INFINITY PROPERTY & CASUALTY CORP – 10-K – Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations INDEX TO MD&A
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Overview 14 Critical Accounting Policies 14 Insurance Reserves 15 Other-than-Temporary Losses on Investments 19 Accruals for Litigation 20 Goodwill 20 Liquidity and Capital Resources 21 Ratios 21 Sources and Uses of Funds 21 Contractual Obligations 22 Investments 23 General 23 Exposure to Market Risk 25 Interest Rate Risk 25 Credit Risk 27 EquityPrice Risk 32 Results of Operations 33 Underwriting 33 Premium 33 Profitability 35 Net Investment Income 38 Realized Gains (Losses) on Investments 39 Gain on Sale of Subsidiaries 39 Other Income 40 Interest Expense 40 Corporate General and Administrative Expenses 40 Other Expenses 41 Income Taxes 41 Receivable for Securities Sold 24 Payable for Securities Purchased 25
See "Cautionary Statement Regarding Forward-Looking Statements" on page 1.
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Overview In 2012 our gross written premium grew 15.9%. Approximately 99% of this growth came fromCalifornia andFlorida , our two most profitable states. Premiums fell in three of the seven Focus States during 2012 as a result of our efforts to improve profitability through rate increases and more restrictive underwriting. See Results of Operations - Underwriting - Premium for a more detailed discussion of our gross written premium growth. Net earnings and diluted earnings per share for the year endedDecember 31, 2012 were$24.3 million and$2.04 , respectively, compared to$41.8 million and$3.37 , respectively, for 2011. The decrease in diluted earnings per share for the year endedDecember 31, 2012 is primarily due to an increase in unfavorable loss reserve development in 2012, deterioration in our accident year combined ratio from 97.6% atDecember 31, 2011 to 99.3% atDecember 31, 2012 and a$13.6 million pre-tax loss on the redemption of our long-term debt. Included in net earnings for the year endedDecember 31, 2012 was$10.5 million ($16.2 million pre-tax) of unfavorable development on prior accident year loss and LAE reserves. This compares to$2.9 million ($4.5 million pre-tax) of unfavorable development for 2011. The following table displays GAAP combined ratio results by accident year developed throughDecember 31, 2012 . Prior Accident Prior Accident Year Favorable Year Favorable (Unfavorable) Accident Year Combined Ratio (Unfavorable) Development Developed Through Development (in millions) Dec. Mar. June Sep. Dec. Q4 YTD Q4 YTD Accident Year 2011 2012 2012 2012 2012 2012 2012 2012 2012 (as adjusted) Prior $ 1.7 $ 0.6 2005 87.8 % 87.8 % 87.8 % 87.8 % 87.8 % 0.0 % 0.0 % 0.0 0.1 2006 90.4 % 90.3 % 90.3 % 90.3 % 90.4 % (0.1 )% 0.1 % (0.7 ) 0.7 2007 92.7 % 92.5 % 92.5 % 92.5 % 92.3 % 0.2 % 0.4 % 1.6 4.0 2008 91.7 % 91.6 % 91.5 % 91.5 % 91.6 % 0.0 % 0.2 % (0.3 ) 1.6 2009 92.9 % 92.7 % 92.6 % 92.6 % 92.6 % 0.0 % 0.3 % 0.0 2.6 2010 99.4 % 99.8 % 99.6 % 99.5 % 99.5 % (0.1 )% (0.1 )% (0.6 ) (1.1 ) 2011 97.6 % 97.9 % 98.3 % 98.9 % 100.0 % (1.1 )% (2.4 )% (10.8 ) (24.7 ) $ (9.1 ) $ (16.2 ) Recent accident years are less developed than prior years and must be interpreted with caution. However, the upward trend in recent accident period combined ratios compared to prior periods reflects an increase in new business during those periods. Our new business combined ratios typically run 20 to 30 points higher than renewal business combined ratios due to higher commission and acquisition expenses as well as typically higher loss ratios. See Results of Operations - Underwriting - Profitability for a more detailed discussion of our underwriting results. Our book value per share increased 0.9% from$56.05 atDecember 31, 2011 to$56.55 atDecember 31, 2012 . This increase was primarily due to earnings, net of shareholder dividends, during 2012. Critical Accounting Policies (See Note 1- Significant Reporting and Accounting Policies of the Notes to Consolidated Financial Statements) The preparation of financial statements requires management to make estimates and assumptions that can have a significant effect on 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. We believe that the establishment of insurance reserves, the determination of "other-than-temporary" impairment on investments, accruals for litigation and goodwill are the areas where the degree of judgment required to determine amounts recorded in the financial statements makes the accounting policies critical. 14
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Insurance Reserves Insurance reserves, or unpaid losses and LAE, are our best estimate of the ultimate amounts that will be paid for (i) all claims that have been reported up to the date of the current accounting period but have not yet been paid, (ii) all claims that have occurred but have not yet been reported to us ("incurred but not reported" or "IBNR"), and (iii) unpaid claim settlement expenses. We establish IBNR reserves for the quarter and year-end based on a quarterly reserve analysis by our actuarial staff. We apply various standard actuarial tests to subsets of the business at a state, product and coverage level. Included in the analyses are the following: • Paid and incurred extrapolation methods utilizing paid and incurred loss development to predict ultimate losses; • Paid and incurred frequency and severity methods utilizing paid and
incurred claims count development and paid and incurred loss development
to predict ultimate average frequency (i.e. claims count per auto insured) or ultimate average severity (cost of claim per claim) and • Paid and incurred Bornhuetter-Ferguson methods adding expected
development to actual paid or incurred experience to project ultimate
losses.
For each subset of the business evaluated, each test generates a point estimate based on development factors applied to known paid and incurred losses and claim counts to estimate ultimate paid losses and claim counts. We base our selection of factors on historical loss development patterns with adjustment based on professional actuarial judgment where anticipated development patterns vary from those seen historically. This estimation of IBNR requires selection of hundreds of such factors. We then select a single point estimate for the subset evaluated from the results of various tests, based on a combination of simple averages of the point estimates of the various tests and selections based on professional actuarial judgment. Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. We estimate liabilities for the costs of losses and LAE for both reported and unreported (IBNR) claims based on historical trends in the following areas adjusted for deviations in such trends: • Claims settlement and payment practices;
• Business mix;
• Coverage limits and deductibles;
• Inflation trends in auto repair and medical costs and
• Legal and regulatory trends affecting claims settlements.
When possible, we make quantitative and qualitative modifications to, or selections of, such factors where deviations from historical trends in these key areas exist. We analyze the adequacy of reserves using actuarial data and analytical reserve development techniques, including projections of ultimate paid losses, to determine the ultimate amount of reserves. The list of historical trends provided above are non-exhaustive examples of major factors that we take into account in developing these estimates. We review loss reserve adequacy quarterly by accident year at a state and coverage level. We adjust reserves as additional information becomes known. We reflect such adjustments in current year operations. During each quarterly review by the internal actuarial staff, using the additional information obtained with the passage of time, factor selections are updated, which in turn adjust the ultimate loss estimates and held IBNR reserves for the subset of the business and accident periods affected by such updates. The actuarial staff also performs various tests to estimate ultimate average severity and frequency of claims. Severity represents the average cost per claim and frequency represents the number of claims per policy. As an overall review, the staff then evaluates for reasonableness loss and LAE ratios by accident year by state and by coverage. Factors that can significantly affect actual frequency include, among others, changes in weather, driving patterns or trends and class of driver. Changes in claims settlement and reserving practices can affect estimates of average frequency and severity. Auto repair and medical cost inflation, jury awards and changes in policy limit profiles can affect loss severity. Estimation of LAE reserves is subject to variation from factors such as the use of outside adjusters, frequency of lawsuits, claims staffing and experience levels. We believe that our relatively low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity. For example, approximately 83% of our policies include only the state-mandated minimum policy limits for bodily injury, which somewhat mitigates the challenge of estimating average severity. These low limits tend to 15
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reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout. Ultimate loss estimates, excluding extra-contractual obligation ("ECO") losses, usually experience the greatest adjustment within the first twelve to eighteen months after the accident year. Accordingly, the highest degree of uncertainty is associated with reserves for the current accident year because the current accident year contains the greatest proportion of losses that have not been reported or settled, and we must estimate these elements as of the current reporting date. The proportion of losses with these characteristics typically diminishes in subsequent years. As compared with loss and LAE reserves held at December 31, 2012 , our best estimate of reserve ranges using indicated results from utilized estimates of loss and LAE could range from a deficiency of 8% or $42.4 million to a redundancy of 7% or $41.2 million . These ranges do not present a forecast of future redundancy or deficiency since actual development of future losses on current loss reserves may vary materially from those estimated in the year-end 2012 reserve tests. Reserves recorded are our best estimate of the ultimate amounts that will be paid. As noted above, the highest degree of uncertainty is associated with reserves in the first twelve to eighteen months. The following table displays the accident year combined ratios as developed through December 31, 2012 for the four most recent accident years along with the potential combined ratios based on the low and high outcomes of the loss and LAE tests utilized: Combined Ratios Developed Through December 31, 2012 Accident year Low As Reported High 2009 92.5 % 92.6 % 92.8 % 2010 99.0 % 99.5 % 99.8 % 2011 99.4 % 100.0 % 100.6 % 2012 97.1 % 99.3 % 101.9 % ECO losses represent estimates of losses incurred from actual or threatened litigation by claimants alleging improper handling of claims by us, which are commonly known as "bad faith" claims. Oftentimes, the onset of such litigation, subsequent discovery, settlement discussions, trial and appeal may occur several years after the date of the original claim. Because of the infrequent nature of such claims, we accrue a liability for each case based on the facts and circumstances in accordance with the Loss Contingency topic of the FASB Accounting Standards Codification, which requires that such loss be probable and estimable. As such, no reserve is permissible for IBNR for threatened litigation yet to occur on accidents with dates prior to the balance sheet date. Consequently, the effect of setting accruals for such items likely will result in unfavorable reserve development in the following reserve table. Calendar year losses incurred for ECO losses, net of reinsurance, over the past five calendar years have ranged from $0.3 million to $18.6 million , averaging $4.3 million per year. Gross of reinsurance, ECO losses have ranged from $0.3 million to $21.1 million , averaging $4.8 million over the past five calendar years. Losses for 2012, 2011 and 2010 have been $1.7 million , $0.8 million and $0.3 million , respectively. The following tables present the development of our loss reserves, net of reinsurance, on a GAAP basis for the calendar years 2002 through 2012. The top line of each table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for the indicated years. The next line, captioned Liability for unpaid losses and LAE - as re-estimated at December 31, 2012 , shows the re-estimated liability as of December 31, 2012 . The remainder of the table presents intervening development as percentages of the initially estimated liability. Additional information and experience in subsequent years results in development. The middle line shows a cumulative deficiency (redundancy) which represents the aggregate percentage increase (decrease) in the liability initially estimated. The lower portion of the table indicates the cumulative amounts paid as of successive periods as a percentage of the original loss reserve liability. These tables do not present accident or policy year development data. Furthermore, in evaluating the re-estimated liability and cumulative deficiency (redundancy), note that each percentage includes the effects of changes in amounts for prior periods. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on these tables. 16
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(in millions) 2002 2003 2004 2005 2006
2007 2008 2009 2010 2011 2012 Liability for unpaid losses & LAE: As originally estimated $ 719 $ 708 $ 669 $ 610 $ 568 $ 590 $ 524 $ 491 $ 461 $ 481 $ 559 As re-estimated at December 31, 2012 799 710 610 510 462 470 396 398 457 497 N/A Liability re-estimated: One year later 103.2 % 99.2 % 97.5 % 94.9 % 97.6 % 95.0 % 87.5 % 85.0 % 101.0 % 103.4 % Two years later 107.1 % 100.3 % 94.2 % 91.6 % 91.3 %
86.5 % 78.7 % 83.0 % 99.2 % Three years later
108.5 % 99.6 % 93.7 % 89.1 % 85.2 % 81.7 % 76.8 % 81.0 % Four years later 108.4 % 100.2 % 93.7 % 85.6 % 82.4 % 80.5 % 75.5 % Five years later 109.6 % 101.5 % 91.9 % 84.0 % 81.7 % 79.6 % Six years later 111.6 % 100.6 % 91.2 % 83.8 % 81.5 % Seven years later 111.1 % 100.3 % 91.2 % 83.7 % Eight years later 111.0 % 100.5 % 91.1 % Nine years later 111.2 % 100.4 % Ten years later 111.1 %
Cumulative
deficiency
(redundancy) 11.1 % 0.4 % (8.9 )% (16.4 )% (18.6 )%
(20.4 )% (24.5 )% (19.0 )% (0.9 )% 3.4 % N/A Cumulative deficiency (redundancy) excluding ECO losses 3.1 % (8.2 )% (17.1 )% (23.0 )% (24.4 )% (24.2 )% (24.8 )% (19.5 )% (1.3 )% 3.0 % N/A Cumulative paid as of: One year later 50.3 % 48.4 % 52.6 % 50.3 % 48.4 % 54.6 % 46.8 % 48.2 % 62.5 % 64.5 % Two years later 77.1 % 75.8 % 72.6 % 66.5 % 69.1 %
67.4 % 61.0 % 65.9 % 81.1 % Three years later
<pre> 94.3 % 87.7 % 80.1 % 77.4 % 74.8 % 72.9 % 67.9 % 72.7 % Four years later 101.5 % 91.6 % 87.3 % 79.9 % 77.4 % 75.8 % 70.9 % Five years later 103.7 % 97.4 % 88.5 % 81.1 % 78.8 % 77.1 % Six years later 108.8 % 98.2 % 89.3 % 81.7 % 79.5 % Seven years later 109.3 % 98.7 % 89.7 % 82.3 % Eight years later 109.7 % 99.0 % 90.1 % Nine years later 110.0 % 99.3 % Ten years later 108.7 % 17
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The following table presents a reconciliation of our net liability to the gross liability for unpaid losses and LAE (in millions):
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 As originally estimated Net liability shown above $ 719 $ 708 $ 669 $ 610 $ 568 $ 590 $ 524 $ 491 $ 461 $ 481 $ 559 Add reinsurance recoverables 33 32 27 15 28 28 21 18 17 15 14 Gross liability $ 752 $ 740 $ 696 $ 625 $ 595 $ 618 $ 545 $ 509 $ 478 $ 495 $ 573 As re-estimated at December 31, 2012 Net liability shown above $ 799 $ 710 $ 610 $ 510 $ 462 $ 470 $ 396 $ 398 $ 457 $ 497 N/A Add reinsurance recoverables 76 58 48 38 32 31 26 22 18 15 N/A Gross liability $ 876 $ 768 $ 658 $ 548 $ 495 $ 501 $ 421 $ 421 $ 475 $ 512 N/A Gross cumulative deficiency (redundancy) 16.4 % 3.8 % (5.5 )% (12.3 )% (16.9 )% (19.0 )% (22.7 )% (17.4 )% (0.6 )% 3.4 % N/A Gross cumulative deficiency (redundancy) excluding ECO losses 6.3 % (6.9 )% (15.7 )% (19.9 )% (23.2 )% (23.1 )% (23.0 )% (17.9 )% (1.1 )% 3.1 % N/A We find it useful to evaluate accident year loss and LAE ratios by calendar year to monitor reserve development. The following table presents, by accident year, loss and LAE ratios (including IBNR): Accident Year Loss and LAE Ratios Through
Calendar Year End
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Accident Year 2003 78.1 % 73.2 % 72.9 % 72.3 % 71.7 % 70.9 % 70.5 % 70.4 % 70.3 % 70.3 % 2004 71.0 % 68.2 % 66.3 % 65.4 % 64.3 % 63.7 % 63.4 % 63.3 % 63.3 % 2005 70.5 % 69.6 % 67.8 % 66.2 % 65.2 % 64.8 % 64.6 % 64.6 % 2006 70.3 % 71.0 % 68.9 % 67.4 % 66.8 % 66.5 % 66.4 % 2007 71.9 % 72.5 % 71.0 % 69.8 % 69.5 % 69.1 % 2008 73.5 % 71.9 % 69.9 % 69.6 % 69.4 % 2009 74.2 % 71.0 % 71.0 % 70.7 % 2010 75.1 % 76.7 % 76.8 % 2011 74.9 % 77.3 % 2012 78.2 % The following table summarizes the effect on each calendar year of reserve re-estimates, net of reinsurance, for each of the accident years presented. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. Favorable reserve re-estimates are in parentheses. 18
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Table of Contents Calendar Year Impact of Reserve Development by Accident Year (in millions) 2004 2005 2006 2007 2008 2009 2010 2011 2012 Accident year Prior $ 29 $ 9 $ (1 ) $ 9 $ 14 $ (3 ) $ (1 ) $ 2 $ (1 ) 2003 (34 ) (2 ) (4 ) (4 ) (5 ) (3 ) (1 ) (0 ) (0 ) 2004 (24 ) (17 ) (8 ) (9 ) (6 ) (3 ) (1 ) 0 2005 (9 ) (17 ) (15 ) (10 ) (4 ) (2 ) (0 ) 2006 7 (21 ) (14 ) (6 ) (3 ) (1 ) 2007 6 (16 ) (12 ) (3 ) (4 ) 2008 (15 ) (19 ) (3 ) (2 ) 2009 (28 ) 0 (3 ) 2010 14 1 2011 25 Total $ (5 ) $ (17 ) $ (31 ) $ (13 ) $ (29 ) $ (65 ) $ (74 ) $ 5 $ 16 During calendar year 2012, we experienced$16.2 million of unfavorable development, primarily due to increases in severities in both bodily injury coverage inCalifornia and personal injury protection coverage inFlorida related to accident year 2011. During calendar year 2011, we experienced$4.5 million of unfavorable development, primarily due to an increase in severity inFlorida personal injury protection coverage related to accident year 2010. During calendar year 2010, we experienced$73.9 million of favorable reserve development primarily from loss and LAE reserves relating to bodily injury coverage in theCalifornia ,Connecticut ,Florida andPennsylvania nonstandard programs as well as in the Commercial Vehicle program. Other-than-Temporary Losses on Investments The determination of whether unrealized losses on investments are "other-than-temporary" requires judgment based on subjective as well as objective factors. We consider the following factors and resources: • whether the unrealized loss is credit-driven or a result of changes in
market interest rates;
• the length of time the security's market value has been below its cost;
• the extent to which fair value is less than cost basis;
• the intent to sell the security;
• whether it is more likely than not that there will be a requirement to
sell the security before its anticipated recovery;
• historical operating, balance sheet and cash flow data contained in
issuerSEC filings; • issuer news releases;
• near-term prospects for improvement in the issuer and/or its industry;
• industry research and communications with industry specialists and
• third-party research and credit rating reports.
We regularly evaluate our investment portfolio for potential impairment by evaluating each security position that has any of the following: a fair value of less than 95% of our book value, an unrealized loss that equals or exceeds$100,000 or one or more impairment charges recorded in the past. In addition, we review positions held related to an issuer of a previously impaired security. The process of evaluation includes assessments of each item listed above. Since accurately predicting if or when a specific security will become other-than-temporarily impaired is not possible, total impairment charges could be material to the results of operations in a future period. 19
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For fixed maturity securities that are other-than-temporarily impaired, we assess our intent to sell and the likelihood that we will be required to sell the security before recovery of our amortized cost. If a fixed maturity security is considered other-than-temporarily impaired but we do not intend to and will not more than likely be required to sell the security before our recovery to amortized cost, the amount of the impairment is separated into a credit loss component and the amount due to all other factors. The excess of the amortized cost over the present value of the expected cash flows determines the credit loss component of an impairment charge on a fixed maturity security. The present value is determined using the best estimate of cash flows discounted at (1) the effective interest rate implicit at the date of acquisition for non-structured securities or (2) the book yield for structured securities. The techniques and assumptions for determining the best estimate of cash flows vary depending on the type of security. We recognize the credit loss component of an impairment charge in net earnings and the non-credit component in accumulated other comprehensive income. If we intend to sell or will, more likely than not, be required to sell a security, the entire amount of the impairment is treated as a credit loss. Accruals for Litigation We continually evaluate potential liabilities and reserves for litigation using the criteria established by the Loss Contingency topic of the FASB Accounting Standards Codification. Under this guidance, we may only record reserves for loss if the likelihood of occurrence is probable and the amount is reasonably estimable. We consider each legal action and record reserves for losses in accordance with this guidance. We believe the current assumptions and other considerations used to estimate potential liability for litigation are appropriate. Certain claims and legal actions have been brought against us for which, under the rules described above, no loss has been accrued. While it is not possible to know with certainty the ultimate outcome of these claims or lawsuits, we do not expect them to have a material effect on our financial condition or liquidity. See Note 13 - Legal and Regulatory Proceedings of the Notes to Consolidated Financial Statements for a discussion of our material Legal Proceedings. Goodwill In accordance with the Goodwill topic of the FASB Accounting Standards Codification, we perform impairment test procedures for goodwill on an annual basis. These procedures require us to calculate the fair value of goodwill, compare the result to our carrying value and record the amount of any shortfall as an impairment charge. We performed this test as ofOctober 1, 2012 using a variety of methods, including estimates of future discounted cash flows and comparisons of our market value to that of our major competitors. Our cash flow projections rely on assumptions that are subject to uncertainty, including premium growth, loss and LAE ratios, interest rates and capital requirements. TheOctober 1, 2012 test results indicated that the fair value of our goodwill exceeded our carrying value and therefore no impairment charge was required at that date. Additionally, there was no indication of impairment atDecember 31, 2012 . 20
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Liquidity and Capital Resources Ratios TheNational Association of Insurance Commissioners' ("NAIC") model law for risk-based capital ("RBC") provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. AtDecember 31, 2012 , the capital ratios of all our insurance subsidiaries exceeded the RBC requirements. Sources of Funds We are a holding company and our insurance subsidiaries conduct our operations. Accordingly, we will have continuing cash needs for administrative expenses, the payment of interest on borrowings, shareholder dividends, share repurchases and taxes. Funds to meet expenditures at the holding company come primarily from dividends from the insurance subsidiaries as well as cash and investments held by the holding company. The ordinary dividend capacity and payment activity of our insurance companies for the two most recent years as well as the dividend capacity for the upcoming year are shown in the following table (in thousands): 2013 2012
2011
Maximum ordinary dividends available to Infinity
N/A 425
14,250
As ofDecember 31, 2012 , the holding company had$141.9 million of cash and investments net of$45.6 million payable for fixed income securities and treasury stock purchased in the normal course of business during 2012 that had not settled atDecember 31, 2012 . In 2012, in order to support the premium growth in our insurance subsidiaries, we contributed net capital in the form of cash and investments of$49.6 million . In 2013, our insurance subsidiaries may pay us up to$60.8 million in ordinary dividends without prior regulatory approval. Rating agency capital requirements, among other factors, will be considered when determining the actual amount of dividends paid in 2013. Our insurance subsidiaries generate liquidity to satisfy their obligations, primarily by collecting and investing premium in advance of paying claims. Our insurance subsidiaries had positive cash flow from operations of approximately$175.3 million in 2012,$72.4 million in 2011 and$73.3 million in 2010. In addition, to satisfy their obligations, our insurance subsidiaries generate cash from maturing securities from their combined$1.3 billion portfolio. InSeptember 2012 , we issued$275 million principal of senior notes dueSeptember 2022 (the "5.0% Senior Notes"). The 5.0% Senior Notes accrue interest at 5.0%, payable semiannually each March and September. The majority of the proceeds from this issuance were used to redeem the 5.5% Senior Notes. OnOctober 17, 2012 , we fully redeemed the$195.0 million outstanding principal of 5.5% Senior Notes due 2014 at a price of 106.729%, or$208.1 million plus accrued interest of$1.8 million . Refer to Note 4 to the Consolidated Financial Statements for more information on our long-term debt. InAugust 2011 , we renewed our agreement for a$50 million three-year revolving credit facility (the "Credit Agreement") that requires us to meet certain financial and other covenants. We are currently in compliance with all covenants under the Credit Agreement. AtDecember 31, 2012 , there were no borrowings outstanding under the Credit Agreement. InAugust 2010 , we filed a "shelf" registration statement with theSecurities and Exchange Commission for$300.0 million , which will allow us to sell any combination of senior or subordinated debt securities, common stock, preferred stock, warrants, depositary shares and units in one or more offerings should we choose to do so in the future. We conducted a shelf take-down of$275.0 million in conjunction with the issuance of the 5.0% Senior Notes and$25.0 million of capacity remains atDecember 31, 2012 . Uses of Funds InFebruary 2013 , we increased our quarterly dividend to$0.30 per share from$0.225 per share. At this current amount, our 2013 annualized dividend payments will be approximately$13.9 million . OnAugust 3, 2010 our Board of Directors adopted a share and debt repurchase program set to expire onDecember 31, 2011 . OnAugust 2, 2011 , our Board of Directors increased the authority under this program by$50.0 million and extended the date to 21
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations execute the program toDecember 31, 2012 . OnNovember 6, 2012 , our Board of Directors again increased the authority under this share and debt repurchase plan by$25.0 million and extended the date to execute the program toDecember 31, 2014 . During 2012, we repurchased 340,334 shares at an average cost, excluding commissions, of$54.84 . As ofDecember 31, 2012 , we had$54.5 million of authority remaining under this program.
We believe that cash balances, cash flows generated from operations or borrowings, and maturities and sales of investments are adequate to meet our future liquidity needs and those of our insurance subsidiaries. Contractual Obligations
Our contractual obligations and those of our insurance subsidiaries as of
Post-retirement Long-Term Loss and LAE Benefit Payments Due in: Debt & Interest Operating Leases Capital Leases Reserves (a) (b) Total 2013 $ 13,750 $ 8,968 $ 976 $ 349,270 $ 315 $ 373,279 2014-2015 27,500 17,028 1,606 162,929 696 $ 209,759 2016-2017 27,500 7,533 288 35,099 785 $ 71,205 2018 and after 343,750 3,793 0 25,596 2,474 $ 375,613 Total $ 412,500 $ 37,322 $ 2,870 $ 572,894 $ 4,270 $ 1,029,857
________________
(a) We base the payout pattern for reserves for losses and LAE upon historical
payment patterns and they do not represent actual contractual obligations.
The timing and amounts ultimately paid will vary from these estimates, as
discussed above under "Critical Accounting Policies" and in Note 1-
Significant Reporting and Accounting Policies of the Notes to Consolidated
Financial Statements. (b) The payments for post-retirement benefits do not represent actual contractual obligations. The payments presented represent the best estimate of future contributions. 22
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Investments
General
Our Investment Committee, which is composed exclusively of independent directors, has approved our investment guidelines. The guidelines specifically address overall investment objectives, permissible assets, prohibited assets, permitted exceptions to the guidelines and credit quality. We engage three unaffiliated money managers for our fixed income portfolio and we own a Vanguard exchange-traded fund designed to track the FTSE Global All Cap Index for our equity portfolio. The investment managers conduct, in accordance with our investment guidelines, all of our investment purchases and sales. Our Chief Financial Officer and the Investment Committee, at least quarterly, review the performance of the money managers and compliance with our investment guidelines. National banks unaffiliated with the money managers maintain physical custody of securities. Our consolidated investment portfolio atDecember 31, 2012 contained$1.3 billion in fixed maturity securities and$73.1 million in equity securities, all carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income, a separate component of shareholders' equity on an after-tax basis. AtDecember 31, 2012 , we had pre-tax net unrealized gains of$43.8 million on fixed maturities and pre-tax net unrealized gains of$3.1 million on equity securities. Combined, the pre-tax net unrealized gain declined by$6.9 million for the twelve months endedDecember 31, 2012 . Approximately 92.4% of our fixed maturity portfolio atDecember 31, 2012 was rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies. The average credit rating of our fixed maturity portfolio was AA- atDecember 31, 2012 . Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate stable and predictable investment returns. Since we carry all of these securities at fair value in the Consolidated Balance Sheets, there is virtually no effect on liquidity or financial condition upon the sale and ultimate realization of unrealized gains and losses. The average duration of our fixed maturity portfolio was 3.0 years atDecember 31, 2012 . Fair values of instruments are based on (i) quoted prices in active markets for identical assets (Level 1), (ii) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs are observable in active markets (Level 2) or (iii) valuations derived from valuation techniques in which one or more significant inputs are unobservable in the marketplace (Level 3). Level 1 securities are U.S. Treasury securities, an exchange-traded fund and equity securities held in a rabbi trust. Level 2 securities are comprised of securities whose fair value was determined using observable market inputs. Level 3 securities are comprised of (i) securities for which there is no active or inactive market for similar instruments, (ii) securities whose fair value is determined based on unobservable inputs and (iii) securities that nationally recognized statistical rating organizations do not rate. A third party nationally recognized pricing service provides the fair value of securities in Level 2. We periodically review the third party pricing methodologies used by our primary independent pricing service to verify that prices are determined in accordance with fair value guidance in U.S. GAAP, including the use of observable market inputs, and to ensure that assets are properly classified in the fair value hierarchy. Further, for all Level 2 securities, we compare the market price from the primary independent third party pricing service that is used to value the security with market prices from recent sales activity or, for those securities with no recent sales activity, with prices from another independent third party pricing service or non-binding broker quotes. This comparison is performed in order to determine if the price obtained from the primary independent pricing service is a reasonable price to use in our financial statements. We made no adjustments to the prices obtained from the primary independent pricing service as a result of this comparison. 23
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Summarized information for our investment portfolio atDecember 31, 2012 follows (in thousands): % of Amortized Fair Total Fair Cost Value Value Fixed maturities: U.S. government and agencies: U.S. government $ 83,320 $ 85,537 6.1 % Government-sponsored enterprises 21,401 22,140 1.6 % Total U.S. government and agencies 104,721 107,678 7.7 % State and municipal 438,367 457,113 32.8 % Mortgage-backed, CMOs and asset-backed: Residential mortgage-backed securities 275,668 281,907 20.2 % Commercial mortgage-backed securities 13,023 13,768 1.0 % Collateralized mortgage obligations: Planned asset class 11,100 11,360 0.8 % Sequentials 6,575 6,727 0.5 % Whole loan 1,172 1,221 0.1 % Total CMO 18,847 19,307 1.4 % Asset-backed securities ("ABS"): Auto loans 53,407 53,759 3.9 % Credit card receivables 18,024 17,948 1.3 % Equipment Leases 6,885 6,903 0.5 % Home equity 505 526 0.0 % Miscellaneous 110 121 0.0 % Total ABS 78,931 79,257 5.7 % Total mortgage-backed, CMOs and asset-backed 386,469 394,239 28.3 % Corporates Investment grade 252,823 262,301 18.8 % Non-investment grade 95,671 100,496 7.2 % Total corporates 348,494 362,797 26.0 % Total fixed maturities 1,278,051 1,321,828 94.8 % Equity securities 69,992 73,106 5.2 % Total investment portfolio $ 1,348,042 $ 1,394,934 100.0 % The following table presents the returns, gross of investment expenses, of our investment portfolios based on quarterly investment balances as reflected in the financial statements. Twelve months ended December 31, 2012 2011 2010 Return on fixed income securities: Excluding realized gains and losses 3.0 % 3.5 % 3.8 % Including realized gains and losses 3.8 % 4.0 % 4.6 % Return on equity securities: Excluding realized gains and losses 4.1 % 2.7 % 2.8 % Including realized gains and losses 44.5 % 13.3 % 5.7 % Return on all investments: Excluding realized gains and losses 3.1 % 3.5 % 3.7 % Including realized gains and losses 4.9 % 4.2 % 4.6 % 24
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Receivable for Securities Sold
The$48.5 million balance in receivable for securities sold atDecember 31, 2012 represents fixed income securities sold in the normal course of business during 2012 that had not settled atDecember 31, 2012 . The$1.2 million balance in receivable for securities sold atDecember 31, 2011 represents fixed income securities sold in the normal course of business during 2011 that had not settled atDecember 31, 2011 .
Payable for Securities Purchased
The
The
Exposure to Market Risk Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. Our exposures to market risk relate primarily to our investment portfolio, which is exposed primarily to interest rate risk and credit risk and, to a lesser extent, equity price risk. Changes in market interest rates directly affect the fair value of our fixed maturity portfolio. Generally, the fair value of fixed-income investments moves inversely with movements in market interest rates. Our fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. We strive to maintain a "laddered" portfolio, with maturities and prepaid principal spread across the maturity spectrum. This portfolio composition allows flexibility in reacting to fluctuations of interest rates. In addition, higher market rates available for new funds available for investment partially mitigate the risk of loss in fair value. We manage the portfolios of our insurance companies to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations. Interest Rate Risk The fair values of our fixed maturity investments fluctuate in response to changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into decreases and increases, respectively, in fair values of those instruments. Additionally, the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions may affect fair values of interest rate sensitive instruments. The following table summarizes the estimated effects of hypothetical increases and decreases in interest rates resulting from parallel shifts in market yield curves on our fixed maturity portfolio and long-term debt. We assume that we will realize the effects immediately upon the change in interest rates. The hypothetical changes in market interest rates do not reflect best or worst case scenarios. Variations in market interest rates could produce significant changes in the timing of repayments due to prepayment options available. For these reasons, actual results might differ from those reflected in the table. Sensitivity to Instantaneous Interest Rate Changes (basis points) (in thousands) (200) (100) (50) - 50 100 200 Fair value of fixed maturity portfolio $ 1,395,339 $ 1,360,197 $ 1,341,441 $ 1,321,828
$ 1,300,841 $ 1,278,764 $ 1,232,249 Fair value of long-term debt 337,797 312,196 300,267 288,879 278,007 267,626 248,239 The following table provides information about our fixed maturity investments atDecember 31, 2012 , which are sensitive to interest rate risk. The table shows expected principal cash flows by expected maturity date for each of the five subsequent years and collectively for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. MBS and sinking fund issues are included based on maturity year adjusted for expected payment patterns. 25
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K Management's Discussion and Analysis of Financial Condition and Results of Operations (in thousands) Expected Principal Cash Flows MBS, CMO and Excluding MBS, ABS only CMO and ABS Total Maturing Book Yield For the twelve months ending December 31, 2013 $ 102,690 $ 68,379 $ 171,069 2.8 % 2014 81,382 110,212 191,593 2.7 % 2015 54,458 153,081 207,540 3.0 % 2016 35,377 158,675 194,052 2.9 % 2017 25,474 168,384 193,857 2.7 % Thereafter 71,060 185,056 256,116 2.8 % Total $ 370,441 $ 843,787 $ 1,214,228 2.8 %
The cash flows presented take into consideration historical relationships of market yields and prepayment rates. However, the actual prepayment rate may differ from historical trends resulting in actual principal cash flows that differ from those presented above.
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Credit Risk We manage credit risk by diversifying our portfolio to avoid concentrations in any single industry group or issuer and by limiting investments in securities with lower credit ratings. The largest investment in any one fixed income security, excluding U.S. government and agencies securities, is$8.4 million or 0.6% of the fixed income investment portfolio. The top five investments in fixed income securities, excluding those issued by the U.S. government and its agencies, make up 2.5% of the fixed income portfolio. The fair value of non-performing fixed maturities, securities that have not produced their stated rate of investment income during the previous twelve months, was$0.1 million or less than 0.1% of the$1.3 billion fixed portfolio as ofDecember 31, 2012 . We categorize securities by rating based upon ratings issued by Moody's, Standard & Poor's or Fitch, where available. If all three ratings are available but not equivalent, we exclude the lowest rating and the lower of the remaining ratings is used. If ratings are only available from two agencies, the lowest is used. This methodology is consistent with that used by the major bond indices. State and municipal bond ratings presented are underlying ratings without regard to any insurance. The following table presents the credit rating and fair value (in thousands) of our fixed maturity portfolio by major security type: Rating Non- % of investment Total AAA AA A BBB Grade Total Fair Value Exposure U.S. government and agencies $ 104,220 $ 3,458 $ 0 $ 0 $ 0 $ 107,678 8.1 % State and municipal 36,826 288,195 132,092 0 0 457,113 34.6 %
Mortgage-backed,
asset-backed and CMO 383,544 6,671 4,025 0 0 394,239 29.8 % Corporates 0 21,328 139,175 101,799 100,496 362,797 27.4 % Total fair value $ 524,589 $ 319,651 $ 275,293 $ 101,799 $ 100,496 $ 1,321,828 100.0 % % of total fair value 39.7 % 24.2 % 20.8 % 7.7 % 7.6 % 100.0 % The following table presents the credit rating and fair value of our residential mortgage-backed securities atDecember 31, 2012 by deal origination year (in thousands): Rating Deal Non- % of Origination investment Total Fair Total Year AAA AA A BBB Grade Value Exposure 2002 $ 324 $ 0 $ 0 $ 0 $ 0 $ 324 0.1 % 2003 1,397 0 0 0 0 1,397 0.5 % 2004 3,648 0 0 0 0 3,648 1.3 % 2005 1,889 0 0 0 0 1,889 0.7 % 2006 4,637 0 0 0 0 4,637 1.6 % 2007 4,341 0 0 0 0 4,341 1.5 % 2008 13,455 0 0 0 0 13,455 4.8 % 2009 43,127 0 0 0 0 43,127 15.3 % 2010 61,199 0 0 0 0 61,199 21.7 % 2011 42,787 0 0 0 0 42,787 15.2 % 2012 105,103 0 0 0 0 105,103 37.3 % Total fair value $ 281,907 $ 0 $ 0 $ 0 $ 0 $ 281,907 100.0 % % of total fair value 100.0 % 0.0 % 0.0 % 0.0 % 0.0 % 100.0 % 27
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations
All of the
The following table presents the credit rating and fair value of our commercial mortgage-backed securities atDecember 31, 2012 by deal origination year (in thousands): Rating Deal % of Origination Non-investment Total Year AAA AA A BBB Grade Total Fair Value Exposure 2004 $ 3,652 $ 0 $ 0 $ 0 $ 0 $ 3,652 26.5 % 2005 2,999 0 0 0 0 2,999 21.8 % 2006 6,036 0 0 0 0 6,036 43.8 % 2012 1,081 0 0 0 0 1,081 7.9 % Total fair value $ 13,768 $ 0 $ 0 $ 0 $ 0 $ 13,768 100.0 % % of total fair value 100.0 % 0.0 % 0.0 % 0.0 % 0.0 % 100.0 %
None of the
The following table presents the credit rating and fair value of our collateralized mortgage obligation portfolio at
Rating Deal % of Origination Non-investment Total Year AAA AA A BBB Grade Total Fair Value Exposure 2002 $ 2,101 $ 0 $ 0 $ 0 $ 0 $ 2,101 10.9 % 2003 1,485 796 0 0 0 2,281 11.8 % 2004 1,576 0 0 0 0 1,576 8.2 % 2009 4,726 0 0 0 0 4,726 24.5 % 2010 4,049 0 0 0 0 4,049 21.0 % 2011 1,547 0 0 0 0 1,547 8.0 % 2012 3,027 0 0 0 0 3,027 15.7 % Total fair value $ 18,511 $ 796 $ 0 $ 0 $ 0 $ 19,307 100.0 % % of total fair value 95.9 % 4.1 % 0.0 % 0.0 % 0.0 % 100.0 %
Of the
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations The following table presents the credit rating and fair value of our ABS portfolio atDecember 31, 2012 by deal origination year (in thousands): Rating Deal % of Origination Non-investment Total Year AAA AA A BBB Grade Total Fair Value Exposure 2001 $ 75 $ 0 $ 0 $ 0 $ 0 $ 75 0.1 % 2003 5,656 0 0 0 0 5,656 7.1 % 2004 5,008 0 0 0 0 5,008 6.3 % 2008 5,071 0 0 0 0 5,071 6.4 % 2009 3,055 0 0 0 0 3,055 3.9 % 2010 1,882 1,908 0 0 0 3,790 4.8 % 2011 16,201 0 0 0 0 16,201 20.4 % 2012 32,410 3,967 4,025 0 0 40,402 51.0 % Total fair value $ 69,357 $ 5,875 $ 4,025 $ 0 $ 0 $ 79,257 100.0 % % of total fair value 87.5 % 7.4 % 5.1 % 0.0 % 0.0 % 100.0 %
The following table shows our fixed maturity securities, by NAIC designation and comparable Standard & Poor's Corporation rating as of
% of Total Fair NAIC Rating Comparable S&P Rating Amortized Cost Total Fair Value Value 1 AAA, AA, A $ 1,127,002 $ 1,161,814 87.9 % 2 BBB 67,787 72,092 5.5 % Total investment grade 1,194,789 1,233,907 93.4 % 3 BB 57,467 61,255 4.6 % 4 B 25,569 26,439 2.0 % 5 CCC, CC, C 0 0 0.0 % 6 D 226 226 0.0 % Total non-investment grade 83,261 87,921 6.7 % Total $ 1,278,051 $ 1,321,828 100.0 %
Actual NAIC ratings of securities may not be consistent with the comparable S&P rating used.
Our investment portfolio consists of$457.1 million of state and municipal bonds, of which$163.1 million are insured. Of the insured bonds, 46.6% are insured with MBIA, 28.7% with Assured Guaranty, 23.0% withAMBAC , 0.8% with Berkshire Hathaway and 0.9% are insured with XL Group. The following table presents the underlying ratings of the state and municipal bond portfolio atDecember 31, 2012 (in thousands): Municipal Bonds Insured Uninsured Total % of % of % of Fair Fair Fair Fair Fair Total Fair Rating Value Value Value Value Value Value AAA $ 3,438 2.1 % $ 33,388 11.4 % $ 36,826 8.1 % AA+, AA, AA- 93,494 57.3 % 194,701 66.2 % 288,195 63.0 % A+, A, A- 66,198 40.6 % 65,894 22.4 % 132,092 28.9 % BBB+, BBB, BBB- 0 0.0 % 0 0.0 % 0 0.0 % Total $ 163,130 100.0 % $ 293,983 100.0 % $ 457,113 100.0 % 29
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations The following table presents the credit rating and fair value of our state and municipal bond portfolio, by state, atDecember 31, 2012 (in thousands): Rating Non- investment Total Fair % of Total State AAA AA A BBB Grade Value Exposure NY $ 3,016 $ 36,229 $ 1,221 $ 0 $ 0 $ 40,466 8.9 % TX 10,364 20,573 8,581 0 0 39,518 8.6 % FL 0 15,549 15,477 0 0 31,027 6.8 % GA 4,745 10,152 10,145 0 0 25,042 5.5 % WA 1,273 18,473 1,778 0 0 21,523 4.7 % VA 0 17,783 0 0 0 17,783 3.9 % IN 987 11,260 5,180 0 0 17,428 3.8 % PA 0 13,917 3,310 0 0 17,227 3.8 % IL 0 4,519 10,633 0 0 15,152 3.3 % MA 0 8,563 4,698 0 0 13,261 2.9 % All other states 16,440 131,177 71,069 0 0 218,686 47.8 % Total fair value $ 36,826 $ 288,195 $ 132,092 $ 0 $ 0 $ 457,113 100.0 %
% of total fair value 8.1 % 63.0 % 28.9 % 0.0 % 0.0 % 100.0 %
The following table presents the fair value of our state and municipal bond portfolio, by state and type of bond, at
Type General Obligation Total Fair % of Total State State Local Revenue Other Value Exposure NY $ 0 $ 6,381 $ 34,086 $ 0 $ 40,466 8.9 % TX 0 12,931 26,588 0 39,518 8.6 % FL 4,766 0 16,926 9,335 31,027 6.8 % GA 4,745 2,365 17,932 0 25,042 5.5 % WA 4,158 3,755 13,610 0 21,523 4.7 % VA 0 3,542 14,241 0 17,783 3.9 % IN 0 0 17,428 0 17,428 3.8 % PA 553 2,724 13,950 0 17,227 3.8 % IL 823 0 14,329 0 15,152 3.3 % MA 2,491 4,280 6,489 0 13,261 2.9 % All other states 32,170 34,777 149,694 2,045 218,686 47.8 % Total fair value $ 49,706 $ 70,755 $ 325,273 $ 11,379 $ 457,113 100.0 % % of total fair value 10.9 % 15.5 % 71.2 % 2.5 % 100.0 % 30
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following table presents the fair value of the revenue category of our state and municipal bond portfolio, by state and further classification, at
Revenue Bonds % of Total State Transportation Utilities Education Other Total Fair Value Exposure NY $ 9,135 $ 0 $ 7,840 $ 17,111 $ 34,086 10.5 % TX 15,783 6,399 3,000 1,405 26,588 8.2 % GA 8,571 4,777 1,379 3,206 17,932 5.5 % IN 3,198 1,231 9,049 3,949 17,428 5.4 % FL 12,328 0 0 4,599 16,926 5.2 % IL 8,116 0 2,242 3,971 14,329 4.4 % VA 767 0 5,280 8,194 14,241 4.4 % PA 6,124 0 4,516 3,310 13,950 4.3 % WA 1,316 9,244 0 3,051 13,610 4.2 % CO 5,747 0 7,379 0 13,126 4.0 % All other states 31,559 41,043 20,916 49,539 143,057 44.0 % Total fair value $ 102,644 $ 62,695 $ 61,599 $ 98,335 $ 325,273 100.0 % % of total fair value 31.6 % 19.3 % 18.9 % 30.2 % 100.0 % The following table presents the fair value of our corporate bond portfolio, by industry sector and rating of bond, atDecember 31, 2012 (in thousands): Rating Non- investment Total Fair % of Total Industry Sector AAA AA A BBB Grade Value Exposure Financial $ 0 $ 9,230 $ 81,521 $ 31,861 $ 15,802 $ 138,414 38.2 % Consumer, Non-cyclical 0 6,805 21,454 18,179 13,273 $ 59,710 16.5 % Energy 0 1,058 19,401 8,031 12,764 $ 41,255 11.4 % Communications 0 0 1,097 16,462 14,416 $ 31,974 8.8 % Industrial 0 0 4,833 5,303 13,846 $ 23,981 6.6 % Consumer, Cyclical 0 4,235 0 4,321 12,550 $ 21,105 5.8 % Utilities 0 0 8,835 7,241 4,779 $ 20,855 5.7 % Basic Materials 0 0 0 6,913 5,333 $ 12,245 3.4 % Technology 0 0 0 3,489 7,185 $ 10,674 2.9 % Foreign Government 0 0 2,033 0 0 $ 2,033 0.6 % Diversified $ 0 $ 0 $ 0 $ 0 $ 550 $ 550 0.2 %
Total fair value $ 0
$ 100,496 $ 362,797 100.0 % % of total fair value 0.0 % 5.9 % 38.4 % 28.1 % 27.7 % 100.0 % 31
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INFINITY PROPERTY AND CASUALTY CORPORATION 10-K
Management's Discussion and Analysis of Financial Condition and Results of
Operations Included in our investments in corporate fixed income securities atDecember 31, 2012 are$51.5 million of dollar-denominated investments with issues or guarantors in foreign countries, as follows (in thousands): Rating Non- investment % of Total Issuer or Guarantor AAA AA A BBB Grade Total Fair Value Exposure Britain $ 0 $ 4,773 $ 10,246 $ 0 $ 0 $ 15,019 29.2 % Canada 0 0 8,579 2,434 2,774 $ 13,787 26.8 % Switzerland 0 0 5,872 0 0 $ 5,872 11.4 % France 0 3,163 1,000 0 0 $ 4,163 8.1 % Germany 0 0 4,065 0 0 $ 4,065 7.9 % Australia 0 0 3,732 0 0 $ 3,732 7.2 % South Korea 0 0 2,033 0 0 $ 2,033 3.9 % Mexico 0 0 1,097 0 0 $ 1,097 2.1 % Cayman Islands 0 0 0 0 950 $ 950 1.8 % Aruba 0 0 774 0 0 $ 774 1.5 % Total fair value $ 0 $ 7,936 $ 37,397 $ 2,434 $ 3,724 $ 51,491 100.0 % % of total fair value 0.0 % 15.4 % 72.6 % 4.7 % 7.2 % 100.0 %
We own no investments that are denominated in a currency other than the U.S. dollar.
The
EquityPrice Risk Equity price risk is the potential economic loss from adverse changes in equity security prices. Our exposure to equity price risk is limited, as our equity investments comprise only 5.2% of our total investment portfolio. AtDecember 31, 2012 , the fair value of our equity portfolio was$73.1 million . 32
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Table of Contents Results of Operations Underwriting Premium Our net earned premium was as follows ($ in thousands): Twelve months ended December 31, 2012 2011 Change % Change Net earned premium Gross written premium Personal Auto Focus States Urban Zones $ 973,021 $ 848,867 $ 124,154 14.6 % Non-urban Zones 157,412 121,891 35,521 29.1 % Total Focus States 1,130,434 970,758 159,675 16.4 % Maintenance States 28,650 29,091 (441 ) (1.5 )% Other States 6,849 7,399 (551 ) (7.4 )% Total Personal Auto 1,165,932 1,007,249 158,684 15.8 % Commercial Vehicle 76,618 64,444 12,175 18.9 % Classic Collector 12,379 10,774 1,605 14.9 % Other (1 ) 0 (1 ) 0.0 % Total gross written premium 1,254,929 1,082,466 172,463 15.9 % Ceded reinsurance (7,731 ) (6,490 ) (1,241 ) 19.1 % Net written premium 1,247,198 1,075,976 171,222 15.9 % Change in unearned premium (63,108 ) (56,916 ) (6,192 ) 10.9 % Net earned premium $ 1,184,090 $ 1,019,060 $ 165,030 16.2 % Twelve months ended December 31, 2011 2010 Change % Change Net earned premium Gross written premium Personal Auto Focus States Urban Zones $ 848,867 $ 739,963 $ 108,903 14.7 % Non-urban Zones 121,891 106,547 15,344 14.4 % Total Focus States 970,758 846,510 124,248 14.7 % Maintenance States 29,091 30,040 (948 ) (3.2 )% Other States 7,399 8,650 (1,251 ) (14.5 )% Total Personal Auto 1,007,249 885,200 122,049 13.8 % Commercial Vehicle 64,444 57,206 7,237 12.7 % Classic Collector 10,774 10,020 753 7.5 % Total gross written premium 1,082,466 952,426 130,040 13.7 % Ceded reinsurance (6,490 ) (5,558 ) (933 ) 16.8 % Net written premium 1,075,976 946,869 129,107 13.6 % Change in unearned premium (56,916 ) (40,950 ) (15,966 ) 39.0 % Net earned premium $ 1,019,060 $ 905,919 $ 113,141 12.5 % 33
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The following table shows our policies in force:
Twelve months ended December 31, 2012 2011 Change % Change Policies in Force Personal Auto Focus States Urban Zones 748,541 706,751 41,790 5.9 % Non-urban Zones 111,133 92,326 18,807 20.4 % Total Focus States 859,674 799,077 60,597 7.6 % Maintenance States 24,401 24,437 (36 ) (0.1 )% Other States 3,540 3,903 (363 ) (9.3 )% Total Personal Auto 887,615 827,417 60,198 7.3 % Commercial Vehicle 39,621 35,108 4,513 12.9 % Classic Collector 38,235 35,527 2,708 7.6 % Total policies in force 965,471 898,052 67,419 7.5 % Twelve months ended December 31, 2011 2010 Change % Change Policies in Force Personal Auto Focus States Urban Zones 706,751 648,921 57,830 8.9 % Non-urban Zones 92,326 80,240 12,086 15.1 % Total Focus States 799,077 729,161 69,916 9.6 % Maintenance States 24,437 28,600 (4,163 ) (14.6 )% Other States 3,903 5,027 (1,124 ) (22.4 )% Total Personal Auto 827,417 762,788 64,629 8.5 % Commercial Vehicle 35,108 32,191 2,917 9.1 % Classic Collector 35,527 34,087 1,440 4.2 % Total policies in force 898,052 829,066 68,986 8.3 % 2012 compared to 2011 Gross written premium grew 15.9% during 2012. We implemented rate revisions in various states with an overall rate increase of 8.0% during the year. Excluding the effect of rate changes inCalifornia , our largest state, the overall rate increase was 12.1%. Policies in force atDecember 31, 2012 increased 7.5% compared with 2011. Gross written premium grew more than policies in force due to a shift in overall business mix toward policies offering broader coverage and higher average premium as well as growth inFlorida business, which has a higher average premium per policy than our other states. During 2012, personal auto insurance gross written premium in our Focus States grew 16.4% when compared with 2011. The increase in gross written premium is primarily due to growth inCalifornia andFlorida . •California gross written premium grew 7.4% during the twelve months endedDecember 31, 2012 . Rate actions taken by competitors and an increase in business retention have stimulated premium growth in the state.
•
in new business application counts, higher business retention, an
increase of 6.8% in average premium from rate increases and competitor rate increases. 34
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A decline of 17.0% in
Gross written premium in the Maintenance States declined 1.5% during the twelve months ended
Our Commercial Vehicle gross written premium grew 18.9% during the twelve months endedDecember 31, 2012 . This growth is primarily due to higher average premium and better retention for this product. Gross written premium in our Classic Collector product grew 14.9% during 2012. This growth is primarily due to growth inFlorida andTexas resulting from an increase in the number of agencies actively producing business for this product. 2011 compared to 2010 Gross written premium grew 13.7% during the twelve months endedDecember 31, 2011 compared with the twelve months endedDecember 31, 2010 . During 2011, we implemented rate revisions in various states with an overall rate increase of 2.2%. Policies in force atDecember 31, 2011 increased 8.3% compared with 2010. Gross written premium grew more than policies in force due to a shift in business mix toward policies offering broader coverage. These policies typically generate a higher premium per policy than those with coverage that is more restricted. During 2011, personal auto insurance gross written premium in our Focus States grew 14.7% when compared with 2010. The increase in gross written premium is primarily due to growth inArizona ,California ,Florida ,Georgia andTexas . •Arizona gross written premium grew 20.9% during the twelve months endedDecember 31, 2011 . This growth is primarily a result of modest rate decreases. •California gross written premium grew 12.0% during the twelve months endedDecember 31, 2011 . Rate actions taken by competitors and a shift
in business mix to policies offering broader coverage have stimulated
premium growth in the state.
•
December 31, 2011 . This growth is primarily a result of higher business retention and rate increases in the state. Our rate increases were not as significant as those made by our competitors and therefore did not negatively impact our ability to grow.
•
December 31, 2011 . This growth is primarily a result of modest rate decreases coupled with a shift in business mix to policies offering broader coverage. •Texas gross written premium grew 15.0% during the twelve months endedDecember 31, 2011 . This growth primarily occurred in the first half of 2011 and related to rate decreases taken in 2010. We raised rates in
this state during the second half of 2011 to improve profitability.
Gross written premium in the Maintenance States declined 3.2% during the twelve months ended
Our Commercial Vehicle gross written premium grew 12.7% during the twelve months endedDecember 31, 2011 . This growth is primarily due to growth inCalifornia resulting from the appointment of new agents.
Profitability
A key operating performance measure of insurance companies is underwriting profitability, as opposed to overall profitability or net earnings. We measure underwriting profitability by the combined ratio. When the combined ratio is under 100%, we consider underwriting results profitable; when the ratio is over 100%, we consider underwriting results unprofitable. The combined ratio does not reflect investment income, other income, interest expense, corporate general and administrative expenses, other expenses or federal income taxes. While we report financial results in accordance with GAAP for shareholder and other users' purposes, we report it on a statutory basis for insurance regulatory purposes. We evaluate underwriting profitability based on a combined ratio calculated using statutory accounting principles. The statutory combined ratio represents the sum of the following ratios: (i) losses and 35
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LAE incurred as a percentage of net earned premium and (ii) underwriting expenses incurred, net of fees, as a percentage of net written premium. Certain expenses are treated differently under statutory and GAAP accounting principles. Under GAAP, commissions, premium taxes and other variable costs incurred in connection with successfully writing new and renewal business are capitalized as deferred policy acquisition costs and amortized on a pro rata basis over the period in which the related premium is earned. On a statutory basis, these items are expensed as incurred. We capitalize costs for computer software developed or obtained for internal use under GAAP and amortize the costs over the software's useful life, rather than expense them as incurred, as required for statutory purposes. Additionally, bad debt charge-offs on agent balances and premium receivables are included only in the GAAP combined ratios.
The following table presents the statutory and GAAP combined ratios:
Twelve months ended December 31, 2012 2011 % Point Change Loss & Loss & Loss & LAE Underwriting Combined LAE
Underwriting Combined LAE Underwriting Combined Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Personal Auto: Focus States: Urban Zones 80.2 % 18.2 % 98.4 % 74.8 % 20.4 % 95.2 % 5.4 % (2.2 )% 3.2 % Non-urban Zones 79.8 % 18.8 % 98.6 % 79.1 % 20.1 % 99.2 % 0.7 % (1.3 )% (0.6 )% Total Focus States 80.2 % 18.3 % 98.4 % 75.4 % 20.4 % 95.7 % 4.8 % (2.1 )% 2.7 % Maintenance States 78.3 % 22.5 % 100.9 % 85.5 % 26.9 % 112.4 % (7.2 )% (4.3 )% (11.5 )% Other States NM NM NM NM NM NM NM NM NM Subtotal 80.2 % 18.3 % 98.5 % 75.8 % 20.5 % 96.3 % 4.4 % (2.2 )% 2.3 % Commercial Vehicle 70.8 % 17.9 % 88.7 % 70.6 % 17.9 % 88.5 % 0.2 % 0.0 % 0.2 % Classic Collector 78.7 % 38.4 % 117.0 % 63.5 % 38.7 % 102.2 % 15.2 % (0.4 )% 14.8 % Total statutory ratios 79.7 % 18.6 % 98.3 % 75.4 % 20.4 % 95.8 % 4.3 % (1.8 )% 2.5 % Total statutory ratios excluding development 78.3 % 18.6 % 96.9 % 75.0 % 20.4 % 95.4 % 3.3 % (1.8 )% 1.5 % GAAP ratios 79.6 % 21.1 % 100.7 % 75.3 % 22.7 % 98.0 % 4.2 % (1.6 )% 2.6 % GAAP ratios excluding development 78.2 % 21.1 % 99.3 % 74.9 % 22.7 % 97.6 % 3.3 % (1.6 )% 1.7 % ________________
NM: Not meaningful due to the low premium for these lines.
Twelve months ended December 31, 2011 2010 % Point Change Loss & Loss & Loss & LAE Underwriting Combined LAE Underwriting Combined LAE Underwriting Combined Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Personal Auto: Focus States: Urban Zones 74.8 % 20.4 % 95.2 % 67.4 %
21.4 % 88.8 % 7.4 % (1.0 )% 6.4 % Non-urban Zones 79.1 % 20.1 % 99.2 % 70.2 %
21.7 % 91.8 % 9.0 % (1.6 )% 7.4 % Total Focus States 75.4 % 20.4 % 95.7 % 67.7 % 21.5 % 89.2 % 7.6 % (1.1 )% 6.5 % Maintenance States 85.5 % 26.9 % 112.4 % 79.5 % 28.9 % 108.4 % 6.0 % (2.1 )% 4.0 % Other States NM NM NM NM NM NM NM NM NM Subtotal 75.8 % 20.5 % 96.3 % 67.7 % 21.7 % 89.4 % 8.1 % (1.2 )% 6.8 % Commercial Vehicle 70.6 % 17.9 % 88.5 % 68.7 % 20.5 % 89.2 % 1.9 % (2.6 )% (0.7 )% Classic Collector 63.5 % 38.7 % 102.2 % 37.1 %
42.0 % 79.1 % 26.3 % (3.3 )% 23.1 % Total statutory ratios
75.4 % 20.4 % 95.8 % 67.0 % 21.4 % 88.4 % 8.4 % (1.0 )% 7.4 % Total statutory ratios excluding development 75.0 % 20.4 % 95.4 % 75.1 % 21.4 % 96.6 % (0.2 )% (1.0 )% (1.2 )% GAAP ratios 75.3 % 22.7 % 98.0 % 67.0 % 22.7 % 89.7 % 8.4 % 0.0 % 8.4 % GAAP ratios excluding development 74.9 % 22.7 % 97.6 % 75.1 % 22.7 % 97.8 % (0.2 )% 0.0 % (0.2 )%
________________
NM: Not meaningful due to the low premium for these lines.
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In evaluating the profit performance of our business, we review underwriting profitability using statutory combined ratios. Accordingly, the discussion of underwriting results that follows will focus on these ratios and the components thereof, unless otherwise indicated. 2012 compared to 2011 The statutory combined ratio for the twelve months endedDecember 31, 2012 increased by 2.5 points from the same period of 2011. The twelve months endedDecember 31, 2012 included$16.2 million of unfavorable development on prior year loss and LAE reserves compared to$4.5 million of unfavorable development on prior year loss and LAE reserves in 2011. Excluding the effect of development from both periods, the statutory combined ratio increased by 1.5 points for the twelve months endedDecember 31, 2012 compared to 2011. The increase is primarily due to an increase in the current accident year loss and LAE ratio offset by a decline in the underwriting ratio. The increase in the loss and LAE ratio is primarily attributable to an increase in new business in states such asFlorida . The underwriting ratio has declined primarily as a result of spreading fixed underwriting costs over a larger written premium base as well as a decline in advertising spending. The GAAP combined ratio for the twelve months endedDecember 31, 2012 increased by 2.6 points compared to 2011. Excluding the effect of development from both periods, the GAAP combined ratio increased by 1.7 points for the twelve months endedDecember 31, 2012 compared to 2011. We expect the GAAP combined ratio, excluding reserve development, to be between 96.5% and 97.5% for the full year 2013. Losses from catastrophes were$4.0 million for the twelve months endedDecember 31, 2012 compared to$4.4 million for 2011. Losses from catastrophes during 2012 were primarily due to hail storms inTexas during the second quarter and Hurricane Sandy during the fourth quarter. The combined ratio in the Focus States increased by 2.7 points for the twelve months endedDecember 31, 2012 . An increase in the loss and LAE ratio was offset by a decline in the underwriting ratio. The increase in the loss and LAE ratio was primarily due to unfavorable development inCalifornia andFlorida . The increase in the loss and LAE ratio in the Focus States was partially offset by a decline in the underwriting ratio of 2.1 points. As we experience premium growth in these states, the ratio of fixed underwriting costs to premium has declined. The combined ratio in the Maintenance States decreased by 11.5 points for the twelve months endedDecember 31, 2012 , primarily due to a decline in the loss and LAE ratio inIllinois . We reclassifiedIllinois from a Focus State to a Maintenance State in 2012 and slowed new business production which drove the decline in the loss and LAE ratio. The combined ratio for the Commercial Vehicle product increased by 0.2 points during the twelve months endedDecember 31, 2012 , due to an increase in the loss and LAE ratio. The increase is due to several large losses incurred during the third quarter of 2012. 2011 compared to 2010 The statutory combined ratio for the twelve months endedDecember 31, 2011 increased by 7.4 points when compared to the twelve months endedDecember 31, 2010 . The twelve months endedDecember 31, 2011 included$4.5 million of unfavorable development on prior year loss and LAE reserves. The twelve months endedDecember 31, 2010 included$73.9 million of favorable development on prior year loss and LAE reserves. An increase in severity inFlorida personal injury protection coverage related to accident year 2010 was the primary source of the unfavorable development during the twelve months endedDecember 31, 2011 . Excluding the effect of development from all periods, the statutory combined ratio decreased by 1.2 points for the twelve months endedDecember 31, 2011 when compared to the twelve months endedDecember 31, 2010 . The GAAP combined ratio for the twelve months endedDecember 31, 2011 increased by 8.4 points when compared to the twelve months endedDecember 31, 2010 . Excluding the effect of development, the GAAP combined ratio decreased by 0.2 points during the twelve months endedDecember 31, 2011 when compared to the twelve months endedDecember 31, 2010 .
Losses from catastrophes were
The combined ratio in the Focus States increased by 6.5 points for the twelve months endedDecember 31, 2011 , primarily due to increases in the loss and LAE ratio inCalifornia . This increase was a result of unfavorable development on prior year loss and LAE reserves in the state versus favorable development in 2010. 37
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The combined ratio in the Maintenance States increased 4.0 points during the twelve months ended <chron>December 31, 2011 when compared to 2010, primarily due to increases in the loss and LAE ratios inAlabama andTennessee . We experienced$0.7 million in catastrophe losses during the year in these states. The loss and LAE ratio for the Commercial Vehicle product increased by 1.9 points during the twelve months endedDecember 31, 2011 when compared to 2010. This increase was primarily due to an increase in the loss ratio inCalifornia . This increase was more than offset by a decline in the underwriting ratio of 2.6 points. As Commercial Vehicle premium has grown, the ratio of fixed underwriting costs to premium has declined.
The loss and LAE ratio for the Classic Collector product increased by 26.3 points during the twelve months ended
Net Investment Income Investment income primarily includes gross investment revenue and investment management fees as shown in the following table (in thousands): Twelve months ended December 31, 2012 2011 2010 Investment income: Interest income on fixed maturities, cash and cash equivalents $ 38,234 $ 41,900 $ 45,813 Dividends on equity securities 1,415 693 853 Gross investment income $ 39,649 $ 42,593 $ 46,666 Investment expenses (2,077 ) (2,036 ) (2,033 ) Net investment income $ 37,571 $ 40,557 $ 44,633 Average investment balance, at cost $ 1,294,932 $ 1,225,885 $ 1,244,763 Returns excluding realized gains and losses 2.9 % 3.3 % 3.7 % 2012 compared to 2011 Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Net investment income for the year endedDecember 31, 2012 declined compared to 2011 primarily due to a decline in book yields because of a general decline in market interest rates for high quality bonds. In the current low interest rate environment, we expect that investment returns will continue to decline as proceeds from maturing or prepaid investments are expected to be reinvested at yields lower than the average book yield for the total portfolio. 2011 compared to 2010 Net investment income for the year endedDecember 31, 2011 declined compared to 2010 primarily due to a decline in book yields because of a general decline in market interest rates for high quality bonds. 38
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Realized Gains (Losses) on Investments We recorded realized gains (losses) on sales and disposals and impairments for unrealized losses deemed other-than-temporary as follows (before tax, in thousands): Twelve months ended December 31, 2012 Net Realized Impairments Gains (Losses) Recognized in Total Realized on Sales Earnings Gains (Losses) Fixed maturities $ 11,594 $ (1,393 ) $ 10,202 Equities 13,853 0 13,853 Total $ 25,447 $ (1,393 ) $ 24,055 Twelve months ended December 31, 2011 Net Realized Impairments Gains (Losses) Recognized in Total Realized on Sales Earnings Gains (Losses) Fixed maturities $ 7,295 $ (1,447 ) $ 5,848 Equities 2,750 0 2,750 Total $ 10,045 $ (1,447 ) $ 8,598 Twelve months ended December 31, 2010 Net Realized Impairments Gains (Losses) Recognized in Total Realized on Sales Earnings Gains (Losses)
Fixed maturities $ 12,423 $ (2,902 ) $ 9,521 Equities 921 (4 ) 917 Total $ 13,344 $ (2,906 ) $ 10,438 2012 compared to 2011 The increase in the total realized gain in 2012 was primarily a result of securities sold in the fourth quarter of 2012. To improve diversification, we sold our investment in a Vanguard U.S. broad based exchange traded fund for a pretax gain of$13.8 million and reinvested in a global exchanged traded fund. 2011 compared to 2010 The total realized gain in 2011 was primarily a result of securities sold to utilize the remainder of our capital loss carryforward. Gain on Sale of Subsidiaries OnSeptember 30, 2012 , we completed the sale of an inactive, shell subsidiary company to an unaffiliated third party. The total gain recorded on a GAAP basis was$2.9 million . OnDecember 31, 2011 , we completed the sale of two inactive, shell subsidiary companies to an unaffiliated third party. The total gain recorded on a GAAP basis was$4.1 million . In the future we intend to sell or dissolve other inactive shell companies. The primary reason for the sale of the companies is to reduce the administrative costs associated with maintaining licenses that are no longer needed to support our insurance operations. 39
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Other Income
Other income of
Interest Expense (in thousands) Twelve months ended December 31, 2012 2011 2010 5.5% Senior Notes $ 8,605 $ 10,807 $ 10,802 5.0% Senior Notes 3,934 0 0 Total $ 12,539 $ 10,807 $ 10,802 AtDecember 31, 2012 we had$275.0 million of senior notes outstanding. These notes carry a coupon rate of 5.0% and require no principal payment until maturity inSeptember 2022 . OnOctober 17, 2012 , we fully redeemed the$195.0 million outstanding principal of senior notes (the "5.5% Senior Notes") due 2014 at a price of 106.729%, or$208.1 million plus accrued interest of$1.8 million . (See Note 4 - Long-Term Debt of the Notes to Consolidated Financial Statements for additional information on the Senior Notes). Corporate General and Administrative Expenses (in thousands) Twelve months ended
December 31,
2012 2011 2010 Corporate general and administrative expenses $ 7,408 $ 7,664 $ 7,814 2012 compared to 2011 Corporate general and administrative expenses are comprised of expenses of the holding company, including board of directors' fees, directors and officers insurance and a portion of the salaries and benefits of senior executives. Corporate general and administrative expenses declined just$0.3 million dollars in 2012 when compared to 2011. 2011 compared to 2010 Corporate general and administrative expenses declined just$0.2 million dollars in 2011 when compared to 2010. Loss on Redemption of Long-Term Debt OnOctober 17, 2012 we fully redeemed the$195.0 million principal outstanding of the 5.5% Senior Notes at a price of 106.729%, or$208.1 million , plus accrued interest of$1.8 million . As a result, we recognized a pre-tax loss on redemption as follows (in thousands): Redemption price $ 208,122 Amortized cost at redemption (194,878 ) Unamortized issuance costs 352
Loss on redemption of debt, pre-tax
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Table of Contents Other Expenses (in thousands) Twelve months ended December 31, 2012 2011 2010 Corporate litigation expense $ 910 $ 630 $ (205 ) Loss on subleases 109 (824 ) 1,911 Loss on disposal of EDP software and equipment 59 635 71 Other 448 893 548 Total other expenses $ 1,526 $ 1,334 $ 2,324 2012 compared to 2011 Other expenses for the twelve months endedDecember 31, 2012 increased$0.2 million , primarily due to$1.0 million in sublease losses reversed in 2011. This increase was partially offset by a$0.6 million decline in losses on disposals of EDP software and equipment. 2011 compared to 2010 Other expenses for the twelve months endedDecember 31, 2011 declined$1.0 million , primarily due to a$2.7 million decline in sublease losses. In 2011, we reversed$1.0 million in sublease losses previously recognized for space that we no longer intend to sublet. Income Taxes The following table reconciles our U.S. statutory rate and effective tax rate for the periods endedDecember 31, 2012 , 2011 and 2010: Twelve months ended December 31, 2012 2011 2010 U.S. Statutory tax rate 35.0 % 35.0 % 35.0 % Adjustments: Dividends received deduction (1.3 )% (0.3 )% (0.1 )% Tax exempt interest (14.9 )% (6.5 )% (2.8 )% Adjustment to valuation allowance (29.0 )% (6.5 )% (3.2 )% Other 0.1 % 0.3 % 0.0 % Effective tax rate (10.1 )% 22.0 % 28.8 % In 2008, as a result of the significant fall in the stock market, the fair value of both our exchange traded fund ("ETF") and fixed securities fell significantly. At that time, we wrote the book value of these securities down to market as an other-than-temporary impairment ("OTTI") and thereby incurred a GAAP pre-tax loss. This loss created a basis difference that generated a significant deferred tax asset. Given the market conditions at the time, and the fact that we were in a capital loss carryover position, we did not believe that it was more-likely-than-not that this deferred tax asset would be recognized. Therefore, a full valuation allowance was established for this deferred tax asset. This was consistent with the full valuation allowance that had been established for the deferred tax asset relating to the capital loss carryover. The market conditions and the need to maintain a valuation allowance on these deferred tax assets were analyzed on a quarterly basis. The valuation allowance on the capital loss carryover was released as the carryover was utilized. In 2011, the capital loss carryover was fully utilized. The valuation allowance on the OTTI deferred tax asset was released as the securities were sold. In the fourth quarter of 2012, the ETF was sold as part of our plan to seek better diversification in our equity portfolio, resulting in a release of the valuation allowance related to the ETF. Due to the market recovery, the tax loss was fully recognized. Based on the remaining OTTI balance as ofDecember 31, 2012 , and our carryback potential, it is management's belief that it is more-likely-than-not that we will be able to fully utilize the tax deductions related to OTTI that would be recognized in the future. Therefore, the balance in the valuation allowance was released in the fourth quarter of 2012. 41
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Table of Contents ITEM 7A Quantitative and Qualitative Disclosures about Market Risk The information required by Item 7A is included in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption, Exposure to Market Risk.
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