For the Periods ended June 30, 2012 and 2011
Forward-Looking Statements
This quarterly report may provide information including certain statements
which constitute forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These include statements regarding the intent,
belief, or current expectations of management, including, but not limited to,
those statements that use the words "believes," "expects," "anticipates,"
"estimates," or similar expressions. You are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
a number of risks and uncertainties, and results could differ materially from
those indicated by such forward-looking statements. Among the important factors
that could cause actual results to differ materially from those indicated by
such forward-looking statements are: the frequency and severity of claims;
uncertainties inherent in reserve estimates; catastrophic events; a change in
the demand for, pricing of, availability or collectability of reinsurance;
increased rate pressure on premiums and on underwriting criteria; ability to
obtain rate increases in current market conditions; investment rate of return
and losses (whether realized or unrealized) in our investment portfolio; changes
in and adherence to insurance or other regulation; actions taken by regulators,
rating agencies or lenders; attainment of certain processing efficiencies;
changing rates of inflation; general economic conditions and other risks
identified in our reports and registration statements filed with the Securities
and Exchange Commission. For additional information with respect to certain of
these and other factors, refer to the "Risk Factors" section contained in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011
and subsequent filings. We are not under any obligation to (and expressly
disclaim any obligation to) update or alter our forward-looking statements,
whether as a result of new information, future events or otherwise.
Business Overview
We are a publicly traded specialty niche, focused commercial insurance
underwriter and insurance administration services company. We market and
underwrite specialty property and casualty insurance programs and products on
both an admitted and non-admitted basis through a broad and diverse network of
independent retail agents, wholesalers, program administrators and general
agents, who value service, specialized knowledge, and focused expertise. Program
business refers to an aggregation of individually underwritten risks that have
some unique characteristic and are distributed through a select group of agents.
We seek to combine profitable underwriting, income from our net commissions and
fees, investment returns and efficient capital management to deliver consistent
long-term growth in shareholder value.
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Through our retail property and casualty agencies, we also generate commission
revenue, which represents 1.9% of our total consolidated revenues. Our agencies
are located in Michigan, California, Massachusetts, and Florida and produce
commercial, personal lines, life and accident and health insurance that is
primarily with unaffiliated insurance carriers. These agencies produce a minimal
amount of business for our affiliated Insurance Company Subsidiaries.
We recognize revenue related to the services and coverages we provide within the
following categories: net earned premiums, management administrative fees,
claims fees, commission revenue, net investment income, and net realized gains
(losses).
We compete in the specialty insurance market. Our wide range of specialty niche
insurance expertise allows us to accommodate a diverse distribution network
ranging from specialized program agents to retail agents. In the specialty
market, competition tends to place considerable focus on availability, service
and other tailored coverages in addition to price. Moreover, our broad
geographical footprint enables us to function with a local presence on both a
regional and national basis. We also have the capacity to write specialty
insurance in both the admitted and non-admitted markets. These unique aspects of
our business model enable us to compete on factors other than price.
Critical Accounting Policies
In certain circumstances, we are required to make estimates and assumptions that
affect amounts reported in our consolidated financial statements and related
footnotes. We evaluate these estimates and assumptions periodically on an
on-going basis based on a variety of factors. There can be no assurance,
however, that actual results will not be materially different than our estimates
and assumptions, and that reported results of operation will not be affected by
accounting adjustments needed to reflect changes in these estimates and
assumptions. The accounting estimates and related risks described in our Annual
Report on Form 10-K, as filed with the United States Securities and Exchange
Commission on March 15, 2012, are those that we consider to be our critical
accounting estimates. For the three months and six months ended June 30, 2012,
there have been no material changes in regard to any of our critical accounting
estimates.
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Non-GAAP Financial Measures
Net Operating (Loss) Income and Net Operating (Loss) Income Per Share
Net operating (loss) income and net operating (loss) income per share are
non-GAAP measures that represent net (loss) income excluding net realized gains
or loss, net of tax. The most directly comparable financial GAAP measures to net
operating (loss) income and net operating (loss) income per share are net (loss)
income and net (loss) income per share. Net operating (loss) income and net
operating (loss) income per share are intended as supplemental information and
are not meant to replace net (loss) income nor net (loss) income per share. Net
operating (loss) income and net operating (loss) income per share should be read
in conjunction with the GAAP financial results. The following is a
reconciliation of net operating (loss) income to net (loss) income, as well as
net operating (loss) income per share to net (loss) income per share:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 2012 2011
(In thousands, except share (In thousands, except share
and per share data) and per share data)
Net operating (loss) income $ (8,752 ) $ 8,381 $ (1,225 ) $ 22,398
Net realized gains, net of tax 1,020 1,399 1,597 2,031
Net (loss) income $ (7,732 ) $ 9,780 $ 372 $ 24,429
Diluted earnings per common share:
Net operating (loss) income $ (0.17 ) $ 0.16 $ (0.02 ) $ 0.42
Net (loss) income $ (0.15 ) $ 0.18 $ 0.01 $ 0.46
Diluted weighted average common shares
outstanding 50,251,591 53,248,573 50,583,368 53,323,802
We use net operating (loss) income and net operating (loss) income per share as
components to assess our performance and as measures to evaluate the results of
our business. We believe these measures provide investors with valuable
information relating to our ongoing performance that may be obscured by the net
effect of realized gains and losses as a result of our market risk sensitive
instruments, which primarily relate to fixed income securities that are
available for sale and not held for trading purposes. Realized gains and losses
may vary significantly between periods and are generally driven by external
economic developments, such as capital market conditions. Accordingly, net
operating (loss) income excludes the effect of items that tend to be highly
variable from period to period and highlights the results from our ongoing
business operations and the underlying loss or profitability of our business. We
believe that it is useful for investors to evaluate net operating (loss) income
and net operating (loss) income per share, along with net (loss) income and net
(loss) income per share, when reviewing and evaluating our performance.
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Accident Year Loss Ratio
The accident year loss ratio is a non-GAAP measure and represents our net loss
and LAE ratio adjusted for any changes in net ultimate loss estimates on prior
year loss reserves. The most directly comparable financial GAAP measure to the
accident year loss ratio is the net loss and LAE ratio. The accident year loss
ratio is intended as supplemental information and is not meant to replace the
net loss and LAE ratio. The accident year loss ratio should be read in
conjunction with the GAAP financial results. The following is a reconciliation
of the accident year loss ratio to the net loss and LAE ratio, which is the most
directly comparable GAAP measure:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 2012 2011
Accident year loss ratio 65.1 % 66.4 % 64.4 % 65.0 %
Increase (decrease) in net ultimate loss
estimates on prior year loss reserves 13.3 % 0.5 % 9.5 % -0.6 %
Net loss & LAE ratio 78.4 % 66.9 % 73.9 % 64.4 %
We use the accident year loss ratio as one component to assess our current year
performance and as a measure to evaluate, and if necessary, adjust our pricing
and underwriting. Our net loss and LAE ratio is based on calendar year
information. Adjusting this ratio to an accident year loss ratio allows us to
evaluate information based on the current year activity. We believe this measure
provides investors with valuable information for comparison to historical trends
and current industry estimates. We also believe that it is useful for investors
to evaluate the accident year loss ratio and net loss and LAE ratio separately
when reviewing and evaluating our performance.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2012 AND 2011
Executive Overview
Our results for the second quarter of 2012 were impacted by the increase in net
ultimate loss estimates for 2011 and prior accident years, which added 13.3
percentage points to the GAAP combined ratio. The second quarter 2012 increase
in net ultimate loss estimates for accident years 2011 and prior primarily
reflects incurred large loss activity that is higher than historic patterns. In
certain segments of the business, this increase is connected to corporate and
branch office claims initiatives that were recently implemented. Our GAAP
combined ratio was 111.1% for the second quarter of 2012 compared to 101.4% for
the comparable quarter in 2011. Our accident year combined ratio was 97.8% for
the second quarter of 2012, compared to 100.9% in 2011.
Net operating loss, a non-GAAP measure, for the second quarter ended June 30,
2012 was ($8.8 million), or ($0.17) per diluted share, compared to net operating
income of $8.4 million, or $0.16 per diluted share for the second quarter ended
June 30, 2011. The second quarter 2012 results include the pre-tax increase in
net ultimate loss estimates for 2011 and prior accident years of $28.2 million.
By contrast, the second quarter of 2011 results include the pre-tax increase in
net ultimate loss estimates for 2010 and prior accident years of $0.9 million.
Gross written premium increased $43.4 million, or 20.4%, to $256.1 million,
compared to $212.7 million in 2011. The growth primarily reflects rate increases
in combination with the maturation of existing programs and to a lesser extent
new business initiatives that were implemented during the past twelve months.
This growth was partially offset by reductions in certain programs where pricing
and underwriting did not meet our targets.
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Results of Operations
Net loss for the three months ended June 30, 2012, was ($7.7 million), or
($0.15) per dilutive share, compared to net income of $9.8 million, or $0.18 per
dilutive share, for the comparable period of 2011. Net operating loss, a
non-GAAP measure, for the second quarter ended June 30, 2012 was ($8.8 million),
or ($0.17) per diluted share, compared to net operating income of $8.4 million,
or $0.16 per diluted share for the second quarter ended June 30, 2011. Total
diluted weighted average shares outstanding for the three months ended June 30,
2012 were 50,251,591 compared to 53,248,573 for the comparable period in
2011. This decrease reflects the impact of our Share Repurchase Plan, which we
have continued to repurchase shares.
Revenues
Revenues for the three months ended June 30, 2012, increased $30.9 million, or
15.1%, to $235.1 million, from $204.2 million for the comparable period in
2011. This increase primarily reflects overall growth within our net earned
premiums.
The following table sets forth the components of revenues (in thousands):
For the Three Months
Ended June 30,
2012 2011
Revenue:
Net earned premiums $ 211,303 $ 181,470
Management administrative fees 2,823 3,041
Claims fees 1,599 1,606
Commission revenue 4,130 3,250
Net investment income 13,683 13,765
Net realized gains 1,567 1,094
Total revenue $ 235,105 $ 204,226
Net earned premiums increased $29.8 million, or 16.4%, to $211.3 million for the
three months ended June 30, 2012, from $181.5 million in the comparable period
in 2011. This growth primarily reflects rate increase in combination with the
maturation of existing programs and to a lesser extent new business initiatives
that were implemented during the past twelve months. This growth was partially
offset by reductions in certain programs where pricing and underwriting did not
meet our targets.
Commission revenue increased $0.9 million, or 27.1%, to $4.1 million for the
three months ended June 30, 2012, from $3.3 million for the comparable period in
2011. This increase was driven primarily by commission revenues generated from
assets of a Michigan agency that was acquired in the fourth quarter of 2011.
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Expenses
Expenses increased $52.9 million from $192.3 million for the three months ended
June 30, 2011 to $245.2 million for the three months ended June 30, 2012.
The following table sets forth the components of expenses (in thousands):
For the Three Months
Ended June 30,
2012 2011
Expense:
Net losses and loss adjustment expenses $ 165,758 $ 121,403
Policy acquisition and other underwriting expenses 68,993 62,694
General selling & administrative expenses
6,327 5,631
General corporate expenses 758 (719 )
Amortization expense 1,307 1,206
Interest expense 2,033 2,082
Total expenses $ 245,176 $ 192,297
Net loss and loss adjustment expenses ("LAE") increased $44.4 million, to $165.8
million for the three months ended June 30, 2012, from $121.4 million for the
same period in 2011. Our loss and LAE ratio was 78.4% for the three months ended
June 30, 2012 and 66.9% for the three months ended June 30, 2011. The loss and
LAE ratio for the second quarter of 2012 includes a 13.3 percentage point
increase from net ultimate loss estimates for accident years 2011 and prior,
whereas the 2011 results include a 0.5 percentage point increase from net
ultimate loss estimates for accident years 2010 and prior. The accident year
loss and LAE ratio was 65.1% for the three months ended June 30, 2012 down from
66.4% in the comparable period in 2011. Additional discussion of our reserve
activity is described below within the Other Items ~ Reserves section.
Policy acquisition and other underwriting expenses increased $6.3 million, to
$69.0 million for the three months ended June 30, 2012 from $62.7 million for
the same period in 2011. Our expense ratio decreased 1.8 percentage points to
32.7% for the three months ended June 30, 2012, from 34.5% for the same period
in 2011. The 2012 expense ratio improvement reflects a reduction in profit
sharing commissions and leveraging of fixed costs over a larger premium base.
These were partially offset by a reduction in the accrual for variable
compensation that reduced policy acquisition expenses in 2011.
General corporate expenses increased $1.5 million, to $0.8 million for the three
months ended June 30, 2012, from a benefit of $0.7 million for the same period
in 2011. The prior year amount reflects a reduction in the accrual for variable
compensation; excluding this item, 2012 general corporate expenses were
consistent with 2011.
The GAAP effective tax rate for both the three months ended June 30, 2012 and
2011, was approximately 18%. Income tax expense (benefit) on capital gains and
the change in our valuation allowance on deferred tax assets, was $547,000 and
($306,000) for the three months ended June 30, 2012 and 2011, respectively. The
annual effective tax rate for 2012 is expected to be approximately 15%.
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Other Items
Equity earnings of affiliated, net of tax;
In July 2009, our subsidiary, Star, purchased a 28.5% ownership interest in an
affiliate, Midwest Financial Holdings, LLC ("MFH"), for $14.8 million in
cash. We are not required to consolidate this investment as we are not the
primary beneficiary of the business nor do we control the entity's
operations. Our ownership interest is significant, but is less than a majority
ownership and, therefore, we are accounting for this investment under the equity
method of accounting. Star recognizes 28.5% of the profits and losses as a
result of this equity interest ownership. We recognized equity earnings, net of
tax, from MFH of $0.6 million, or $0.01 per diluted share, for the three months
ended June 30, 2012, compared to $0.2 million, which had no per diluted share
impact, for the comparable period of 2011. We received dividends from MFH in the
three months ended June 30, 2012 and 2011, of $0.9 million and $1.2 million,
respectively.
Reserves
For the three months ended June 30, 2012, we reported an increase in net
ultimate loss estimates for accident years 2011 and prior of $28.2 million, or
3.2% of $879.1 million of net loss and LAE reserves at December 31, 2011. There
were no significant changes in the key assumptions utilized in the analysis and
calculations of our reserves during 2011 and 2012.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND 2011
Executive Overview
Our results for the six months ended June 30, 2012, were impacted by the
increase in net ultimate loss estimates for 2011 and prior accident years, which
added 9.5 percentage points to the GAAP combined ratio. The year-to-date 2012
increase in net ultimate loss estimates for accident years 2011 and prior
primarily reflects incurred large loss activity that is higher than historic
patterns. Our GAAP combined ratio was 106.6% for the six months ended June 30,
2012, compared to 98.7% for the comparable quarter in 2011. Our accident year
combined ratio was 97.1% for the six months ended June 30, 2012, compared to
99.3% in 2011.
Net operating loss, a non-GAAP measure, for the six months ended June 30, 2012
was ($1.2 million), or ($0.02) per diluted share, compared to net operating
income of $22.4 million, or $0.42 per diluted share for the six months ended
June 30, 2011. The six months ended June 30, 2012, results include the pre-tax
increase in net ultimate loss estimates for 2011 and prior accident years of
$38.4 million. By contrast, the six months ended 2011 results include an
after-tax decrease in net ultimate loss estimates for 2010 and prior accident
years of $2.4 million.
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Gross written premium increased $76.4 million, or 17.5%, to $514.0 million,
compared to $437.6 million in 2011. The growth primarily reflects rate increases
in combination with the maturation of existing programs and to a lesser extent
new business initiatives that were implemented during the past twelve months.
This growth was partially offset by reductions in certain programs where pricing
and underwriting did not meet our targets.
Results of Operations
Net income for the six months ended June 30, 2012, was $0.4 million, or $0.01
per diluted share, compared to net income of $24.4 million, or $0.46 per diluted
share, for the comparable period of 2011. Net operating loss, a non-GAAP
measure, for the six months ended June 30, 2012 was ($1.2 million), or ($0.02)
per diluted share, compared to net operating income of $22.4 million, or $0.42
per diluted share for the six months ended June 30, 2011. Total diluted weighted
average shares outstanding for the six months ended June 30, 2012 were
50,583,368 compared to 53,323,802 for the comparable period in 2011. This
decrease reflects the impact of our Share Repurchase Plan, which we have
continued to repurchase shares.
Revenues
Revenues for the six months ended June 30, 2012, increased $53.6 million, or
13.5%, to $451.3 million, from $397.7 million for the comparable period in
2011. This increase primarily reflects overall growth within our net earned
premiums.
The following table sets forth the components of revenues (in thousands):
For the Six Months
Ended June 30,
2012 2011
Revenue:
Net earned premiums $ 404,118 $ 352,128
Management administrative fees 5,751 6,399
Claims fees 3,261 3,213
Commission revenue 8,505 6,723
Net investment income 27,415 27,337
Net realized gains 2,299 1,906
Total revenue $ 451,349 $ 397,706
Net earned premiums increased $52.0 million, or 14.8%, to $404.1 million for the
six months ended June 30, 2012, from $352.1 million in the comparable period in
2011. This growth primarily reflects rate increases in combination with the
maturation of existing programs and to a lesser extent new business initiatives
that were implemented during the past twelve months. This growth was partially
offset by reductions in certain programs where pricing and underwriting did not
meet our targets.
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Commission revenue increased $1.8 million, or 26.5%, to $8.5 million for the six
months ended June 30, 2012, from $6.7 million for the comparable period in 2011.
This increase was driven primarily by commission revenues generated from assets
of a Michigan agency that was acquired in the fourth quarter of 2011.
Expenses
Expenses increased $85.4 million from $366.7 million for the six months ended
June 30, 2011 to $452.1 million for the six months ended June 30, 2012.
The following table sets forth the components of expenses (in thousands):
For the Six Months
Ended June 30,
2012 2011
Expense:
Net losses and loss adjustment expenses $ 298,505 $
226,665
Policy acquisition and other underwriting expenses 132,106 120,851
General selling & administrative expenses
12,666 11,875
General corporate expenses 2,131 636
Amortization expense 2,723 2,438
Interest expense 4,010 4,254
Total expenses $ 452,141 $ 366,719
Net loss and LAE increased $71.8 million, to $298.5 million for the six months
ended June 30, 2012, from $226.7 million for the same period in 2011. Our loss
and LAE ratio was 73.9% for the six months ended June 30, 2012 and 64.4% for the
six months ended June 30, 2011. The loss and LAE ratio for the second quarter of
2012 include a 9.5 percentage point increase from net ultimate loss estimates
for accident years 2011 and prior, whereas the 2011 results include a 0.6
percentage point decrease from net ultimate loss estimates for accident years
2010 and prior. The accident year loss and LAE ratio was 64.4% for the six
months ended June 30, 2012 down from 65.0% in the comparable period in 2011.
Additional discussion of our reserve activity is described below within the
Other Items ~ Reserves section.
Policy acquisition and other underwriting expenses increased $11.3 million, to
$132.1 million for the six months ended June 30, 2012 from $120.9 million for
the same period in 2011. Our expense ratio decreased 1.6 percentage points to
32.7% for the six months ended June 30, 2012, from 34.3% for the same period in
2011. The 2012 expense ratio improvement reflects a reduction in profit sharing
commissions and leveraging of fixed costs over a larger premium base.
General corporate expenses increased $1.5 million, to $2.1 million for the six
months ended June 30, 2012, from $0.6 million for the same period in 2011. The
prior year amount reflects a reduction in the accrual for variable compensation;
excluding this item, 2012 general corporate expenses were consistent with 2011.
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The GAAP effective tax rate for the six months ended June 30, 2012 was
approximately 15%, compared to 24%, for the same period in 2011. Income tax
expense (benefit) on capital gains and the change in our valuation allowance on
deferred tax assets was $702,000 and ($126,000) for the six months ended June
30, 2012 and 2011, respectively. The lower rate reflects a higher proportion of
taxable income derived from net investment income, which includes a portion of
tax exempt income, rather than, fee based or underwriting income. The annual
effective tax rate for 2012 is expected to be approximately 15%.
Other Items
Equity earnings of affiliated, net of tax;
In July 2009, our subsidiary, Star, purchased a 28.5% ownership interest in an
affiliate, Midwest Financial Holdings, LLC ("MFH"), for $14.8 million in
cash. We are not required to consolidate this investment as we are not the
primary beneficiary of the business nor do we control the entity's
operations. Our ownership interest is significant, but is less than a majority
ownership and, therefore, we are accounting for this investment under the equity
method of accounting. Star recognizes 28.5% of the profits and losses as a
result of this equity interest ownership. We recognized equity earnings, net of
tax, from MFH of $1.3 million, or $0.02 per diluted share, for the six months
ended June 30, 2012, compared to $1.2 million, or $0.02 per diluted share, for
the comparable period of 2011. We received dividends from MFH in the six months
ended June 30, 2012 and 2011, for $1.8 million and $1.7 million, respectively.
Reserves
At June 30, 2012 our best estimate for the ultimate liability for loss and LAE
reserves, net of reinsurance recoverables, was $951.6 million. We established a
reasonable range of reserves of approximately $875.5 million to $1.0 billion.
This range was established primarily by considering the various indications
derived from standard actuarial techniques and other appropriate reserve
considerations. The following table sets forth this range by line of business
(in thousands):
Minimum Maximum
Reserve Reserve Selected
Line of Business Range Range Reserves
Workers' Compensation $ 363,707 $ 415,290 $ 389,086
Residual Markets 16,094 17,825 17,307
Commercial Multiple Peril / General Liability 346,339 429,171
386,092
Commercial Automobile 115,851 130,613 123,464
Other 33,510 37,603 35,692
Total Net Reserves $ 875,501 $ 1,030,502 $ 951,641
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Reserves are reviewed and established by our internal actuaries for adequacy and
are peer reviewed by our third-party actuaries. When reviewing reserves, we
analyze historical data and estimate the impact of numerous factors such as (1)
per claim information; (2) industry and our historical loss experience; (3)
legislative enactments, judicial decisions, legal developments in the imposition
of damages, and changes in political attitudes; and (4) trends in general
economic conditions, including the effects of inflation. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for predicting future events. There
is no precise method for subsequently evaluating the impact of any specific
factor on the adequacy of reserves, because the eventual deficiency or
redundancy is affected by multiple factors.
The key assumptions used in our selection of ultimate reserves included the
underlying actuarial methodologies, a review of current pricing and underwriting
initiatives, an evaluation of reinsurance costs and retention levels, and a
detailed claims analysis with an emphasis on how aggressive claims handling may
be impacting the paid and incurred loss data trends embedded in the traditional
actuarial methods. With respect to the ultimate estimates for losses and LAE,
the key assumptions remained consistent for the six months ended June 30, 2012,
and the year ended December 31, 2011.
For the six months ended June 30, 2012, we reported an increase in net ultimate
loss estimates for accident years 2011 and prior of $38.4 million, or 4.4% of
$879.1 million of beginning net loss and LAE reserves at December 31, 2011. The
change in net ultimate loss estimates reflected revisions in the estimated
reserves as a result of actual claims activity in calendar year 2012 that
differed from the projected activity. There were no significant changes in the
key assumptions utilized in the analysis and calculations of our reserves during
2011 and for the six months ended June 30, 2012. The major components of this
change in ultimates are as follows (in thousands):
Incurred Losses Paid Losses
Reserves at Reserves at
December 31, Current Prior Total Current Prior Total June 30,
Line of Business 2011 Year Years Incurred Year Years Paid 2012
Workers' Compensation $ 358,131 $ 107,272 $ 10,873 $ 118,145 $ 10,429 $ 76,761 $ 87,190 $ 389,086
Residual Markets 17,682 2,027 (732 ) 1,295 592 1,078 1,670 17,307
Commercial Multiple
Peril /General
Liability 353,311 72,494 16,491 88,985 2,841 53,363 56,204 386,092
Commercial Automobile 117,594 44,482 9,043 53,525 10,828 36,827 47,655 123,464
Other 32,375 33,804 2,751 36,555 14,923 18,315 33,238 35,692
Net Reserves 879,093 $ 260,079 $ 38,426 $ 298,505 $ 39,613 $ 186,344 $ 225,957 951,641
Reinsurance
Recoverable 315,884 349,361
Consolidated $ 1,194,977 $ 1,301,002
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The following table shows the re-estimated December 31, 2011 held reserves by
line of business as of June 30, 2012 (in thousands):
Total
Re-estimated Development as a
Reserves at Reserves at Percentage of
December 31, June 30, 2012 Prior Year
Line of Business 2011 on Prior Years Reserves
Workers' Compensation $ 358,131 $ 369,004 3.0 %
Commercial Multiple
Peril / General
Liability 353,311 369,802 4.7 %
Commercial Automobile 117,594 126,637 7.7 %
Other 32,375 35,126 8.5 %
Sub-total 861,411 900,569 4.5 %
Residual Markets 17,682 16,950 -4.1 %
Total Net Reserves $ 879,093 $ 917,519 4.4 %
Workers' Compensation Excluding Residual Markets
The net ultimate loss estimates for accident years 2011 and prior in the
workers' compensation line of business increased $10.9 million, or 3.0%. This
was driven primarily by accident years 2009 through 2011. The increase in net
ultimate loss estimates is $3.0 million, $4.6 million, and $3.5 million for the
2011, 2010 and 2009 accident years, respectively. These increases were partially
offset by a reduction in net ultimate loss estimates for accident years 2008 and
prior.
In this line of business we continue to see favorable overall underwriting
results. In California, where we have achieved a cumulative filed rate increase
of 41.4% starting in 2009, our workers' compensation business remains
profitable. These rate increases have exceeded loss cost trends. However, we
have slightly increased loss estimates for prior accident years. In other areas
of the country, underwriting actions and rate increases have been effective and
ultimate loss estimates have decreased.
Commercial Multiple Peril / General Liability
The $16.5 million increase, or 4.7%, in net ultimate loss estimates in the
commercial multiple peril/general liability line of business is primarily from
higher than expected large case reserve movement in our Public Entity Excess
liability program by about $9.6 million. As a result of our ongoing and
proactive oversight of the primary claim management process within our insureds'
underlying self-insured layer, particularly on high exposure cases, we believe
our reserving to the ultimate probable costs per file has accelerated at a pace
that is unprecedented in this program. While we adjusted for this acceleration
we also recognized a need for higher ultimate loss estimates and these additions
totaled $9.6 million as noted above.
The remainder of the increase in net ultimate loss estimates for accident years
2011 and prior was driven by a number of large claims that were strengthened in
the second quarter of 2012.
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Commercial Automobile
The $9.0 million increase, or 7.7%, in net ultimate loss estimates for the
commercial automobile line of business is primarily in the 2011 and 2010
accident years and also reflects the emergence of higher than expected large
loss activity. The increase in net ultimate loss estimates includes the policies
written prior to July 2011 on our transportation program and slightly higher
than expected severity on a smaller west coast based program. The Company has
been aggressively raising rates and reducing premium volume to lower future loss
ratios in this line of business.
Cumulative rate increases in the transportation program have been approximately
46% since 2010 and exposure base is down more than 50%. As these rate increases
continue to earn out in 2012, we expect improved current accident year results
for this business.
Other
The $2.8 million increase, or 8.5%, in net ultimate loss estimates in the other
lines of business is primarily from 2011 accident year property exposures where
we had a handful of larger claims that occurred in late 2011, but were not
reported until the first quarter of 2012. These occurrences were partially
offset by better than expected frequency in our medical malpractice line of
business.
Cumulative rate increases in other lines since 2009 have been approximately
4.6%.
Residual Markets
The workers' compensation residual market line of business had a decrease in net
ultimate loss estimate of $0.7 million, or 4.1% of net reserves. This decrease
reflects reductions in various accident years. We record loss reserves as
reported by the National Council on Compensation Insurance ("NCCI"), plus a
provision for the reserves incurred but not yet analyzed and reported to us due
to a two quarter lag in reporting. These changes reflect a difference between
our estimate of the lag incurred but not reported and the amounts reported by
the NCCI in the year.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of funds are insurance premiums, investment income,
proceeds from the maturity and sale of invested assets from our Insurance
Company Subsidiaries, and risk management fees and agency commissions from our
non-regulated subsidiaries. Funds are primarily used for the payment of claims,
commissions, salaries and employee benefits, other operating expenses,
shareholder dividends, share repurchases, capital expenditures, and debt
service.
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A significant portion of our consolidated assets represents assets of our
Insurance Company Subsidiaries that may not be transferable to the holding
company in the form of dividends, loans or advances in accordance with state
insurance laws. These laws generally specify that dividends can be paid only
from unassigned surplus and only to the extent that all dividends in the current
twelve months do not exceed the greater of 10% of total statutory surplus as of
the end of the prior fiscal year or 100% of the statutory net income for the
prior year, less any dividends paid in the prior twelve months. Using these
criteria, the ordinary dividend available that can be paid from the Insurance
Company Subsidiaries during 2012 is $41.2 million without prior regulatory
approval. Of this $41.2 million, ordinary dividends of $12.5 million have been
declared and paid as of June 30, 2012. In addition to ordinary dividends, the
Insurance Company Subsidiaries have the capacity to pay $96.0 million of
extraordinary dividends in 2012, subject to prior regulatory approval. The
Insurance Company Subsidiaries' ability to pay future dividends without advance
regulatory approval is dependent upon maintaining a positive level of unassigned
surplus, which in turn, is dependent upon the Insurance Company Subsidiaries
generating net income. Total ordinary dividends paid from our Insurance Company
Subsidiaries to our holding company were $12.5 million and zero for the six
months ended June 30, 2012 and 2011, respectively. We remain within our targets
as they relate to our premium leverage ratios, taking into consideration the
dividends paid by our Insurance Company Subsidiaries. Our guidelines for gross
and net written premium to statutory surplus are 2.75 to 1.0 and 2.25 to 1.0,
respectively. As of June 30, 2012, on a trailing twelve month statutory
consolidated basis, the gross and net premium leverage ratios were 2.6 to 1.0
and 2.2 to 1.0, respectively.
We also generate operating cash flow from non-regulated subsidiaries in the form
of commission revenue, outside management fees, and intercompany management
fees. These sources of income are available for debt service, shareholders'
dividends, and other operating expenses of the holding company and non-regulated
subsidiaries. Earnings before interest, taxes, depreciation, and amortization
from non-regulated subsidiaries were approximately $5.4 million for the six
months ended June 30, 2012.
We have a total revolving credit facility of $35.0 million, which may include up
to $15.0 million in letters of credit. As of June 30, 2012, we had $14.5 million
outstanding balance on our revolving credit facility and $0.5 million in letters
of credit issued. The undrawn portion of the revolving credit facility is
available to finance working capital and for general corporate purposes,
including but not limited to, surplus contributions to our Insurance Company
Subsidiaries to support premium growth or strategic acquisitions.
Based on our subsidiaries' subsidiaries' membership in the FHLBI, we have the
ability to borrow on a collateralized basis at relatively low borrowing rates,
providing a source of liquidity. As of June 30, 2012, we had borrowed $30.0
million from the FHLBI. The proceeds were used to fund purchases of high quality
bonds with maturities that match the maturity of the FHLBI credit facility. Due
to the low cost of the FHLBI funding, the Company expects to generate returns in
excess of its cost of borrowing under this strategy. We have the ability to
increase our borrowing capacity through additional investments and pledging
additional securities.
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Cash flow provided by operations was $73.0 million and $61.9 million for the six
months ended June 30, 2012 and 2011, respectively. The increase in operating
cash flows is driven primarily by a decrease in estimated federal income tax
payments in the current year. We maintain a strong balance sheet with
diversified geographic risks, high quality reinsurance and a high quality
investment portfolio.
Other Items - Liquidity and Capital Resources
Interest Rate Swaps
We have entered into interest rate swap transactions to mitigate our interest
rate risk on our existing debt obligations. These interest rate swap
transactions have been designated as cash flow hedges and are deemed highly
effective hedges. These interest rate swap transactions are recorded at fair
value on the balance sheet and the effective portion of the changes in fair
value are accounted for within other comprehensive income. The interest
differential to be paid or received is accrued and recognized as an adjustment
to interest expense.
Refer to Note 5 ~ Derivative Instruments of the Notes to the Consolidated
Financial Statements, for additional information specific to our interest rate
swaps.
Credit Facilities
Refer to Note 4 ~ Debt of the Notes to the Consolidated Financial Statements,
for additional information specific to our credit facilities and debentures.
Investment Portfolio
As of June 30, 2012 and December 31, 2011, the recorded values of our investment
portfolio, including cash and cash equivalents, were $1.6 billion and $1.5
billion, respectively.
In general, we believe our overall investment portfolio is conservatively
invested. The effective duration of the investment portfolio at June 30, 2012,
is 4.9 years, compared to 5.0 years at June 30, 2011. Our pre-tax book yield as
of June 30, 2012 is 3.9%, compared to 4.2% in 2011. The current after-tax yield
is 3.0% as of June 30, 2012, compared to 3.1% in 2011. Approximately 99.1% of
our fixed income investment portfolio is investment grade.
Shareholders' Equity
Refer to Note 7 ~ Shareholders' Equity of the Notes to the Consolidated
Financial Statements.
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Contractual Obligations and Commitments
For the six months ended June 30, 2012, there were no material changes in
relation to our contractual obligations and commitments, outside of the ordinary
course of our business.
Recent Accounting Pronouncements
Refer to Note 1 ~ Summary of Significant Accounting Policies of the Notes to the
Consolidated Financial Statements.
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