AMERINST INSURANCE GROUP LTD – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Management's discussion and analysis ("MD&A") provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. The MD&A is divided into subsections entitled "Business Overview," "Critical Accounting Policies," "Results of Operations," "Liquidity and Capital Resources" and "Losses and Loss Adjustment Expenses." CAUTION CONCERNING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K, including this MD&A section, contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "target," "goal," and similar expressions are intended to identify forward-looking statements. All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A "Risk Factors" of this Form 10-K for a discussion of factors that could cause our actual results to differ materially from those in the forward-looking statements. However, the risk factors listed in Item 1A "Risk Factors" or discussed in this Form 10-K should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management's analysis only as of the date they are made. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
The following discussion addresses our financial condition and results of operations for the periods and as of the dates indicated.
Business Overview We are an insurance holding company based inBermuda owned primarily by accounting firms, persons associated with accounting firms, and individual CPA practitioners. We were formed in response to concerns about the pricing and availability of accountants' professional liability insurance in a difficult or "hard" market. Our mission is to be a company that provides insurance protection for professional service firms and engages in investment activities. Through APSL, aDelaware corporation and a wholly owned subsidiary of Mezco which is a wholly owned subsidiary of AmerInst, we act as the exclusive agent for C&F for the purposes of soliciting, underwriting, quoting, binding, issuing, cancelling, non-renewing and endorsing accountants' professional liability and lawyers' professional liability insurance coverage in all 50 states ofthe United States and the 18
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District of Columbia . We conduct our reinsurance business throughAMIC Ltd. , our wholly owned subsidiary, which is a registered insurer inBermuda . We are prepared, subject to obtaining the required licenses and registrations, to act as a direct issuer of accountants' professional liability insurance policies. Our investment portfolio is held in and managed by Investco, which is a subsidiary ofAMIC Ltd. AmerInst has two operating segments: (1) reinsurance activity, which includes investments and other activities, and (2) insurance activity, which offers professional liability solutions to professional service firms. See Note 13, Segment Information, of the notes to the consolidated financial statements contained in Item 8 of this annual report on Form 10-K for financial information concerning these segments.
The reinsurance segment had revenues of
The insurance segment had revenues of$856,085 for the year endedDecember 31, 2012 and$388,717 for the year endedDecember 31, 2011 . Operating and management expenses were$2,535,193 for the year endedDecember 31, 2012 and$2,680,058 for the year endedDecember 31, 2011 . This resulted in segment losses of$1,679,108 and$2,291,341 for the years endedDecember 31, 2012 and 2011, respectively. AmerInst has filed an application with the U.S. Patent andTrademark Office for a patent on a unique financing concept called RINITS™ that it has developed to securitize insurance and reinsurance risk, involving property, casualty, life and health. Such securitization would be by equity and debt financing ofBermuda special purpose companies licensed as reinsurers. It is AmerInst's intention to grant patent licenses to the special purpose companies and investment banking organizations which would market the securities. In addition to the license royalties, AmerInst would manage the special purpose companies for a fee, and at its option could invest in them as well. However, AmerInst may not be issued a patent, and even if so, may not be able to license such patent.
In addition to the patent application, AmerInst has obtained a trademark under which the concept would be marketed.
Our results of operations for the years ended
We operate our business with no long-term debt, no capital lease obligations, no purchase obligations, and no off-balance sheet arrangements required to be disclosed under applicable rules of theSEC . AmerInst's access to operating cash flows is from the payment of dividends from its subsidiaries. Critical Accounting Policies Basis of Presentation The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The major estimates reflected in the Company's financial statements include but are not limited to the liability for loss and loss adjustment expenses and other than temporary impairment of investments.
Unpaid Losses and Loss Adjustment Expense Reserves
The amount that we record as our liability for loss and loss adjustment expenses is a major determinant of net income each year. As discussed in more detail below under the heading "Losses and Loss Adjustment
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Expenses," the amount that we have reserved is based on actuarial estimates which were prepared as ofDecember 31, 2012 . Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a "low," "central" and "high" estimate of the loss and loss adjustment expenses. As ofDecember 31, 2012 , the range of actuarially determined liability for loss and loss adjustment expense reserves was as follows: the low estimate was$1.2 million , the high estimate was$1.6 million , and the central estimate was$1.4 million . We selected reserves of$1,408,190 as ofDecember 31, 2012 , which approximates the central estimate of our independent actuary. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management's policy has been to reserve conservatively, slightly above the actuarial central estimate.
Other than Temporary Impairment of Investments
Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include the Company's intent and ability to hold the security, changes in general economic conditions, the issuer's financial condition or near term recovery prospects, and the effects of changes in interest rates. AmerInst's accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis. Results of Operations We recorded a net loss of$734,093 and$1,069,160 in 2012 and 2011, respectively. The decrease in the net loss is mainly attributable to (i) the reduction of operating and management expenses from$4,056,243 in 2011 to$3,795,409 in 2012 as a result of the Company's focus on reducing operating expenses and (ii) the increase in commission income from$388,488 in 2011 to$855,597 in 2012 as a result of a higher volume of premiums written under the Agency Agreement in 2012, as discussed in further detail below. The net loss recorded for the year endedDecember 31, 2012 was largely attributable to operating and management expenses incurred by APSL, which were partially offset by (1) net realized gains on investments, (2) net premiums earned under the Reinsurance Agreement, (3) commission income earned under the Agency Agreement, and (4) other income, as discussed below in further detail. The net loss recorded during the year endedDecember 31, 2011 was largely attributable to operating and management expenses incurred by APSL, which were partially offset by net realized gains on investments and the recognition of the additional recoveries associated with the Arbitration. Our net premiums earned were$1,267,470 for the year endedDecember 31, 2012 compared to$412,840 for the year endedDecember 31, 2011 , an increase of$854,630 or 207%. The net premiums earned during 2012 and 2011 were attributable to net premium cessions from C&F under the Reinsurance Agreement in the amounts of$1,231,436 and$423,364 and to revisions to CAMICO premium estimates for prior years in the amounts of$36,034 and$(10,524) , respectively. The increase in net premiums earned under the Reinsurance Agreement resulted from increased cessions from C&F in 2012, arising from a higher level of underwriting activity under the Agency Agreement due to the marketing of the program by APSL. For the years endedDecember 31, 2012 and 2011, we recorded commission income under the Agency Agreement of$855,597 and$388,488 , respectively, an increase of$467,109 or 120.2%. This increase resulted from a higher volume of premiums written under the Agency Agreement in 2012.
We recorded other income of
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our equity investment portfolio in prior years and (2) net interest received from PDIC in the amount of
We recorded net investment income of$392,542 for the year endedDecember 31, 2012 compared to$409,434 for the year endedDecember 30, 2011 , a decrease of$16,892 or 4.1%. The marginal decline in net investment income was due to the reduction in the investment portfolio due to sales of certain equity securities. Annualized investment yield, calculated as total interest and dividends divided by the net average amount of total investments and cash and cash equivalents, was 1.7% in 2012, a marginal increase from the 1.6% yield earned in 2011. Sales of securities during the year endedDecember 31, 2012 resulted in realized gains on investments net of impairment of$1,615,628 compared to$1,779,892 during the year endedDecember 31, 2011 , a decrease of$164,264 or 9.2%. The decrease in realized gains primarily related to decreased sales of equity securities in an unrealized gain position in 2012 compared to 2011. Unrealized gain on investments was$5,789,076 atDecember 31, 2012 compared to$5,256,349 atDecember 31, 2011 . We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at fair value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The increase in unrealized gain on investments was due primarily to an improvement in the market value of the Company's equity portfolio. Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the fair value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis. The composition of the investment portfolio atDecember 31, 2012 and 2011 is as follows: 2012 2011 U.S. government agency securities 2 % 6 % Obligations of state and political subdivisions 34 38 Corporate debt securities 2 1 Equity securities (including the hedge fund) 62 55 100 % 100 % For the year endedDecember 31, 2012 , we recorded loss and loss adjustment expenses of$711,124 , derived by multiplying a loss ratio of 57.9% and the net premiums earned under the Reinsurance Agreement of$1,231,436 , partially offset by favorable development on PDIC. For the year endedDecember 31, 2011 , we recorded loss and loss adjustment recoveries of$153,028 as a result of the recognition of the additional recoveries awarded to the Company following the Arbitration in the amount of$315,299 , net of loss and loss adjustment expenses of$162,271 , derived by multiplying a loss ratio of 77.6% and the net premiums earned under the Reinsurance Agreement of$423,364 , offset by favorable development on CAMICO and PDIC. The reduction in the loss ratio associated with the Reinsurance Agreement resulted from favorable development in the 2010 and 2011 policy years.
We will continue to monitor our reserve for losses and loss expenses for any new claims information and adjust our reserve for losses and loss expenses accordingly.
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We recorded policy acquisition costs of$456,953 for the year endedDecember 31, 2012 compared to policy acquisition costs of$156,599 for the year endedDecember 31, 2011 . Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. The policy acquisition costs recorded for the years endedDecember 31, 2012 and 2011 were approximately 37% of the premiums earned under the Reinsurance Agreement of$1,231,436 and$423,364 , net of some immaterial policy acquisition costs and recoveries that were attributable to the revisions to the CAMICO premium estimates for prior years, respectively, as noted above. The Company expensed operating and management expenses of$3,795,409 for the year endedDecember 31, 2012 compared to$4,056,243 for the year endedDecember 31, 2011 , a decrease of$260,834 or 6.4%. The decrease is largely attributable to (1) a reduction in overall marketing expenses incurred by APSL during the year endedDecember 31, 2012 compared to 2011, (2) a decrease in salary expense incurred by APSL during the year endedDecember 31, 2012 compared to 2011 as a result of a reduction in the number of full-time salaried employees and employees who are paid hourly wages and (3) a reduction in legal expenses associated with the Arbitration during the year endedDecember 31, 2012 compared to 2011. Fair Value of Investments
The following tables show the fair value of the Company's investments in accordance with ASC 820, "Fair Value Measurements and Disclosures" as of
Fair value measurement using: Quoted prices in active markets for Significant other Significant Carrying Total fair identical assets observable inputs unobservable inputs amount value (Level 1) (Level 2) (Level 3)December 31, 2012 Fixed maturity investments: U.S. government agency securities $ 466,357 $ 466,357 $ - $ 466,357 $ - Obligations of state and political subdivisions 6,854,569 6,854,569 6,854,569 Corporate debt securities 344,556 344,556 344,556 Total fixed maturity investments 7,665,482 7,665,482 Equity securities (excluding the hedge fund) 11,098,669 11,098,669 11,098,669 Hedge fund 1,485,151 1,485,151 1,485,151 Total equity securities 12,583,820 12,583,820 Total investments $ 20,249,302 $ 20,249,302 $ 11,098,669 $ 7,665,482 $ 1,485,151 22
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Fair value measurement using: Quoted prices in active markets for Significant other Significant Carrying Total fair identical assets observable inputs unobservable inputs amount value (Level 1) (Level 2) (Level 3)December 31, 2011 Fixed maturity investments: U.S. government agency securities $ 1,454,105 $ 1,454,105 $ - $ 1,454,105 $ - Obligations of state and political subdivisions 8,665,534 8,665,534 8,665,534 Corporate debt securities 329,208 329,208 329,208 Total fixed maturity investments 10,448,847 10,448,847 Equity securities (excluding the hedge fund) 10,900,770 10,900,770 10,900,770 Hedge fund 1,395,933 1,395,933 1,395,933 Total equity securities 12,296,703 12,296,703 Total investments $ 22,745,550 $ 22,745,550 $
10,900,770 $ 10,448,847 $ 1,395,933
There were no transfers between Levels 1 and 2 during the years ended
The following is a reconciliation of the beginning and ending balance of investments measured at fair value on a recurring basis using significant unobservable (Level 3) inputs for the year ended
2012
2011
Balance classified as Level 3, beginning of year
Total gains or losses included in earnings: - - Net realized gains - -
Change in fair value of hedge fund investments 89,218 (88,951 )
Purchases or sales - - Transfers in and/or out of Level 3 - - Ending balance $ 1,485,151 $
1,395,933
There were no transfers into or from the Level 3 hierarchy during the years ended
The Company assesses whether declines in the fair value of its fixed maturity investments classified as available-for-sale represent impairments that are other-than-temporary by reviewing each fixed maturity investment that is impaired and (1) determining if the Company has the intent to sell the fixed maturity investment or if it is more likely than not that the Company will be required to sell the fixed maturity investment before its anticipated recovery; and (2) assessing whether a credit loss exists, that is, where the Company expects that the present value of the cash flows expected to be collected from the fixed maturity investment are less than the amortized cost basis of the investment. The Company had no planned sales of its fixed maturity investments classified as available-for-sale that were in an unrealized loss position atDecember 31, 2012 . In assessing whether it is more likely than not that the Company will be required to sell a fixed maturity investment before its anticipated recovery, the Company 23
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considers various factors including its future cash flow requirements, legal and regulatory requirements, the level of its cash, cash equivalents, short term investments and fixed maturity investments available for sale in an unrealized gain position, and other relevant factors. For the year endedDecember 31, 2012 , the Company did not recognize any other-than-temporary impairments due to required sales. In evaluating credit losses, the Company considers a variety of factors in the assessment of a fixed maturity investment including: (1) the time period during which there has been a significant decline below cost; (2) the extent of the decline below cost and par; (3) the potential for the fixed maturity investment to recover in value; (4) an analysis of the financial condition of the issuer; (5) the rating of the issuer; and (6) failure of the issuer of the fixed maturity investment to make scheduled interest or principal payments. If we conclude a security is other-than-temporarily impaired, we write down the amortized cost of the security to fair value, with a charge to net realized investment gains (losses) in the Consolidated Statement of Operations. Gross unrealized losses on the investment portfolio as ofDecember 31, 2012 andDecember 31, 2011 , relating to three and two fixed maturity securities and one and two equity securities, amounted to$17,440 and$39,791 , respectively. This decrease was attributable to equity securities which we determined were not other than temporarily impaired based on the process described above. The Company has the intent and ability to hold these securities either to maturity or until the fair value recovers above the adjusted cost. The unrealized losses on these available for sale fixed maturity securities were not as a result of credit, collateral or structural issues. As a result of the decline in fair value below cost, the Company recorded a total other-than-temporary impairment charge of$229,697 and$152,450 on three and two equity securities during the years endedDecember 31, 2012 and 2011, respectively. Our fixed income, equity and hedge fund portfolios are invested in accordance with a written Investment Policy Statement adopted by our Board of Directors. We engage professional advisors to manage day-to-day investment matters under the oversight of our Investment Committee. Our fixed income portfolio is managed with the target objectives of achieving an annualized rate of return for the trailing 5-year period of 250 basis points over the Consumer Price Index, and total returns commensurate with Merrill Lynch's U.S. Domestic Index. Our overall fixed income portfolio is required to have at least an "A" S&P rating, an "A2" Moody's rating or an equivalent rating from comparable rating agencies. Our equity securities are managed by an external large cap value advisor. Our investment approach is to focus on increasing the fair market value of our equity securities by investing in companies that may or may not be paying a dividend but whose market values may increase over time. Some of the key factors we consider in a prospective company to invest in include the discount to value and the quality of the management team. Our equity portfolios are managed with the target objectives of achieving an annualized rate of return over a trailing 3-year to 5-year period of 400 basis points over the Consumer Price Index, total returns at least equal to representative benchmarks such as the various S&P indices, and a ranking in the top half of the universe of other actively managed equity funds with similar objectives and risk profiles.
Our hedge fund portfolio is managed to reduce overall portfolio risk and it is required to invest over all major strategies.
Under existing accounting principles generally accepted inthe United States , we are required to recognize certain assets at their fair value in our consolidated balance sheets. This includes our fixed maturity investments and equity securities. In accordance with the Fair Value Measurements and Disclosures Topic of FASB's ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement 24
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date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows: • Level 1: Observable inputs to the valuation methodology that are quoted
prices (unadjusted) for identical assets or liabilities in active markets.
• Level 2: Observable inputs to the valuation methodology other than quoted
market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets and liabilities in markets that are not active and inputs other than quoted
prices that are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the asset or liability.
• Level 3: Inputs to the valuation methodology that are unobservable for the
asset or liability. At each measurement date, we estimate the fair value of the security using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our investments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of investments. The following describes the valuation techniques we used to determine the fair value of investments held as ofDecember 31, 2012 and what level within the fair value hierarchy each valuation technique resides:
• U.S. government agency securities: Comprised primarily of bonds issued by
the
fair values of U.S. government agency securities are priced using the
spread above the risk-free U.S. Treasury yield curve. As the yields for the
risk-free U.S. Treasury yield curve are observable market inputs, the fair
values of U.S. government agency securities are included in the Level 2
fair value hierarchy. AmerInst considers that there is a liquid market for
the types of securities held. Broker quotes are not used for fair value
pricing.
• Obligations of state and political subdivisions: Comprised of fixed income
obligations of state and local governmental municipalities. The fair values
of these securities are based on quotes and current market spread
relationships, and are included in the Level 2 fair value hierarchy.
AmerInst considers that there is a liquid market for the types of securities held. Broker quotes are not used for fair value pricing.
• Corporate debt securities: Comprised of bonds issued by corporations. The
fair values of these securities are based on quotes and current market
spread relationships, and are included in the Level 2 fair value hierarchy.
AmerInst considers that there is a liquid market for the types of securities held. Broker quotes are not used for fair value pricing.
• Equity securities, at fair value: Comprised primarily of investments in the
common stock of publicly traded companies in the U.S. All of the Company's
equities are included in the Level 1 fair value hierarchy. The Company
receives prices based on closing exchange prices from independent pricing
sources to measure fair values for the equities.
• Hedge fund: Comprised of a hedge fund whose objective is to seek attractive
long-term returns with lower volatility by investing in a range of
diversified investment strategies. The fund invests in a diversified pool
of hedge fund managers, generally across six different strategies: long/short equities, long/short credit, macro, multi-strategy opportunistic, event-driven, and portfolio hedge. The fair value of the hedge fund is based on the net asset value of the fund as reported by the external fund manager. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset
value is a permitted practical expedient. The fair value of our hedge fund
is included in the Level 3 fair value hierarchy. 25
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While we obtain pricing from independent pricing services, management is ultimately responsible for determining the fair value measurements for all securities. To ensure fair value measurement is applied consistently and in accordance with U.S. GAAP, we periodically update our understanding of the pricing methodologies used by the independent pricing services. We also challenge any prices we believe may not be representative of fair value under current market conditions. Our review process includes, but is not limited to: (i) initial and ongoing evaluation of the pricing methodologies and valuation models used by outside parties to calculate fair value; (ii) quantitative analysis; (iii) a review of multiple quotes obtained in the pricing process and the range of resulting fair values for each security, if available, and (iv) randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates provided by the independent pricing sources. There have been no material changes to any of our valuation techniques from what was used as ofDecember 31, 2011 . Since the fair value of a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets or transfer our liabilities in an orderly transaction between participants at the measurement date. Though current market conditions appear to have improved, there is still the potential for further instability. This could present additional risks and uncertainties for our business and make it more difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions and estimates that may have significant period-to-period changes that could have a material adverse effect on our results of operations or financial condition. During 2012, the Company invested in certificates of deposit ("CD") in the amount of$1,470,000 comprising of fully insured time deposits placed withFederal Deposit Insurance Corporation ("FDIC") insured commercial banks and savings associations. TheFDIC , an independent agency of theUnited States government , protects depositors up to an amount of$250,000 per depositor, per insured institution.FDIC insurance is backed by the full faith and credit of theUnited States government . The stated interest rate of anFDIC insured CD varies greatly among commercial banks and savings associations, depending on the term of the CD and the institution's need for funding. The liquidity of "marketable" CDs is marginal, even though they are assigned anFDIC number, a CUSIP number and are held in book-entry form through theDepository Trust Company . Depending on market liquidity and conditions, the bid price for anFDIC insured CD would reflect the supply of and the demand for deposits of the particular bank or savings association, as well as prevailing interest rates, the remaining term of the deposit, specific features of the CD, and compensation of the broker arranging the sale of the CD. These time deposits have maturities ranging from two to five years and are classified as other invested assets on the Company's consolidated balance sheet. As ofDecember 31, 2012 , our total investments were$20,249,302 , a decrease of$2,496,248 , or 11%, from$22,745,550 atDecember 31, 2011 . The decrease was primarily due to sales of certain equity securities, the maturity of two fixed maturity securities and the increase in time deposits placed withFDIC insured commercial banks and saving associations classified as other invested assets. The cash and cash equivalents balance increased from$904,485 atDecember 31, 2011 to$1,034,485 atDecember 31, 2012 , an increase of$130,000 or 14.4%. The amount of cash and cash equivalents varies depending on the maturities of fixed term investments and on the level of funds invested in money market funds. The restricted cash and cash equivalents balance increased from$435,924 atDecember 31, 2011 to$1,349,744 atDecember 31, 2012 , an increase of$913,820 or 209.6%. The increase is due to the timing of sales and maturities of investments held as restricted cash atDecember 31, 2012 that have not yet been reinvested. As discussed above, during 2012, the Company invested in CDs classified as other invested assets in the amount of$1,470,000 . The ratio of cash, total investments and other invested assets to total liabilities atDecember 31, 2012 was 6.34:1, compared to a ratio of 8.25:1 atDecember 31, 2011 .
The decrease in total cash and investments at
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during 2012, and (3) dividends of$327,992 paid during 2012. These reductions were partially offset by the increase in the fair value of certain equity securities as a result of favorable market conditions and positive cash inflows in relation to net investment income and net premiums received under the Reinsurance Agreement in the amount of$833,757 .
Liquidity and Capital Resources
Our cash needs consist of settlement of losses and expenses under our reinsurance treaties and funding day-to-day operations. During the continued implementation of our business plan, our management expects to meet these cash needs from cash flows arising from our investment portfolio. Because substantially all of our assets are marketable securities, we expect that we will have sufficient flexibility to provide for unbudgeted cash needs which may arise without resorting to borrowing, subject to regulatory limitations. Because of CNA's election not to renew its reinsurance agreement withAMIC Ltd. in 2009, we experienced a significant decrease in our net premiums earned which has adversely affected our revenues over the past three years. As a result we have experienced a decrease in our total investments in 2010, 2011 and 2012 due to net cash outflows in order to fund our operational expenses. The reduction in the value of our investment portfolio has been accompanied by a corresponding reduction in our shareholders' equity during this three-year period. Unless we are able to significantly increase our revenues under new or existing agency and/or reinsurance agreements in future periods, we would expect the value of our investment portfolio and our shareholders' equity to continue to decrease as investment assets are used to cover our revenue shortfall. The assumed reinsurance balances receivable represents the current assumed premiums receivable less commissions payable to the fronting carriers. As ofDecember 31, 2012 , the balance was$274,526 compared to$183,518 as ofDecember 31, 2011 . The increase resulted from a higher level of premiums assumed under the Reinsurance Agreement during 2012. The assumed reinsurance payable represents current reinsurance losses payable to the fronting carriers. As ofDecember 31, 2012 , the balance was$178,880 compared to$86,685 as ofDecember 31, 2011 . This balance fluctuates due to the timing of reported losses. Deferred policy acquisition costs, which represent the deferral of ceding commission expense related to premiums not yet earned, increased from$146,226 atDecember 31, 2011 to$268,643 atDecember 31, 2012 . The increase in deferred policy acquisition costs in 2012 was due to the increase in both net premiums written and unearned premiums assumed under the Reinsurance Agreement compared to the prior year. The ceding commission rate under the Reinsurance Agreement is approximately 37%. Prepaid expenses and other assets were$412,065 atDecember 31, 2012 , an increase of 8.9% fromDecember 31, 2011 . The balance primarily relates to (1) prepaid directors' and officers' liability insurance costs, (2) the prepaid directors' retainer, (3) prepaid professional fees and (4) premiums due to APSL under the Agency Agreement. The increase in the balance was attributable to an increase in prepaid professional fees. This balance fluctuates due to the timing of the prepayments. Accrued expenses and other liabilities primarily represent premiums payable by APSL to C&F under the Agency Agreement and expenses accrued relating largely to professional fees. The balance increased from$1,396,332 atDecember 31, 2011 to$1,490,727 atDecember 31, 2012 , an increase of$94,395 or 6.8%. The increase in the balance was attributable to an increase in premiums payable by APSL to C&F under the Agency Agreement, which were partially offset by a reduction in expenses accrued in relation to professional fees. This balance fluctuates due to the timing of the (1) premium payments to C&F and (2) payments of professional fees. AmerInst paid two semi-annual dividends of$0.25 and$0.47 per share during 2012 and 2011, respectively. During 2012, the total dividend amount was reduced by$14,585 which represents a write back of uncashed 27
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dividends issued prior to 2007 to shareholders that we have been unable to locate. During 2011, the total dividend amount was reduced by$39,513 , which represents a write back of uncashed dividends issued prior to 2006 to shareholders that we were unable to locate. Since AmerInst began paying consecutive dividends in 1995, our original shareholders have received approximately$19.37 in cumulative dividends per share, which when measured by a total rate of return calculation has resulted in an effective annual rate of return of approximately 9.38% from the inception of the Company, based on a per share purchase price of$8.33 paid by the original shareholders, and using a book value of$32.46 per share as ofDecember 31, 2012 . Total dividends declared were$327,992 and$615,993 in 2012 and 2011, respectively, net of the recorded write backs. Continuation of dividend payments is subject to the Board of Directors' continuing evaluation of our level of surplus compared to our capacity to accept more business. One of our objectives is to retain sufficient surplus to enable the successful implementation of our new business plan.AMIC Ltd.'s ability to pay dividends to AmerInst is subject to the provisions of theBermuda insurance and companies laws and the requirement to provide the ceding companies with collateral. Under the Companies Act,AMIC Ltd. would be prohibited from declaring or paying a dividend atDecember 31, 2012 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. As ofDecember 31, 2012 , approximately$33 million was available for the declaration of dividends to shareholders. However, due to the requirement to provide the ceding companies with collateral, approximately$25 million was available for the payment of dividends to the shareholders. In addition, AMIC Ltd. must be able to pay its liabilities as they fall due after the payment of a dividend. Our ability to pay dividends to common shareholders and to pay our operating expenses is dependent on cash dividends from our subsidiaries. The payment of such dividends byAMIC Ltd. , including its subsidiary Investco, to us is also limited underBermuda law by the Insurance Act and Related Regulations which require thatAMIC Ltd. maintain minimum levels of solvency and liquidity. For the years endedDecember 31, 2012 and 2011 these requirements have been met as follows: Statutory Capital & Surplus Relevant Assets Minimum Actual Minimum Actual December 31, 2012 $ 1,000,000 $ 33,911,845 $ 14,858,789 $ 14,858,789 December 31, 2011 $ 1,000,000 $ 33,315,313 $ 14,430,343 $ 14,430,343AMIC Ltd. has received the BMA's approval for the utilization of its investment in Investco as a relevant asset up to an aggregate amount sufficient to meet and maintain the minimum liquidity ratio. The BMA has authorized Investco to purchase the Company's common shares from shareholders who have died or retired from the practice of public accounting and on a negotiated basis. ThroughMarch 1, 2013 , Investco had purchased 152,801 common shares from shareholders who had died or retired for a total purchase price of$4,229,376 . From time to time, Investco has also purchased shares in privately negotiated transactions. Through that date, Investco had purchased an additional 75,069 common shares in such privately negotiated transactions for a total purchase price of$1,109,025 .
Losses and Loss Adjustment Expenses
The consolidated financial statements include our estimated liability for unpaid losses and loss adjustment expenses ("LAE") for our insurance operations. LAE is determined utilizing both case-basis evaluations and actuarial projections, which together represent an estimate of the ultimate net cost of all unpaid losses and LAE incurred throughDecember 31 of each year. These estimates are subject to the effect of trends in future claim severity and frequency. The estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as appropriate, and reflected in current financial reports. The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. Future average severity 28
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is projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. These anticipated trends are monitored based on actual developments and are modified as necessary.
An actuarial review and projection was performed for us by our independent actuary as of
Loss reserves relate only to accountants' and attorneys' professional liability from PDIC, CAMICO and C&F programs, and were calculated under the methodologies described below. PDIC was a new program for the Company in 2003. The relationship with the carrier of that insurance ended onDecember 31, 2003 . Therefore, policies written during 2003 are the only ones we have reinsured. To calculate the policy year ultimate losses and allocated loss adjustment expenses for PDIC the actuary applied incurred loss development, incurred Bornhuetter-Ferguson ("BF"), and expected loss methods to the actual PDIC experience. In the calculations, the actuary used industry incurred loss and allocated loss adjustment expenses development patterns and an a priori loss and allocated loss adjustment expenses ratio for use in the BF and expected loss and allocated loss adjustment expenses method calculations. The a priori loss and allocated loss adjustment expenses ratio was selected judgmentally based on the Company's unpaid claim liability review as ofDecember 31, 2011 . The actuary selected low and high scenario loss ratio estimates around the central loss ratio estimates. The low and high scenario ultimate loss and allocated loss adjustment expenses estimates were calculated by multiplying net earned premium throughDecember 31, 2012 by the low and high scenario loss ratio selections. The final reported claim was closed during 2011 and although we no longer anticipate any liability for further claims related to this period of coverage, there is a remote possibility further claims could be reported. CAMICO was a new program for the Company in 2005. To calculate the policy year ultimate losses and allocated loss adjustment expenses for CAMICO the actuary applied paid and incurred loss development, paid and incurred BF, and expected loss and allocated loss adjustment expenses ratio methods to the actual CAMICO experience as ofDecember 31, 2012 . In the calculations, the actuary used CAMICO and industry benchmark paid and incurred loss and allocated loss adjustment expenses development information. The a priori loss and allocated loss adjustment expenses ratios used in the BF and expected loss and allocated loss adjustment expenses method calculations were selected based on the Company's unpaid claim liability review of CAMICO experience as ofDecember 31, 2011 . Low and high scenario ultimate loss and allocated loss adjustment expense estimates were calculated by selecting and applying lower and higher a priori loss and allocated loss adjustment expense ratios for use in the actuarial methods, and by selecting low and high estimates of ultimate loss and allocated loss adjustment expense amounts from the results of the applied actuarial methods. C&F was a new program for the Company in 2010. To calculate the policy year ultimate losses and allocated loss adjustment expenses for C&F, the actuary applied incurred loss development, incurred BF, and expected loss and allocated loss adjustment expense ratio methods to the actual C&F experience as ofDecember 31, 2012 . In the calculations, the actuary used an industry benchmark incurred loss and allocated loss adjustment expense development patterns. The Low, Central, and High a priori loss and allocated loss adjustment expenses ratios used in the BF and expected loss and allocated loss adjustment expense method calculations were selected based on previous work performed for AmerInst related to the pricing of accountants' professional liability insurance as well as on a review of industry ultimate loss ratios for accountants' professional liability and lawyers' professional liability coverages from publicly available data. The low and high scenario ultimate loss and allocated loss adjustment expense estimates were calculated by applying the selectedLow and High a priori loss and allocated loss adjustment expense ratios in the actuarial methods, and by selecting low and high estimates of ultimate loss and allocated loss adjustment expense amounts from the results of the applied actuarial methods. 29
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The following table shows the development of the estimated liability for the previous 10 years of the Company's operations:
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSES DEVELOPMENT (Thousands of U.S. Dollars) Year Ended December 31, 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Gross Liability for Loss and LAE Reserves $ 30,479 $ 28,724 $ 29,702 $ 28,885 $ 28,161 $ 27,411 $ 24,416 $ 1,510 $ 1,203 $ 1,043 $ 1,408 Reinsurance Recoverable for Unpaid Loss and LAE Reserves 674 - - - - - - - - - - Net Liability for Unpaid Losses and LAE Reserves $ 29,805 $ 28,724 $ 29,702 $ 28,885 $ 28,161 $ 27,411 $ 24,416 $ 1,510 $ 1,203 $ 1,043 $ 1,408 Year Ended December 31, 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Losses Re-estimated as of: One Year Later $ 25,193 $ 27,210 $
27,454
23,676 24,962
24,893 23,493 19,780 18,006 20,980 1,399
1,006
Three Years Later 21,429 22,400
22,062 17,752 15,143 17,832 20,873 1,296 Four Years Later
18,867 19,570
16,321 13,916 15,011 17,740 20,786 Five Years Later
16,037 13,836 14,115 13,844 14,931 17,682 Six Years Later 11,783 12,976 14,076 13,784 14,899 Seven Years Later 11,120 12,953 13,974 13,782 Eight Years Later 11,120 12,894 13,974 Nine Years Later 11,120 12,894 Ten Years Later 11,120
Cumulative Redundancy (Deficiency) 18,685 15,830 15,728 15,103 13,262 9,729 3,630 214
197 104 - Cumulative Amount Paid Through: One Year Later 3,697 3,557 4,678 3,820 3,314 3,970 19,902 334 322 217 - Two Years Later 6,165 6,943 7,729 6,166 6,310 17,208 20,195 656 444 Three Years Later 7,195 8,995 9,049 8,176 14,653 17,406 20,427 773 Four Years Later 8,954 9,690 10,225 13,675 14,759 17,540 20,480 Five Years Later 9,079 10,149 13,957 13,687 14,830 17,553 Six Years Later 9,205 12,885 13,969 13,747 14,839 Seven Years Later 11,120 12,892 13,974 13,752 Eight Years Later 11,120 12,895 13,974 Nine Years Later 11,120 12,895 Ten Years Later 11,120 The above table of losses re-estimated has been prepared on a net basis (i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up. The table has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the costs of providing such information relative to any benefits of providing it. The above table presents the development of balance sheet liabilities for 2002 through 2012 as of year-end 2012, and includes the CNA program liabilities through 2008. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years. 30
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This liability represents the estimated amount of losses and LAE for claims arising in all prior years, both paid and unpaid at the balance sheet date, including losses that had been incurred, but not yet reported, to the Company. The upper portion of the table shows the experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 2005 liability has developed a$15,103,000 redundancy which has been reflected in income in subsequent years as the reserves were re-estimated. The lower section of the table shows the cumulative amount paid in respect of the previously recorded liability as of the end of each succeeding year. For example, the 2005 year end liability was originally$28,885,000 . As ofDecember 31, 2012 , we had paid$13,752,000 of the currently estimated$13,782,000 of losses and LAE that had been incurred for 2005 and prior years through the end of 2012; thus an estimated$30,000 in losses incurred through 2005 remain unpaid as of the current financial statement date. In evaluating this information, it should be understood that each amount includes the effects of all changes in amounts for prior periods. This table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements required to be disclosed under Item 303(a)(4) of Regulation S-K promulgated by the
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