |
80,419 | 27.7 | % | 37,090 | 17.1 | % | ||||||||||
Specialty Personal Lines |
29,790 | 10.2 | % | 34,673 | 16.0 | % | ||||||||||
Hawaii and Alaska |
8,193 | 2.8 | % | 8,176 | 3.8 | % | ||||||||||
Other |
2,951 | 1.0 | % | 2,429 | 1.1 | % | ||||||||||
Gross premiums written |
$ | 290,798 | 100.0 | % | $ | 216,530 | 100.0 | % | ||||||||
Gross premiums written includes both direct and assumed premium. During the second quarter of
2011, our gross premiums written increased $45.8 million, or 41.3%, compared to the same period in
2010, primarily attributable to the growth experienced in our transportation and ART components.
Gross premiums written in our transportation component increased $27.3 million, or 143.3%, during
the second quarter of 2011 compared to the same period in 2010 due to the addition of Vanliners
moving and storage products, which totaled $27.6 million for the three months ended June 30, 2011.
Our ART components gross premiums written increased by $20.4 million, or 29.9%, in the second
quarter of 2011 compared to the same period in 2010, due to a combination of growth in existing ART
programs including the addition of a new customer to our large account ART product, the
introduction of our second group ART program for Vanliners moving and storage business and near
100% member retention in group ART programs renewing during the period. The decrease of $2.7
million, or 14.9%, in our specialty personal lines component was primarily related to the pricing
and underwriting actions associated with the commercial vehicle product which were first initiated
in late 2009 and have continued into 2011. We also experienced a decrease in our recreational
vehicle product due to a decline in the number of agents quotes, as we are seeing a trend toward
recreational vehicle owners going directly to insurance companies for quotes versus using an agent.
During the first six months of 2011, our gross premiums written increased $74.3 million, or 34.3%,
compared to the same period in 2010. This increase is primarily attributable to our transportation
component, which increased $43.3 million, or 116.8%, driven by the Vanliner moving and storage
products gross premiums written of $46.4 million during the first half of 2011. This growth was
partially offset by a decrease in certain of our traditional passenger and trucking transportation
products, which were impacted by increasingly competitive pricing in the continued soft insurance
market. Our ART component grew by $35.3 million, or 26.3%, during the first six months of 2011
compared to the first half of 2010, while our specialty personal lines component decreased $4.9
million, or 14.1%. The period-over-period changes in both of these components were due to the same
factors discussed above for the three month period.
Our group ART programs, which focus on specialty or niche businesses, provide various services and
coverages tailored to meet specific requirements of defined client groups and their members. These
services include risk management consulting, claims administration and handling, loss control and
prevention and reinsurance placement, along with providing various types of property and casualty
insurance coverage. Insurance coverage is provided primarily to companies with similar risk
profiles and to specified classes of business of our agent partners.
As part of our ART programs, we have analyzed, on a quarterly basis, members loss performance on a
policy year basis to determine if there would be a premium assessment to participants or if there
would be a return of premium to participants as a result of less-than-expected losses. Assessment
premium and return of premium are recorded as adjustments to premiums written (assessments increase
premiums written; returns of premium reduce premiums written). For the second quarter of 2011 and
2010,
21
we recorded a $0.5 million premium assessment and a $1.2 million return of premium, respectively.
For the first half of 2011 and 2010, we recorded a $1.7 million premium assessment and a $0.3
million return of premium, respectively.
Premiums Earned
Three months ended June 30, 2011 compared to June 30, 2010. The following table shows premiums
earned summarized by the broader business component description, which were determined based
primarily on similar economic characteristics, products and services:
Three Months Ended June 30, | Change | |||||||||||||||
2011 | 2010 | Amount | Percent | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Premiums earned: |
||||||||||||||||
Alternative Risk Transfer |
$ | 49,509 | $ | 35,003 | $ | 14,506 | 41.4 | % | ||||||||
Transportation |
38,221 | 14,984 | 23,237 | 155.1 | % | |||||||||||
Specialty Personal Lines |
13,551 | 14,538 | (987 | ) | (6.8 | )% | ||||||||||
Hawaii and Alaska |
3,492 | 3,361 | 131 | 3.9 | % | |||||||||||
Other |
1,691 | 1,347 | 344 | 25.5 | % | |||||||||||
Total premiums earned |
$ | 106,464 | $ | 69,233 | $ | 37,231 | 53.8 | % | ||||||||
Our premiums earned increased $37.2 million, or 53.8%, to $106.5 million during the three
months ended June 30, 2011 compared to $69.2 million for the same period in 2010 primarily
attributable to the transportation and ART components. Our transportation component grew $23.2
million, or 155.1%, over the second quarter of 2010 mainly due to Vanliners moving and storage
products. Approximately $8.2 million of the Vanliner premiums earned relate to the runoff of the
business covered by the balance sheet guaranty. Our ART component increased $14.5 million, or
41.4%, reflecting the continued growth experienced in this component throughout 2010 and the first
six months of 2011. These increases were partially offset by a decrease of $1.0 million, or 6.8%,
in the specialty personal lines component attributable to the decline in premiums written in our
commercial vehicle and recreational vehicle products beginning in the fourth quarter of 2010 and
continuing into the first half of 2011.
Six months ended June 30, 2011 compared to June 30, 2010. The following table shows premiums earned
summarized by the broader business component description, which were determined based primarily on
similar economic characteristics, products and services:
Six Months Ended June 30, | Change | |||||||||||||||
2011 | 2010 | Amount | Percent | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Premiums earned: |
||||||||||||||||
Alternative Risk Transfer |
$ | 95,617 | $ | 72,373 | $ | 23,244 | 32.1 | % | ||||||||
Transportation |
78,608 | 29,183 | 49,425 | 169.4 | % | |||||||||||
Specialty Personal Lines |
27,413 | 28,684 | (1,271 | ) | (4.4 | )% | ||||||||||
Hawaii and Alaska |
6,854 | 6,680 | 174 | 2.6 | % | |||||||||||
Other |
3,111 | 2,494 | 617 | 24.7 | % | |||||||||||
Total premiums earned |
$ | 211,603 | $ | 139,414 | $ | 72,189 | 51.8 | % | ||||||||
Our premiums earned increased $72.2 million, or 51.8%, to $211.6 million during the six months
ended June 30, 2011 compared to $139.4 million for the same period in 2010 primarily attributable
to the transportation and ART components. Our transportation component grew $49.4 million, or
169.4%, over 2010 mainly due to Vanliners moving and storage products. Approximately $23.5
million of the Vanliner premiums earned relate to the runoff of the business covered by the balance
sheet guaranty. Our ART component increased $23.2 million, or 32.1%, while our specialty personal
lines component decreased $1.3 million, or 4.4%. The period-over-period changes in both of these
components were due to the same factors discussed above for the three month period.
Underwriting and Loss Ratio Analysis
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the
combined ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting
expense ratio. A combined ratio under 100% is indicative of an underwriting profit.
Losses and LAE are a function of the amount and type of insurance contracts we write and of the
loss experience of the underlying risks. We seek to establish case reserves at the maximum
probable exposure based on our historical claims experience. Our ability to accurately estimate
losses and LAE at the time of pricing our contracts is a critical factor in determining our
profitability. The amount reported under losses and LAE in any period includes payments in the
period net of the change in reserves for unpaid losses and LAE between the beginning and the end of
the period.
22
Our underwriting expense ratio includes commissions and other underwriting expenses and other
operating and general expenses, offset by other income. Commissions and other underwriting
expenses consist principally of brokerage and agent commissions reduced by ceding commissions
received from assuming reinsurers, and vary depending upon the amount and types of contracts
written and, to a lesser extent, premium taxes.
Our underwriting approach is to price our products to achieve an underwriting profit even if we
forgo volume as a result. Since 2007, we have experienced modest single digit decreases in rate
levels on our renewal business overall due to a continued soft market. However, during the first
six months of 2011, we have begun to see some rate level increases on new and renewal business
among several of our products.
The table below presents our net premiums earned and combined ratios for the periods indicated:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||
Gross premiums written |
$ | 156,485 | $ | 110,726 | $ | 290,798 | $ | 216,530 | ||||||||
Ceded reinsurance |
(22,742 | ) | (24,799 | ) | (46,804 | ) | (49,149 | ) | ||||||||
Net premiums written |
133,743 | 85,927 | 243,994 | 167,381 | ||||||||||||
Change in unearned premiums, net of ceded |
(27,279 | ) | (16,694 | ) | (32,391 | ) | (27,967 | ) | ||||||||
Total premiums earned |
$ | 106,464 | $ | 69,233 | $ | 211,603 | $ | 139,414 | ||||||||
Combined Ratios: |
||||||||||||||||
Loss and LAE ratio (1) |
73.8 | % | 66.5 | % | 72.4 | % | 63.9 | % | ||||||||
Underwriting expense ratio (2) |
23.0 | % | 25.6 | % | 22.8 | % | 25.4 | % | ||||||||
Combined ratio |
96.8 | % | 92.1 | % | 95.2 | % | 89.3 | % | ||||||||
(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. |
Three months ended June 30, 2011 compared to June 30, 2010. Our consolidated loss and LAE
ratio for the second quarter of 2011 increased 7.3 percentage points to 73.8% compared to 66.5% in
the same period in 2010. The loss and LAE ratio for our ongoing operations, which excludes the
impact from the runoff of the guaranteed Vanliner business, was 72.2% for the three months ended
June 30, 2011. This increase over the prior period is primarily attributable to our recreational
vehicle product, which continued to experience higher than expected claims activity in the second
quarter of 2011, and claims on our commercial vehicle product attributable to policies
predominantly written prior to our pricing and underwriting actions. For the second quarter of
2011, we had favorable development from prior years loss reserves of $0.7 million, or 0.7
percentage points, compared to favorable development of $1.5 million, or 2.2 percentage points, in
the second quarter of 2010. This favorable development was primarily related to settlements below
the established case reserves and revisions to our estimated future settlements on an individual
case by case basis. The prior years loss reserve development for both periods is not considered
to be unusual or significant to prior years reserves based on the history of our business and the
timing of events in the claims adjustment process.
The consolidated underwriting expense ratio for the three months ended June 30, 2011 decreased 2.6
percentage points to 23.0% compared to 25.6% for the same period in 2010, primarily attributable to
leveraging existing operating expenses over an increase in earned premium. Included in the
underwriting expense ratio for the three months ended June 30, 2010 are costs associated with the
Vanliner acquisition totaling 0.8 percentage points.
Six months ended June 30, 2011 compared to June 30, 2010. Our consolidated loss and LAE ratio for
the six months ended June 30, 2011 increased 8.5 percentage points to 72.4% compared to 63.9% in
the same period in 2010. The loss and LAE ratio for our ongoing operations, which excludes the
impact from the runoff of the guaranteed Vanliner business, was 69.7% for the first six months of
2011. This increase over the prior period is primarily due to our specialty personal lines
component as discussed above for the three month period. For the first half of 2011, we had
favorable development from prior years loss reserves of $0.5 million, or 0.3 percentage points,
compared to favorable development of prior years loss reserves of $3.2 million, or 2.3 percentage
points, in the first six months of 2010.
The consolidated underwriting expense ratio for the six months ended June 30, 2011 decreased 2.6
percentage points to 22.8% compared to 25.4% for the same period in 2010, primarily due to the
factors discussed above for the three month period. Included in the underwriting expense ratio for
the six months ended June 30, 2011 are costs associated with the Vanliner acquisition totaling 0.6
percentage points.
23
Net Investment Income
2011 compared to 2010. For the three and six month periods ended June 30, 2011, net
investment income was $7.8 million and $14.7 million, respectively, compared to $5.0 million and
$10.0 million for the same periods in 2010. The increase in investment income for both the three
and six months ended June 30, 2011 is primarily due to a net increase in the portfolio of
approximately $300 million associated with the Vanliner acquisition. While the yield on the
acquired Vanliner portfolio was lower than the yield on the existing investment portfolio, cash
flows, including those from matured investments, have been invested in higher yielding securities
primarily corporate obligations, state and local obligations and agency residential mortgage-backed
securities.
Net Realized Gains (Losses) on Investments
2011 compared to 2010. Pre-tax net realized gains on investments were $1.3 million for
the second quarter of 2011 compared to $1.7 million for the second quarter of 2010. For the six
months ended June 30, 2011 and 2010, pre-tax net realized gains were $2.5 million and $2.6 million,
respectively. The pre-tax net realized gains for both the three and six months ended June 30, 2011
were primarily generated from net realized gains associated with sales of securities totaling $1.0
million and $2.0 million, respectively. Additionally, we recorded gains of $0.3 million and $0.5
million associated with equity partnership investments for the three and six months ended June 30,
2011, respectively. There were no other-than-temporary impairment charges taken during three and
six months ended June 30, 2011. The pre-tax net realized gains for both the three and six months
ended June 30, 2010 were primarily generated from net realized gains associated with sales of
securities to generate funds for the Vanliner acquisition totaling $2.0 million and $2.5 million,
respectively. Additionally, we recorded net gains of $0.2 million from equity in earnings of a
limited partnership investment for the six months ended June 30, 2010. Offsetting these gains was
an other-than-temporary impairment credit loss of $0.1 million relating to one mortgage-backed
security, both recorded during the second quarter of 2010.
Commissions and Other Underwriting Expenses
2011 compared to 2010. During the second quarter of 2011, commissions and other underwriting
expenses of $21.2 million increased $6.5 million, or 43.8%, from $14.7 million in the comparable
period in 2010. For the six months ended June 30, 2011 and 2010, commissions and other
underwriting expenses were $41.5 million and $29.6 million, respectively, increasing $11.9 million,
or 40.4%. Both the quarter and year-to-date increases are primarily a result of the growth in
premiums during 2011 compared to 2010.
Other Operating and General Expenses
2011 compared to 2010. Other operating and general expenses were relatively flat for the quarter
ended June 30, 2011 compared to the same period in 2010, increasing $0.1 million, or 2.5%, to $4.1
million from $4.0 million in the prior period. For the six months ended June 30, 2011 and 2010,
other operating and general expenses were $8.6 million and $7.6 million, respectively, increasing
$1.0 million, or 13.3%. This year-to-date increase was primarily due to additional expenses
associated with growth in our employee headcount which began in the second quarter of 2010 and was
driven by the acquisition of Vanliner.
Income Taxes
2011 compared to 2010. The effective tax rate of 28.9% for the three month period ended June 30,
2011 decreased 2.5 percentage points, from 31.4%, as compared to the same period in 2010, primarily
attributable to an increase in tax-exempt income. The 2011 year-to-date effective tax rate
increased 1.6 percentage points to 30.4%, as compared to 28.8% for the same period in 2010. Our
2010 income tax expense was favorably impacted by 3.2 percentage points related to a first quarter
of 2010 reduction to our valuation allowance related to net realized losses due to both available
tax strategies and the future realizability of previously impaired securities. No valuation
allowance against deferred tax assets was necessary subsequent to March 31, 2010. The remaining
change in the year-to-date 2011 effective tax rate is attributable to an increase in tax-exempt
income as compared to the same period in 2010.
Financial Condition
Investments
At June 30, 2011, our investment portfolio contained $914.7 million in fixed maturity securities
and $22.8 million in equity securities, all carried at fair value, with unrealized gains and losses
reported as a separate component of shareholders equity and $27.4 million in other investments,
which are limited partnership investments accounted for in accordance with the equity method. At
June 30, 2011, we had pre-tax net unrealized gains of $16.8 million on fixed maturities and $2.5
million on equity securities.
24
Our investment portfolio allocation is based on diversification among primarily high quality fixed
maturity investments and guidelines in our investment policy.
At June 30, 2011, 94.3% of the fixed maturities in our portfolio were rated investment grade
(credit rating of AAA to BBB-) by nationally recognized rating agencies. Investment grade
securities generally bear lower degrees of risk and corresponding lower yields than those that are
unrated or non-investment grade.
Summary information for securities with unrealized gains or losses at June 30, 2011 is shown in the
following table. Approximately $4.1 million of fixed maturities had no unrealized gains or losses
at June 30, 2011.
Securities with | Securities with | |||||||
Unrealized Gains | Unrealized Losses | |||||||
(Dollars in thousands) | ||||||||
Fixed Maturities: |
||||||||
Fair value of securities |
$ | 738,979 | $ | 171,573 | ||||
Amortized cost of securities |
717,360 | 176,381 | ||||||
Gross unrealized gain or (loss) |
$ | 21,619 | $ | (4,808 | ) | |||
Fair value as a % of amortized cost |
103.0 | % | 97.3 | % | ||||
Number of security positions held |
672 | 146 | ||||||
Number individually exceeding $50,000 gain or (loss) |
146 | 16 | ||||||
Concentration of gains or losses by type or industry: |
||||||||
U.S. Government and government agencies |
$ | 3,046 | $ | (288 | ) | |||
Foreign governments |
11 | | ||||||
State, municipalities and political subdivisions |
7,337 | (892 | ) | |||||
Residential mortgage-backed securities |
3,722 | (2,916 | ) | |||||
Commercial mortgage-backed securities |
10 | (85 | ) | |||||
Banks, insurance and brokers |
3,113 | (313 | ) | |||||
Industrial and other |
4,380 | (314 | ) | |||||
Percent rated investment grade (a) |
96.1 | % | 86.5 | % | ||||
Equity Securities: |
||||||||
Fair value of securities |
$ | 19,687 | $ | 3,142 | ||||
Cost of securities |
16,803 | 3,548 | ||||||
Gross unrealized gain or (loss) |
$ | 2,884 | $ | (406 | ) | |||
Fair value as a % of cost |
117.2 | % | 88.6 | % | ||||
Number individually exceeding $50,000 gain or (loss) |
9 | 1 |
(a) | Investment grade of AAA to BBB- by nationally recognized rating agencies. |
The table below sets forth the scheduled maturities of available for sale fixed maturity
securities at June 30, 2011, based on their fair values. Actual maturities may differ from
contractual maturities because certain securities may be called or prepaid by the issuers.
Securities with | Securities with | |||||||
Unrealized Gains | Unrealized Losses | |||||||
Maturity: |
||||||||
One year or less |
3.7 | % | 0.6 | % | ||||
After one year through five years |
30.7 | % | 13.4 | % | ||||
After five years through ten years |
34.5 | % | 32.2 | % | ||||
After ten years |
12.2 | % | 15.0 | % | ||||
81.1 | % | 61.2 | % | |||||
Mortgage-backed securities |
18.9 | % | 38.8 | % | ||||
100.0 | % | 100.0 | % | |||||
25
The table below summarizes the unrealized gains and losses on fixed maturities and equity
securities by dollar amount:
At June 30, 2011 | ||||||||||||
Aggregate | Fair Value | |||||||||||
Aggregate | Unrealized | as % of | ||||||||||
Fair Value | Gain (Loss) | Cost Basis | ||||||||||
(Dollars in thousands) | ||||||||||||
Fixed Maturities: |
||||||||||||
Securities with unrealized gains: |
||||||||||||
Exceeding $50,000 and for: |
||||||||||||
Less than one year (86 issues) |
$ | 163,926 | $ | 6,353 | 104.0 | % | ||||||
More than one year (60 issues) |
102,191 | 6,808 | 107.1 | % | ||||||||
Less than $50,000 (526 issues) |
472,862 | 8,458 | 101.8 | % | ||||||||
$ | 738,979 | $ | 21,619 | |||||||||
Securities with unrealized losses: |
||||||||||||
Exceeding $50,000 and for: |
||||||||||||
Less than one year (6 issues) |
$ | 21,951 | $ | (432 | ) | 98.1 | % | |||||
More than one year (10 issues) |
14,142 | (3,025 | ) | 82.4 | % | |||||||
Less than $50,000 (130 issues) |
135,480 | (1,351 | ) | 99.0 | % | |||||||
$ | 171,573 | $ | (4,808 | ) | ||||||||
Equity Securities: |
||||||||||||
Securities with unrealized gains: |
||||||||||||
Exceeding $50,000 and for: |
||||||||||||
Less than one year (0 issues) |
$ | | $ | | 0.0 | % | ||||||
More than one year (9 issues) |
7,801 | 2,399 | 144.4 | % | ||||||||
Less than $50,000 (36 issues) |
11,886 | 485 | 104.3 | % | ||||||||
$ | 19,687 | $ | 2,884 | |||||||||
Securities with unrealized losses: |
||||||||||||
Exceeding $50,000 and for: |
||||||||||||
Less than one year (1 issues) |
$ | 2,411 | $ | (384 | ) | 86.3 | % | |||||
More than one year (0 issues) |
| | 0.0 | % | ||||||||
Less than $50,000 (3 issues) |
731 | (22 | ) | 97.1 | % | |||||||
$ | 3,142 | $ | (406 | ) | ||||||||
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.
Premiums and Reinsurance
In the ART component, under most group ART programs, all members of the group share a common
renewal date. These common renewal dates are scheduled throughout the year. However, we have
several large ART programs that renew during the first six months of a given fiscal year. These
renewals in the first six months have historically resulted in a large increase in premiums
receivable, unearned premiums, prepaid reinsurance premiums and reinsurance balances payable during
the first half of a given fiscal year. These increases continually decrease through the year. The
acquisition of Vanliner has created a shift in these trends on a consolidated basis from December
31, 2010 to June 30, 2011, which may change in future periods based on Vanliners growth, the
timing of its premium writings during a given year and the runoff of the guaranteed business.
Premiums receivable increased $40.0 million, or 24.6%, and unearned premiums increased $37.4
million, or 16.8%, from December 31, 2010 to June 30, 2011. Excluding the runoff of the balances
associated with the guaranteed Vanliner business, premiums receivable increased $54.8 million, or
37.5%, and unearned premiums increased $53.4 million, or 25.9%. These increases in premiums
receivable and unearned premiums are primarily due to the increase in direct premiums written in
our ART and transportation components during the second quarter of 2011 as compared to the fourth
quarter of 2010. The increase in the transportation component was driven by Vanliners moving and
storage products.
Prepaid reinsurance premiums increased $4.9 million, or 14.1%, and reinsurance balances payable
increased $12.0 million, or 73.9%, from December 31, 2010 to June 30, 2011. The increases in
prepaid reinsurance premiums and reinsurance balances payable are primarily due to an increase in
ceded premium for the second quarter of 2011 as compared to the fourth quarter of
26
2010. Vanliner did not significantly affect these trends due to its reinsurance structure, as
Vanliner retains a greater portion of its direct premiums written and the associated underwriting
risks when compared to our historical operations.
Liquidity and Capital Resources
The liquidity requirements of our insurance subsidiaries relate primarily to the liabilities
associated with their products as well as operating costs and payments of dividends and taxes to us
from insurance subsidiaries. Historically and during the first six months of 2011, cash flows from
premiums and investment income have provided sufficient funds to meet these requirements, without
requiring significant liquidation of investments. If our cash flows change dramatically from
historical patterns, for example as a result of a decrease in premiums, an increase in claims paid
or operating expenses, or financing an acquisition, we may be required to sell securities before
their maturity and possibly at a loss, or borrow against our credit facility. Our insurance
subsidiaries generally hold a significant amount of highly liquid, short-term investments or cash
and cash equivalents to meet their liquidity needs. Our historic pattern of using receipts from
current premium writings for the payment of liabilities incurred in prior periods provides us with
the option to extend the maturities of our investment portfolio beyond the estimated settlement
date of our loss reserves. Funds received in excess of cash requirements are generally invested in
additional marketable securities.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and
operating expenses, as well as meet commitments in the event of unforeseen events such as reserve
deficiencies, inadequate premium rates or reinsurer insolvencies. Our principal sources of
liquidity are our existing cash, cash equivalents and short-term investments. Cash, cash
equivalents and short-term investments increased $12.4 million from $27.1 million at December 31,
2010 to $39.5 million at June 30, 2011. We generated net cash from operations of $20.2 million for
the six months ended June 30, 2011, compared to $29.3 million during the comparable period in 2010.
This decrease of $9.1 million primarily relates to a large amount of claim payments made during
the first six months of 2011 associated with the runoff of the guaranteed Vanliner business.
Additionally, in the first half of 2011, we made an estimated federal income tax payment which
included approximately $8.4 million (included in the line item Accounts payable and other
liabilities on our Consolidated Balance Sheet at December 31, 2010) associated with the Vanliner
acquisition. This payment is offset by cash received of an equal amount which is included in
Collection of amounts refundable on the purchase price of Vanliner in the investing activities
section of our Consolidated Statements of Cash Flows.
Net cash used in investing activities was $6.3 million and $32.4 million for the six months ended
June 30, 2011 and 2010, respectively. This $26.1 million decrease in cash used in investing
activities was primarily related to the $128.1 million deposited on June 30, 2010 for the July 1,
2010 purchase of Vanliner, a $32.8 million decrease in the purchases of fixed maturity investments
and receiving the $14.3 million refund in 2011 on the purchase price of Vanliner related to making
the election under Section 338(h)(10) of the Internal Revenue Code and the finalization of the
tangible book value, which were partially offset by a $130.4 million decrease in the proceeds from
sales, maturities and redemptions of fixed maturity investments and $13.0 million from the purchase
of other investments, which are comprised of limited partnership investments, in 2011. The
decreases in the purchases of fixed maturities and the proceeds from sales, maturities and
redemptions of fixed maturity investments in the first half of 2011 as compared to the same period
in 2010 were primarily due to the positioning of our portfolio which took place during the first
six months of 2010 to generate funds to finance the Vanliner acquisition. The net purchases of
fixed maturities during the first half of 2011 were primarily concentrated in corporate
obligations, state and local obligations and agency residential mortgage-backed securities. The
purchases of limited partnership investments during the six months ended June 30, 2011 were due to
rebalancing Vanliners investment portfolio, which was entirely comprised of fixed maturity
securities at December 31, 2010.
Net cash used in financing activities was $1.6 million for the six months ended June 30, 2011 as
compared to net cash provided by financing activities of $27.3 million for the same period in 2010.
This $28.9 million decrease in cash provided by financing activities was primarily driven by a $30
million draw on our credit facility in June 2010 to help fund the purchase of Vanliner.
We have continuing cash needs for administrative expenses, the payment of principal and interest on
borrowings, shareholder dividends and taxes. Funds to meet these obligations will come primarily
from parent company cash, dividends and other payments from our insurance company subsidiaries and
from our remaining line of credit.
We have a $50.0 million unsecured Credit Agreement (the Credit Agreement) that terminates in
December 2012, which includes a sublimit of $10.0 million for letters of credit. We have the
ability to increase the line of credit to $75.0 million subject to the Credit Agreements accordion
feature. At June 30, 2011 there was $22.0 million drawn on this credit facility. Amounts borrowed
bear interest at either (1) a rate per annum equal to the greater of the administrative 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 June 30, 2011. As of
June 30, 2011, the interest rate on this debt is equal to the six-month LIBOR (0.375% at June 30,
2011) plus 65 basis points, with interest payments due quarterly.
27
The Credit Agreement requires us to maintain specified financial covenants measured on a quarterly
basis, including consolidated net worth, fixed charge coverage ratio and debt-to-capital ratio. In
addition, the Credit Agreement contains certain affirmative and negative covenants, including
negative covenants that limit or restrict our ability to, among other things, incur additional
indebtedness, effect mergers or consolidations, make investments, enter into asset sales, create
liens, enter into transactions with affiliates and other restrictions customarily contained in such
agreements. As of June 30, 2011, 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 against our credit facility, 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 under our Credit Agreement 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. We are not aware of any trends or uncertainties affecting our
liquidity, including any significant future reliance on short-term financing arrangements.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles (GAAP) requires management to make estimates and assumptions that affect amounts
reported in the financial statements. As more information becomes known, these estimates and
assumptions could change and thus impact amounts reported in the future. Management believes that
the establishment of losses and LAE reserves and the determination of other-than-temporary
impairment on investments are the two areas where the degree of judgment required in determining
amounts recorded in the financial statements make the accounting policies critical. For a more
detailed discussion of these policies, see Managements Discussion and Analysis of Financial
Condition and Results of Operations Critical Accounting Policies in our Annual Report on Form
10-K for the year ended December 31, 2010.
Losses and LAE Reserves
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of
that loss to us and our final payment of that loss and its related LAE. To recognize liabilities
for unpaid losses, we establish reserves as balance sheet liabilities. At both June 30, 2011 and
December 31, 2010, we had $795.4 million and $798.6 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, VIC,
NIIC-HI and TCC utilizing current period data and provide a Statement of Actuarial Opinion,
required annually in accordance with state insurance regulations, on the statutory reserves
recorded by these U.S. insurance subsidiaries. The actuarial analysis of NIICs, VICs, NIIC-HIs
and TCCs net reserves for the year ending December 31, 2010 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 June 30, 2011 and December 31, 2010.
The quarterly reviews of unpaid loss and LAE reserves by Great American actuaries are prepared
using standard actuarial techniques. These may include (but may not be limited to):
| the Case Incurred Development Method; |
| the Paid Development Method; |
| the Bornhuetter-Ferguson Method; and |
| the Incremental Paid LAE to Paid Loss Methods. |
28
The period of time from the occurrence of a loss through the settlement of the liability is
referred to as the tail. Generally, the same actuarial methods are considered for both short-tail
and long-tail lines of business because most of them work properly for both. The methods are
designed to incorporate the effects of the differing length of time to settle particular claims.
For short-tail lines, management tends to give more weight to the Case Incurred and Paid
Development methods, although the various methods tend to produce similar results. For long-tail
lines, more judgment is involved and more weight may be given to the Bornhuetter-Ferguson method.
Liability claims for long-tail lines are more susceptible to litigation and can be significantly
affected by changing contract interpretation and the legal environment. Therefore, the estimation
of loss reserves for these classes is more complex and subject to a higher degree of variability.
Supplementary statistical information is reviewed to determine which methods are most appropriate
and whether adjustments are needed to particular methods. This information includes:
| open and closed claim counts; |
| average case reserves and average incurred on open claims; |
| closure rates and statistics related to closed and open claim percentages; |
| average closed claim severity; |
| ultimate claim severity; |
| reported loss ratios; |
| projected ultimate loss ratios; and |
| loss payment patterns. |
Other-Than-Temporary Impairment
Our investments are exposed to at least one of three primary sources of investment risk: credit,
interest rate and market valuation risks. The financial statement risks are those associated with
the recognition of impairments and income, as well as the determination of fair values. We evaluate
whether impairments have occurred on a case-by-case basis. Management considers a wide range of
factors about the security issuer and uses its best judgment in evaluating the cause and amount of
decline in the estimated fair value of the security and in assessing the prospects for near-term
recovery. Inherent in 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. |
29
Under current other-than-temporary impairment accounting guidance, if management can assert that it
does not intend to sell an impaired fixed maturity security and it is not more likely than not that
it will have to sell the security before recovery of its amortized cost basis, then an entity may
separate the other-than-temporary impairments into two components: 1) the amount related to credit
losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other
comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is
measured by comparing a 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 4
Investments.
We closely monitor each investment that has a fair value that is below its amortized cost and make
a determination each quarter for other-than-temporary impairment for each of those investments.
There were no impairment charges taken during the three and six months ended June 30, 2011.
During both the three and six months ended June 30, 2010, we recorded an other-than-temporary
impairment charge on one mortgage-backed security, for which a previous impairment charge had been
recorded. The other-than-temporary impairment charge on this security was separated into: a credit
loss of $0.1 million, which is recognized in earnings, and a reduction in the non-credit loss of
$0.1 million, which was previously included in other comprehensive income. The credit loss of $0.1
million was the result of managements analysis that we may not receive the full principal amounts
due to potential defaults on the mortgage loans underlying the mortgage-backed security and that
the recovery of expected principal will take longer than previously expected. 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 Discussion and Analysis
of Financial Condition and Results of Operations Financial Condition Investments.
Contractual Obligations/Off-Balance Sheet Arrangements
During the first six months of 2011, our contractual obligations did not change materially from
those discussed in our Annual Report on Form 10-K for the year ended December 31, 2010.
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.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
As of June 30, 2011, there were no material changes to the information provided in our Annual
Report on Form 10-K for the year ended December 31, 2010 under Item 7A Quantitative and
Qualitative Disclosures About Market Risk.
ITEM 4. Controls and Procedures
Our management is responsible for establishing and maintaining effective disclosure controls and
procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934.
Our management, with participation of our Chief Executive Officer and Chief Financial Officer, has
evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule
13a-15(e)) as of June 30, 2011. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were effective as of June
30, 2011, to ensure that information required to be disclosed by us in reports that we file or
submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange Commissions rules
and forms, and that such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.
There have been no significant changes in our internal controls over financial reporting or in
other factors that have occurred during the quarter ended June 30, 2011 that have materially
affected, or are reasonably likely to affect, our internal control over financial reporting.
30
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings
There are no material changes from the legal proceedings previously reported in our Annual Report
on Form 10-K for the year ended December 31, 2010. For more information regarding such legal
matters please refer to Item 3 of our Annual Report on Form 10-K for the year ended December 31,
2010, Note 16 to the Consolidated Financial Statements included therein and Note 10 to the
Consolidated Financial Statements contained in this quarterly report.
ITEM 1A. Risk Factors
There are no material changes to the risk factors previously reported in our Annual Report on Form
10-K for the year ended December 31, 2010. For more information regarding such risk factors, please
refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. [RESERVED]
ITEM 5. Other Information
None.
ITEM 6. Exhibits
3.1
|
Amended and Restated Articles of Incorporation (1) | |
3.2
|
Amended and Restated Code of Regulations (1) | |
31.1
|
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2
|
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1
|
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2
|
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101.INS
|
XBRL Instance Document (2) | |
101.SCH
|
XBRL Taxonomy Extension Schema Document (2) | |
101.CAL
|
XBRL Taxonomy Extension Calculation Linkbase Document (2) | |
101.DEF
|
XBRL Taxonomy Extension Definition Linkbase Document (2) | |
101.LAB
|
XBRL Taxonomy Extension Label Linkbase Document (2) | |
101.PRE
|
XBRL Taxonomy Extension Presentation Linkbase Document (2) |
(1) | These exhibits are incorporated by reference to our Registration Statement on Form S-1 (Registration No. 333-119270). | |
(2) | In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed furnished not filed. |
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL INTERSTATE CORPORATION |
||||
Date: August 5, 2011 | /s/ David W. Michelson | |||
David W. Michelson | ||||
President and Chief Executive Officer (Duly Authorized Officer and Principal Executive Officer) |
||||
Date: August 5, 2011 | /s/ Julie A. McGraw | |||
Julie A. McGraw | ||||
Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) |
||||
32