Cautionary Statement
You should read the following discussion and analysis in conjunction with our
unaudited condensed consolidated financial statements and the related notes
thereto included in Item 1 of Part I of this quarterly report. The information
contained in this quarterly report is not a complete description of our business
or the risks associated with an investment in our common stock. We urge you to
carefully review and consider the various disclosures made by us in this
quarterly report and in our other reports filed with the U.S. Securities and
Exchange Commission (the "SEC"), including our Annual Report on Form 10-K for
the year ended December 31, 2011 filed with the SEC on March 5, 2012.
The discussion under the heading "Risk Factors" in our Annual Report on Form
10-K for the year ended December 31, 2011 and in this Quarterly Report on Form
10-Q, and similar discussions in our other SEC filings, describe some of the
important risk factors that may affect our business, results of operations and
financial condition. You should carefully consider those risks, in addition to
the other information in this report and in our other filings with the SEC,
before deciding to purchase, hold or sell our common stock.
Some of the statements in this Item 2 and elsewhere in this quarterly report may
include forward-looking statements that reflect our current views with respect
to future events and financial performance. These statements include
forward-looking statements, both with respect to us specifically and the
insurance sector in general, and include statements about our expectations for
future periods with respect to payroll levels, rate changes in states where we
write business, our adverse development cover with Lumbermens Mutual Casualty
Company ("LMC"), stockholder dividends, our capital needs and the expected
effect of operational changes and cost savings initiatives. Statements that
include the words "expect," "intend," "plan," "believe," "project," "estimate,"
"may," "should," "anticipate," "will" and similar statements of a future or
forward-looking nature identify forward-looking statements for purposes of the
federal securities laws or otherwise.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause our actual results to differ materially from those indicated in these
statements. We believe that these factors include but are not limited to the
following:
• greater frequency or severity of claims and loss activity, including as a
result of catastrophic events, than our underwriting, reserving or investment
practices anticipate based on historical experience or industry data;
• changes in the U.S. economy and workforce levels, including the length of the
economic recovery;
• our dependency on a concentrated geographic market;
• changes in the availability, cost or quality of reinsurance and failure of our
reinsurers to pay claims timely or at all;
• changes in regulations or laws applicable to us, our subsidiaries, brokers or
customers;
• uncertainty about the effect of rules and regulations to be promulgated under
the Dodd-Frank Wall Street Reform and Consumer Protection Act on us and the
economy and the financial services sector in particular;
• potential downgrades in our rating or changes in rating agency policies or
practices;
• ineffectiveness or obsolescence of our business strategy due to changes in
current or future market conditions;
• unexpected issues relating to claims or coverage and changes in legal theories
of liability under our insurance policies;
• increased competition on the basis of pricing, capacity, coverage terms or
other factors;
• developments in financial and capital markets that adversely affect the
performance of our investments;
• loss of the services of any of our executive officers or other key personnel;
- 16 ---------------------------------------------------------------------------------
• our inability to raise capital in the future;
• our status as an insurance holding company with no direct operations;
• our reliance on independent insurance brokers;
• increased assessments or other surcharges by states in which we write
policies;
• our potential exposure to losses;
• the effects of mergers, acquisitions and divestitures that we may undertake;
• failure of our customers to pay additional premium under our retrospectively
rated policies;
• the effects of acts of terrorism or war;
• cyclical changes in the insurance industry;
• changes in accounting policies or practices; and
• changes in general economic conditions, including inflation and other factors.
The foregoing factors should not be construed as exhaustive and should be read
in conjunction with the other cautionary statements that are included in this
quarterly report. We undertake no obligation to publicly update or review any
forward-looking statement, whether as a result of new information, future
developments or otherwise.
If one or more of these or other risks or uncertainties materialize, or if our
underlying assumptions prove to be incorrect, actual results may vary materially
from what we project. Any forward-looking statements you read in this quarterly
report reflect our views as of the date of this quarterly report with respect to
future events and are subject to these and other risks, uncertainties and
assumptions relating to our operations, results of operations, growth strategy
and liquidity. Before making an investment decision, you should carefully
consider all of the factors identified in this quarterly report that could cause
actual results to differ.
Additional information concerning these and other factors is contained in our
SEC filings, including, but not limited to, our 2011 Annual Report on Form 10-K.
Overview
We are a holding company whose wholly-owned subsidiary, SeaBright Insurance
Company, operates as a specialty provider of multi-jurisdictional workers'
compensation insurance. Through our other wholly-owned subsidiaries, PointSure
Insurance Services, Inc. and Paladin Managed Care Services, Inc., we also
provide related wholesale brokerage services and integrated managed medical care
services. SeaBright Insurance Company is domiciled in Illinois, commercially
domiciled in California and headquartered in Seattle, Washington. SeaBright
Insurance Company is licensed in 49 states, the District of Columbia and Guam,
to write workers' compensation and other lines of insurance. Traditional
underwriters of workers' compensation insurance provide coverage to employers
under one or more state workers' compensation laws, which prescribe benefits
that employers are obligated to provide to their employees who are injured
arising out of or in the course of employment. We focus on employers with
complex workers' compensation exposures and provide coverage under multiple
state and federal acts, applicable common law or negotiated agreements. We also
provide traditional state act coverage in markets we believe are underserved.
Our workers' compensation policies are issued to employers who also pay the
premiums.
Our operations and financial performance have been impacted by changes in the
U.S. economy. The significant downturn in the U.S. economy from 2008 through
2010 led to lower reported payrolls, which has had a negative impact on our
gross premiums written, and the recovery that began in 2010 has not resulted in
a significant improvement in reported payrolls. The economic downturn had a
particularly severe impact on the construction industry. When our customers
reduce their workforce levels, the level of workers' compensation insurance
coverage they require and, as a result the premiums that we charge, are reduced,
and if our customers cease operations, they may cancel or choose not to renew
their policies. The economic downturn and high levels of unemployment have the
effect of increasing claims and claim severity and duration, which drives up our
medical, indemnity and litigation costs. The economic downturn has also
diminished opportunities for injured workers to return to transitional, modified
duty positions during their recoveries, which has lengthened the periods of
their recoveries and increased our medical, indemnity and litigation costs,
particularly in California. The longer a claim remains open, the more exposed we
become to the effects of medical cost inflation. All of these factors have had,
and could continue to have, a significant negative impact on our claims costs.
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If we fail to accurately assess our future claims costs, our loss reserves may
be inadequate to cover our actual losses. As discussed under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies, Estimates and Judgments - Unpaid Loss
and Loss Adjustment Expenses" in our 2011 Annual Report on Form 10-K, there are
many variables that can impact the adequacy of our loss and loss adjustment
expense liabilities and we continually refine our loss reserve estimates.
Quarterly, management determines what, if any, adjustments to prior accident
years' loss reserves are necessary after considering the results of actuarial
studies performed by internal and/or consulting actuaries; the impact of recent
operational initiatives on our claims costs and loss reserves; discussions with
key executives in Underwriting, Claims, and other relevant functional areas;
changing environmental conditions; and other factors. In response to the factors
described in the preceding paragraph, we strengthened our net loss reserves for
prior accident years by $28.4 million in 2011 and lowered our net reserves by
$1.0 million in the first six months of 2012. We may ultimately conclude that
our current estimate of loss reserves is inadequate, if the negative claim
trends experienced over the last several years described above continue or
worsen. Future adverse development could require us to increase our loss
reserves, which could have a material adverse effect on our earnings and
financial position in the periods in which such increases are made.
It is uncertain if economic conditions will deteriorate further, or when
economic conditions will show significant improvement. If the recovery from the
recent economic recession continues to be slow, or the recovery fails to
positively impact employment levels, or if we experience another recession, it
could further reduce payrolls and increase our claims costs, which could have a
significant negative impact on our business, financial condition or results of
operations.
Results of Operations
Three Months and Six Months Ended June 30, 2012 and 2011
Gross Premiums Written. Gross premiums written consists of direct premiums
written and premiums assumed from the NCCI residual market pools. The number of
customers we service, in-force payrolls and in-force premiums represent some of
the factors we consider when analyzing gross premiums written.
Gross premiums written for the three months ended June 30, 2012 totaled $66.9
million, a decrease of $0.9 million, or 1.3%, from $67.8 million of gross
premiums written in the same period of 2011. Gross premiums written for the six
months ended June 30, 2012 totaled $133.6 million, a decrease of $3.7 million,
or 2.7%, from $137.3 million of gross premiums written in the same period of
2011.
Our "core" product lines contributed $50.8 million, or 75.9%, of the total gross
premiums written for the three months ended June 30, 2012 compared to $50.9
million, or 75.1%, in the same period of 2011. The slight decrease in our core
product lines was accompanied by a net $0.3 million decrease in our "Program
Business," which contributed $16.9 million of gross premiums written for the
quarter ended June 30, 2012. Our Program Business includes alternative markets
and small maritime and small energy programs. For the six months ended June 30,
2012, our core product lines contributed $95.1 million, or 71.2%, of gross
premiums written in the period, essentially flat as compared to the same period
in 2011. Our Program Business contributed $38.6 million, or 28.9%, of gross
premiums written in the six months ended June 30, 2012, a decrease of $3.5
million from the $42.1 million of gross premiums written in the same period in
2011.
The reductions in written premiums and customer count resulted in part from our
previously announced efforts to reduce our concentration in the California
construction and agriculture markets. Our average California renewal retention
rate over the four most recent quarters was 58.5% compared to 68.8% in the prior
four quarters. Our overall renewal retention rate for the second quarter of 2012
was 81.0%, up from 63.0% in the first quarter of 2012 and 75.0% in the second
quarter of 2011.
Excluding work we perform as the servicing carrier for the Washington State
USL&H Compensation Act Assigned Risk Plan (the "Washington USL&H Plan"), the
total number of customers we serviced decreased from approximately 1,580 at June
30, 2011 to approximately 1,400 at June 30, 2012. The majority of the customer
decrease was in our core business, which was offset by an increase of
approximately 60 customers in our Program Business. By design, our Program
Business will have a larger number of customers with a smaller average premium
size than our core business. Our average premium size at June 30, 2012 was
approximately $297,000 in our core business and approximately $93,000 in our
Program Business, compared to approximately $249,000 in our core business and
approximately $105,000 in our Program Business one year earlier.
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Total in-force payrolls, a factor used in determining premiums charged,
decreased 1.5% from $6.8 billion at June 30, 2011 to $6.7 billion a year later.
California continues to be our largest market, accounting for approximately
$103.9 million, or 41.8%, of our in-force premiums at June 30, 2012. This
represents a decrease of $38.8 million, or 27.2%, from approximately $142.7
million, or 50.4% of total in-force premiums in California at June 30, 2011.
Premiums assumed from the NCCI residual market pools for the three months ended
June 30, 2012 totaled $(2.7) million, a decrease of $3.0 million from $0.3
million during the same period in 2011. For the six months ended June 30, 2012,
assumed premiums decreased $2.8 million, or 186.7%, to $(1.3) million from $1.5
million for the same period in 2011. The decreases for the three months and six
months ended June 30, 2012 were primarily the result of true-ups of our
actuarial estimates for prior policy years based on current NCCI data and
reapportionment figures. The balance of our gross premiums written (consisting
of Washington USL&H Plan, general liability and other miscellaneous amounts) for
the three month and six month periods ended June 30, 2012 totaled $1.9 million
and $1.2 million, respectively, compared to $(0.5) million and $(1.3) million,
respectively, in the same periods in 2011.
Net Premiums Written. Net premiums written totaled $63.6 million for the three
months ended June 30, 2012 compared to $58.0 million in the same period in 2011,
representing an increase of $5.6 million, or 9.7%. For the six months ended June
30, 2012, net premiums written totaled $123.9 million, an increase of $6.3
million, or 5.4%, from $117.6 million in the same period of 2011. The increase
in net premiums written for the three months and six months ended June 30, 2012
was primarily attributable to a decrease in ceded premiums written of $10.0
million as a result of a lower ceding rate in our excess of loss reinsurance
program that renewed in October 2011, offset by a $3.7 million decrease in gross
premiums written. Our ceding rate decreased by approximately 50% as a result of
raising the attachment point from $0.25 million to $0.5 million and reducing
maximum coverage from $100.0 million to $75.0 million. The coverage provided by
the reinsurance program that renewed in October 2011 is more in line with
historical levels.
Net Premiums Earned. Net premiums earned totaled $56.6 million for the three
months ended June 30, 2012 compared to $62.1 million for the same period in
2011, representing a decrease of $5.5 million, or 8.8%. For the six months ended
June 30, 2012, net premiums earned totaled $115.7 million, a decrease of $3.1
million, or 2.6%, from $118.8 million in the same period of 2011. We record the
entire annual policy premium as unearned premium when written and earn the
premium over the life of the policy, which is generally twelve months.
Consequently, the amount of premiums earned in any given year depends on when
during the current or prior year the underlying policies were written and the
actual reported payroll of the underlying policies. Our direct premiums earned
totaled $62.6 million for the three months ended June 30, 2012, a decrease of
$8.9 million, or 12.4%, from $71.5 million for the same period in 2011. Our
direct premiums earned totaled $126.5 million for the six months ended June 30,
2012, a decrease of $10.0 million, or 7.3%, from $136.5 million for the same
period in 2011.
The following is a summary of our top five markets based on direct premiums
earned:
Six Months Ended June 30,
2012 2011
Direct Direct
Premiums Premiums
Earned % Earned %
($ in thousands)
California $ 53,040 41.8 % $ 67,364 49.4 %
Louisiana 12,474 9.9 12,524 9.2
Texas 8,549 6.8 7,894 5.8
Alaska 6,061 4.8 7,849 5.8
Pennsylvania 5,095 4.0 4,516 3.3
Total $ 85,219 67.3 % $ 100,147 73.5 %
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Net premiums earned are also affected by premiums ceded under reinsurance
agreements. Ceded premiums earned for the three months ended June 30, 2012
totaled $3.0 million compared to $9.8 million for the same period in 2011,
representing a decrease of $6.8 million, or 69.4%. Ceded premiums earned for the
six months ended June 30, 2012 totaled $9.1 million compared to $19.3 million
for the same period in 2011, representing a decrease of $10.2 million, or
52.8%.This decrease was primarily attributable to lower ceding rates under our
October 2011 reinsurance program. The decrease in ceded premiums earned was
offset by a decrease in premiums assumed from the NCCI for residual market
business. Assumed premiums earned decreased $3.3 million from $1.6 million for
the six months ended June 30, 2011 to $(1.7) million in the same period in 2012.
This decrease was primarily due to true-ups of our actuarial estimates for prior
policy years based on current NCCI data and reapportionment figures.
Net Investment Income. Net investment income was $4.4 million for the three
months ended June 30, 2012 compared to $5.3 million for the same period in 2011,
representing a decrease of $0.9 million, or 17.0%. Net investment income was
$9.4 million for the six months ended June 30, 2012, compared to $10.7 million
for the same period in 2011, representing a decrease of $1.2 million, or 11.5%.
Average invested assets were $749.2 million for the three months ended June 30,
2012, an increase of $53.8 million, or 7.7%, from $695.4 million for the same
period in 2011. For the six months ended June 30, 2012, average invested assets
were $739.5 million, an increase of $45.2 million, or 6.5%, from $694.3 million
for the same period in 2011. Our yield on average invested assets decreased from
approximately 3.0% for the three months ended June 30, 2011 to approximately
2.4% for the same period in 2012, driven mainly by reduced reinvestment rates
and sales of higher-yielding investment securities. For the six months ended
June 30, 2012, our yield on average invested assets was 2.6% compared to
approximately 3.1% for the same period in 2011.
Net Realized Gains. Net realized gains totaled $2.1 million for the three months
ended June 30, 2012 compared to $0.1 million for the same period in 2011. For
the six months ended June 30, 2012, net realized gains totaled $10.1 million
compared to $0.4 million in the same period in 2011. The increase in net
realized gains for the three months and six months ended June 30, 2012 resulted
from the sale of investment securities in order to reduce exposure to interest
rate risk and realize a portion of our tax loss carry forwards. The majority of
proceeds from these sales were reinvested in taxable securities in a continuing
effort to shorten the overall portfolio duration and reduce the municipal
exposure.
Other Income. Other income totaled $1.0 million for the three months ended June
30, 2012 compared to $1.2 million for the same period in 2011, representing a
decrease of $0.2 million, or 22.6%. For the six months ended June 30, 2012,
other income totaled $1.9 million compared to $2.3 million in the same period in
2011, representing a decrease of $0.4 million, or 17.9%. Other income is derived
primarily from the operations of PointSure, our wholesale insurance broker, and
PMCS, our provider of medical bill review, utilization review, nurse case
management and related services.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses totaled
$43.3 million for the three months ended June 30, 2012 compared to $72.7 million
for the same period in 2011, representing a decrease of $29.4 million, or 40.4%.
For the six months ended June 30, 2012, loss and loss adjustment expenses
totaled $86.7 million, compared to $115.9 million for the same period in 2011,
representing a decrease of $29.2 million, or 25.2%. Our net loss ratio, which is
calculated by dividing loss and loss adjustment expenses less claims service
income by premiums earned, for the three months ended June 30, 2012 was 76.1%
compared to 116.5% for the same period in 2011. Our net loss ratio for the six
months ended June 30, 2012 was 74.5% compared to 97.0% for the same period in
2011. The decrease in our net loss ratio for the three months ended June 30,
2012 was primarily attributable to $1.0 million of favorable development of
prior accident years' loss reserves recorded in the three months ended June 30,
2012 compared with $27.1 million adverse development in the three months ended
June 30, 2011. Net favorable development of prior years' reserves in the six
months ended June 30, 2012 totaled $1.0 million compared to $28.4 million
adverse development in the same period of 2011.
As discussed under the heading "Critical Accounting Policies, Estimates and
Judgments - Unpaid Loss and Loss Adjustment Expenses - Actuarial Loss Reserve
Estimation Methods" in Part II, Item 7 of our Annual Report on Form 10-K for the
year ended December 31, 2011, we use an expected loss ratio ("ELR") method to
establish the loss reserves for the current accident year. Once the accident
year is complete and begins to age, the ELR method is blended with the actual
paid and incurred loss development to determine the revised estimated ultimate
losses for the accident year.
Accident year 2012 is incomplete, as only six months of the year have been
earned as of June 30, 2012. An ELR was established for each jurisdiction and
type of loss (indemnity, medical, ALAE) and was multiplied by the booked
accident year earned premium to produce the ultimate losses to date. The ELR
selections are reviewed quarterly with each internal reserve study. Given the
short experience period for the current accident year, the ELRs are usually
maintained at least through the first 12 months of the accident year and revised
thereafter as the underlying data matures. The net ELR used in the first six
months of 2012 was 65.0%, compared to 62.5% used in the first six months of the
2011 accident year. The 2011 net ELR was subsequently increased to 65.0% in the
fourth quarter of 2011, after reviewing the year-to-date results for the 2011
accident year and considering the adverse development in recent accident years.
The 2012 accident year ELR takes into consideration factors including, but not
limited to: the development of recent accident years, the impact of recent rate
increases, and provisions of the excess-of-loss reinsurance treaty that we
entered into on October 1, 2011.
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For prior accident years, the net ultimate loss estimates at June 30, 2012 were
lower when compared to March 31, 2012 and resulted in a net decrease of $1.0
million in our loss reserves in the second quarter of 2012, compared to a net
increase of $27.1 million recorded in the same period of last year. Adverse
development of prior years' direct loss reserves totaled $2.0 million and
related to the following accident years: $6.9 million in 2010 and $2.0 million
in 2009, offset by favorable development of $2.9 million in 2011, $2.5 million
in 2008, and $1.5 million in 2007 and prior. This adverse development was offset
by $3.0 million of net favorable development of other amounts such as ULAE, loss
based assessments and losses assumed from the NCCI pools. In the three months
ended June 30, 2011, we increased our loss reserves by a net amount of $27.1
million. Adverse development of prior years' direct loss reserves totaled $28.5
million and related to the following accident years: $2.4 million in 2010, $8.4
million in 2009, $8.8 million in 2008, $6.7 million in 2007, and $2.2 million in
2006 and prior. This adverse development was partially offset by $1.4 million of
net favorable development of ULAE, loss based assessments and NCCI pool
reserves.
As of June 30, 2012, we had recorded a receivable of approximately $3.1 million
for KEIC loss development under the adverse development cover we entered into
with LMC on September 30, 2003, the date we acquired KEIC from LMC. We do not
expect this receivable to have any material adverse effect on our future cash
flows if LMC fails to perform its obligations under the adverse development
cover. At June 30, 2012, we had access to approximately $3.1 million under the
related collateralized reinsurance trust in the event that LMC fails to satisfy
its obligations under the adverse development cover. December 31, 2011 was the
date as of which the parties are to settle amounts due under the adverse
development cover. We are currently working through the final settlement of the
receivable from LMC. For an update regarding the status of LMC, see the
discussion under Note 7.c., "Contingencies" in Item 1 of this Part I.
Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled
$16.7 million for the three months ended June 30, 2012, compared to $19.1
million for the same period in 2011, representing a decrease of $2.4 million, or
12.6%. For the six months ended June 30, 2012, underwriting expenses totaled
$33.6 million, a decrease of $4.5 million, or 11.7%, from $38.1 million for the
same period in 2011. Our net underwriting expense ratio, which is calculated by
dividing underwriting, acquisition and insurance expenses by premiums earned,
for the three months ended June 30, 2012 was 29.5%, compared to 30.8% for the
same period in 2011. For the six months ended June 30, 2012, our net
underwriting expense ratio was 29.1%, compared to 32.1% for the same period in
2011. The primary driver of the decreases in underwriting expenses was a
reduction in commission expense, of which approximately $1.0 million resulted
from true-ups of our actuarial estimates of commissions assumed from the NCCI
pools for prior policy years. Direct commission expense for the six months ended
June 30, 2012 decreased approximately $1.3 million from the same period in 2011
due to a change in product mix and lower commission rates. Contingent
commissions for the six months ended June 30, 2012 decreased approximately $0.9
million from the same period in 2011.
Interest Expense. Interest expense related to the surplus notes issued by our
insurance subsidiary in May 2004 totaled $136,000 for the three months ended
June 30, 2012, compared to $129,000 for the same period in 2011, representing an
increase of $7,000, or 5.4%. For the six months ended June 30, 2012, interest
expense totaled $272,000, an increase of $13,000, or 5.0%, from $259,000 in the
same period of 2011. The surplus notes interest rate, which is calculated at the
beginning of each interest payment period using the 3-month LIBOR plus 400 basis
points, was 4.5% at June 30, 2012 compared to 4.3% at June 30, 2011.
Other Expenses. Other expenses totaled $2.6 million for the three months ended
June 30, 2012 compared to $2.1 million for the same period in 2011, representing
an increase of $0.5 million, or 24.8%. For the six months ended June 30, 2012,
other expenses totaled $4.4 million compared to $4.0 million in the same period
of 2011. Other expenses result primarily from the operations of PointSure and
PMCS, which together accounted for approximately $1.9 million and $3.3 million
of expenses for the three months and six months ended June 30, 2012, compared to
approximately $1.7 million and $3.4 million for the same periods in 2011.
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Income Tax Expense. The effective tax rate for the three months ended June 30,
2012 was 12.0%, compared to 37.2% for the same period in 2011. The effective tax
rate for the six months ended June 30, 2012 was 24.9% compared to 38.1% in the
same period of 2011. Our effective tax rate differed from the statutory tax rate
of 35.0% primarily as a result of tax exempt interest income. At June 30, 2012,
approximately 40.4% of our investment portfolio was invested in tax exempt
municipal bonds, compared to approximately 44.1% at June 30, 2011.
Net Income (Loss). Net income was $1.4 million for the three months ended June
30, 2012, compared to a net loss of $15.7 million for the same period in 2011.
Net income for the six months ended June 30, 2012 totaled $9.5 million, a
difference of $25.3 million from a net loss of $15.8 million in the same period
of 2011. The increase in net income for the three months and six months ended
June 30, 2012 was primarily the result of decreases in loss and loss adjustment
expenses and increases in net realized gains.
Liquidity and Capital Resources
Our principal sources of funds are underwriting operations, investment income
and proceeds from sales and maturities of investments. Our primary use of funds
is to pay claims and operating expenses, to purchase investments and to pay
declared common stock dividends.
Our investment portfolio is structured so that investments mature periodically
over time in reasonable relation to current expectations of future claim
payments. Since we have limited claims history, we have derived our expected
future claim payments from industry and predecessor trends. Our investment
portfolio as of June 30, 2012 had an effective duration of 4.1 years with
individual maturities extending out to 29 years. Currently, we make claim
payments from positive cash flow from operations and invest excess cash in
securities with appropriate maturity dates to balance against anticipated future
claim payments. As these securities mature, we intend to invest any excess funds
in investments with appropriate durations to match against expected future claim
payments.
At June 30, 2012, our investment portfolio consisted of investment-grade fixed
income securities with fair values subject to fluctuations in interest rates, as
well as other factors such as credit. All of the securities in our investment
portfolio are accounted for as "available for sale" securities. While we have
structured our investment portfolio to provide an appropriate matching of
maturities with anticipated claim payments, if we decide or are required in the
future to sell securities in a rising interest rate environment, we would expect
to incur losses from such sales.
Our ability to adequately provide funds to pay claims comes from our disciplined
underwriting and pricing standards and the purchase of reinsurance to protect us
against severe claims and catastrophic events. Effective October 1, 2011, our
reinsurance program provides for retention of the first $0.5 million of each
loss occurrence. The next $0.5 million of losses per occurrence (excess of the
first $0.5 million of losses retained by us) are 50% reinsured. Losses in excess
of $1.0 million per loss occurrence are fully reinsured through the program
limit of $75.0 million per loss occurrence, subject to various deductibles,
limitations and exclusions as more fully described in the treaties. The new
reinsurance program is effective through September 30, 2012. Given industry and
predecessor trends, we believe we are sufficiently capitalized to cover our
retained losses.
SeaBright is a holding company with minimal unconsolidated revenue. As SeaBright
pays stockholder dividends and has other capital needs in the future, we
anticipate that it will be necessary for our insurance subsidiary to pay
additional dividends to SeaBright. Our insurance subsidiary is required by law
to maintain a certain minimum level of surplus on a statutory basis. The payment
of such dividends will be regulated as described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of
Part II of our Annual Report on Form 10-K for the year ended December 31, 2011.
Our condensed consolidated net cash provided by operating activities for the six
months ended June 30, 2012 was $19.5 million, compared to $7.4 million for the
same period in 2011. The increase is mainly attributable to an increase in
premium collections.
Net cash provided by investing activities was $5.5 million in the six months
ended June 30, 2012, compared to $9.0 million in the same period in 2011. The
decrease in net cash provided by investing activities was primarily driven by
lower net investment sales activity (sales and maturities, net of purchases).
For the six months ended June 30, 2012, cash used in financing activities
totaled $3.0 million, compared to $3.2 million in the same period in 2011. The
decrease was primarily due to a decrease in tax withholding obligations
associated with the vesting of restricted stock.
As of June 30, 2012, SBIC's statutory surplus totaled $303.3 million, compared
to $286.4 million as of June 30, 2011.
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Contractual Obligations and Commitments
During the six months ended June 30, 2012, there were no material changes to our
contractual obligations and commitments.
Off-Balance Sheet Arrangements
As of June 30, 2012, we had no off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial condition,
changes in financial condition, revenues or expenses, results of operations,
liquidity, capital expenditures or capital resources.
Critical Accounting Policies, Estimates and Judgments
It is important to understand our accounting policies in order to understand our
financial statements. Management considers some of these policies to be critical
to the presentation of our financial results, since they require management to
make estimates and assumptions. These estimates and assumptions affect the
reported amounts of assets, liabilities, revenues, expenses and related
disclosures at the financial reporting date and throughout the period being
reported upon. Some of the estimates result from judgments that can be
subjective and complex, and consequently, actual results reflected in future
periods might differ from these estimates.
The most critical accounting policies involve the reporting of unpaid loss and
loss adjustment expenses including losses that have occurred but were not
reported to us by the financial reporting date, the amount and recoverability of
reinsurance recoverable balances, deferred policy acquisition costs, income
taxes, the valuation of goodwill, the impairment of investment securities,
earned but unbilled premiums and retrospective premiums. These critical
accounting policies are described in Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of Part II of our
Annual Report on Form 10-K for the year ended December 31, 2011.
Regulation
On July 21, 2010, the President signed into law the Dodd Frank Wall Street
Reform and Consumer Protection Act (the "Dodd-Frank Act"), which has significant
implications for the insurance industry. In addition to imposing a number of new
compliance obligations on publicly traded companies, the Dodd-Frank Act
established the Financial Services Oversight Council ("FSOC"), which is
authorized to recommend that certain systemically significant non-bank financial
companies, including insurance companies, be regulated by the Board of Governors
of the Federal Reserve. The Dodd-Frank Act also created within the United States
Department of the Treasury a new Federal Insurance Office ("FIO") and authorizes
the federal preemption of certain state insurance laws. The FSOC and the FIO are
authorized to study, monitor and report to Congress on the U.S. insurance
industry and the significance of global reinsurance to the U.S. insurance
market. Many sections of the Dodd-Frank Act become effective over time, and
certain provisions of the Dodd-Frank Act require the implementation of
regulations that have not yet been adopted. The potential impact of the
Dodd-Frank Act on the U.S. insurance industry is not clear. However, our
business could be affected by changes to the U.S. system of insurance regulation
or our designation or the designation of insurers or reinsurers with which we do
business as systemically significant non-bank financial companies.
As previously disclosed, on July 29, 2011, we were notified by the Illinois
Department of Insurance that our insurance subsidiary was due for a routine
comprehensive examination of its condition and affairs as of and for the five
year period ended December 31, 2010. The field work portion of the comprehensive
financial examination began on August 29, 2011 and concluded this year. On June
29, 2012, the Illinois Director of Insurance officially adopted, without fines
or penalties assessed, the Report of Examination prepared by the Illinois
Department of Insurance. On July 9, 2012, we were notified by the Illinois
Department of Insurance that due to concerns arising in connection with its
December 31, 2010 examination, it intends to conduct an actuarial examination of
our reserves for unpaid loss and loss adjustment expense as of December 31,
2011. That work has not yet commenced.
