NATIONAL INTERSTATE CORP – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Forward-Looking Statements
This document, including information incorporated by reference, contains "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements, trend analyses and other information contained in this Form 10-Q relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "may," "target," "anticipate," "believe," "plan," "estimate," "expect," "intend," "project," and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Factors that could contribute to these differences include, among other things:
• general economic conditions, weakness of the financial markets and other
factors, including prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other
things) our ability to sell our products and to collect amounts due to us,
our ability to access capital resources and the costs associated with such
access to capital and the market value of our investments; • our ability to manage our growth strategy; • customer response to new products and marketing initiatives; • tax law and accounting changes;
• increasing competition in the sale of our insurance products and services
and the retention of existing customers; • changes in legal environment;
• regulatory changes or actions, including those relating to the regulation
of the sale, underwriting and pricing of insurance products and services
and capital requirements; • levels of natural catastrophes, terrorist events, incidents of war and other major losses; • adequacy of insurance reserves; and • availability of reinsurance and ability of reinsurers to pay their
obligations.
The forward-looking statements herein are made only as of the date of this report. We assume no obligation to publicly update any forward-looking statements.
General
We underwrite and sell traditional and alternative risk transfer ("ART") property and casualty insurance products primarily to the passenger transportation industry, the trucking industry and to moving and storage transportation companies, general commercial insurance to small businesses inHawaii andAlaska and personal insurance to owners of recreational vehicles and commercial vehicles throughoutthe United States . EffectiveJuly 1, 2010 , we and our principal insurance subsidiary,National Interstate Insurance Company ("NIIC"), completed the acquisition ofVanliner Group, Inc. ("Vanliner") fromUniGroup, Inc. ("UniGroup") whereby NIIC acquired all of the issued and outstanding capital stock ofVanliner and we acquired certain information technology assets. As part of this acquisition, UniGroup agreed to provide us with comprehensive financial guarantees, including a four and a half-year balance sheet guaranty whereby both favorable and unfavorable balance sheet developments inure to UniGroup. Through the acquisition of, NIIC acquired Vanliner Insurance Company ("VIC"), a market leader in providing insurance for the moving and storage industry. Obtaining a presence in this industry was our primary strategic objective associated with the acquisition. We have five property and casualty insurance subsidiaries: NIIC, VIC,National Interstate Insurance Company of Hawaii, Inc. ("NIIC-HI"),Triumphe Casualty Company ("TCC"),Hudson Indemnity, Ltd. ("HIL") and five active agency and service subsidiaries. We write our insurance policies on a direct basis through NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed 19
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in all 50 states and theDistrict of Columbia . NIIC-HI is licensed inOhio ,Hawaii ,Michigan andNew Jersey . TCC holds licenses for multiple lines of authority, including auto-related lines, in 26 states and theDistrict of Columbia . HIL is domiciled in theCayman Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC, primarily for the ART component. Insurance products are marketed through multiple distribution channels, including independent agents and brokers, program administrators, affiliated agencies and agent internet initiatives. We use our five active agency and service subsidiaries to sell and service our insurance business.
As of
Results of Operations
Overview
Through the operations of our subsidiaries, we are engaged in property and casualty insurance operations. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry.
We derive our revenues primarily from premiums generated by our insurance policies and income from our investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses ("LAE"), commissions and other underwriting expenses and other operating and general expenses.
The following table sets forth ourMarch 31, 2012 and 2011 net income from operations and the after-tax impact from the operating results ofVanliner's guaranteed runoff business, which are non-GAAP financial measures, as well as after-tax net realized gains from investments and net income, all of which we believe are useful tools for investors and analysts in analyzing ongoing operating trends. Three Months Ended March 31, 2012 2011(1) Amount Per Share Amount Per Share (Dollars in thousands, except per share data) Net income from operations $ 8,564 $ 0.44 $ 9,909 $ 0.51 After-tax net realized gain from investments 1,132 0.06 780 0.04 After-tax impact from balance sheet guaranty for Vanliner 50 0.00 (1,271 ) (0.07 ) Net income $ 9,746 $ 0.50 $ 9,418 $ 0.48
(1) 2011 results have been retrospectively adjusted for the changes to
accounting for deferred policy acquisition costs required under Accounting
Standards Update No. 2010-26 ("ASU 2010-26").
As discussed above, UniGroup provided us with comprehensive financial guarantees related to the runoff ofVanliner's final balance sheet whereby both favorable and unfavorable balance sheet development inures to the seller. In accordance with purchase accounting requirements we were required to determine the fair value of the future economic benefit of the financial guarantees and acquired loss reserves as of the date of acquisition, despite the fact that certain gains and losses related to the financial guaranty would be reflected in operations as they are incurred in future periods. As a result, the recognition of the revenues and expenses associated with the guaranteed runoff business will not occur in the same period and will result in combined ratios which are inconsistent with the negotiated combined ratio which was to approximate 100% for theVanliner guaranteed business. As such, the after-tax impact from the runoff business guaranteed by the seller for the three months endedMarch 31, 2012 and 2011 have been removed from the net after-tax earnings from operations to reflect only those results of the ongoing business. Our net income from operations for the first quarter of 2012 was$8.6 million ($0.44 per share diluted) compared to$9.9 million ($0.51 per share diluted) for the same period in 2011. This decrease was driven by the elevated loss and LAE ratio from our ongoing operations, which excludes the impact from the runoff of the guaranteedVanliner business, of 73.1% for the three months endedMarch 31, 2012 as compared to 67.0% for the same period in 2011. This 6.1 percentage point increase was driven by higher than average claims severity experienced in two historically high-performing products within ourHawaii andAlaska and ART transportation components during the first quarter of 2012, as well as adverse claim development from prior years' loss reserves. Partially offsetting the elevated loss results was the growth in net investment income, which was attributable to the shift into higher-yielding state and local government obligations and mortgage-backed securities that was concentrated in the second half of 2011. 20
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We recorded after-tax net realized gains from investments of$1.1 million ($0.06 per share diluted) for the first quarter of 2012 compared to$0.8 million ($0.04 per share diluted) for the same period in 2011. The after-tax net realized gains for the three months endedMarch 31, 2012 were primarily generated by net gains associated with equity partnership investments, while the after-tax net realized gains for the comparable period in 2011 related primarily to sales of securities.
Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following table sets forth an analysis of gross premiums written by business component during the periods indicated: Three Months Ended March 31, 2012 2011 Amount Percent Amount Percent (Dollars in thousands) Alternative Risk Transfer $ 76,438 58.7 % $ 80,861 60.2 % Transportation 35,207 27.0 % 34,097 25.4 % Specialty Personal Lines 13,053 10.0 % 14,660 10.9 % Hawaii and Alaska 3,880 3.0 % 3,678 2.7 % Other 1,647 1.3 % 1,017 0.8 % Gross premiums written $ 130,225 100.0 % $ 134,313 100.0 % Gross premiums written includes both direct and assumed premium. During the first quarter of 2012, our gross premiums written decreased$4.1 million , or 3.0%, compared to the same period in 2011, primarily due to the impact from actions taken in 2011 in two ART programs, as previously reported. These programs, one of which underwent significant underwriting actions while the other was terminated, comprised 6.9% of our gross premiums written during the first quarter of 2011. Gross premiums written in our ART component decreased$4.4 million , or 5.5%, during the first quarter of 2012 compared to the same period in 2011. Excluding the impact of the two aforementioned programs, the remainder of our ART component increased$3.7 million , or 5.1%, due to a combination of growth in existing ART programs, both from the addition of new customers and an increase in exposures on renewal business, and near 100% member retention in group ART programs renewing during the period. Our transportation component's gross premiums written increased by$1.1 million , or 3.3%, in the first quarter of 2012 compared to the same period in 2011, primarily due to growth in our trucking transportation product which benefited from increases in both rates and exposures during the period, as we have begun to see the effects of a gradually improving commercial insurance market. The decrease of$1.6 million , or 11.0%, in our specialty personal lines component was primarily related to the impact of the ongoing pricing and underwriting actions associated with the commercial vehicle product which have continued into 2012. We also experienced a decrease in our recreational vehicle product due to the continued trend toward recreational vehicle owners going directly to insurance companies for quotes versus using an agent. Our group ART programs, which focus on specialty or niche businesses, provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention and reinsurance placement, along with providing various types of property and casualty insurance coverage. Insurance coverage is provided primarily to companies with similar risk profiles and to specified classes of business of our agent partners. As part of our ART programs, we have analyzed, on a quarterly basis, members' loss performance on a policy year basis to determine if there would be a premium assessment to participants or if there would be a return of premium to participants as a result of less-than-expected losses. Assessment premium and return of premium are recorded as adjustments to premiums written (assessments increase premiums written; returns of premium reduce premiums written). For the first quarter of 2012 and 2011, we recorded premium assessments of$1.5 million and$1.2 million , respectively. 21
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Premiums Earned
Three months ended
Three Months Ended March 31, Change 2012 2011 Amount Percent (Dollars in thousands) Premiums earned: Alternative Risk Transfer $ 58,210 $ 46,108 $ 12,102 26.2 % Transportation 35,137 40,387 (5,250 ) (13.0 %) Specialty Personal Lines 11,817 13,862 (2,045 ) (14.8 %) Hawaii and Alaska 3,384 3,362 22 0.7 % Other 1,577 1,420 157 11.1 % Total premiums earned $ 110,125 $ 105,139 $ 4,986 4.7 % Our premiums earned increased$5.0 million , or 4.7%, to$110.1 million during the three months endedMarch 31, 2012 compared to$105.1 million for the same period in 2011. The increase is primarily attributable to our ART component, which grew$12.1 million , or 26.2%, over 2011 mainly due to the gross premiums written growth from existing and new programs experienced throughout 2011. Partially offsetting this increase were decreases in our transportation and specialty personal lines components of$5.3 million , or 13.0%, and$2.0 million , or 14.8%, respectively. The$5.3 million decline in our transportation component was driven by a$15.1 million decrease related to the runoff ofVanliner's earned premiums related to the business covered by the balance sheet guaranty, which was partially offset by growth experienced in our moving and storage products throughout 2011. The decrease in our specialty personal lines component was due to the decline in premiums written in our commercial vehicle and recreational vehicle products experienced throughout 2011.
Underwriting and Loss Ratio Analysis
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio. A combined ratio under 100% is indicative of an underwriting profit. Losses and LAE are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to accurately estimate losses and LAE at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and LAE in any period includes payments in the period net of the change in reserves for unpaid losses and LAE between the beginning and the end of the period. Our underwriting expense ratio includes commissions and other underwriting expenses and other operating and general expenses, offset by other income. Commissions and other underwriting expenses consist principally of brokerage and agent commissions reduced by ceding commissions received from assuming reinsurers, and vary depending upon the amount and types of contracts written and, to a lesser extent, premium taxes. Our underwriting approach is to price our products to achieve an underwriting profit even if we forgo volume as a result. After several years of modest single digit decreases in rate levels on our renewal business as a whole, beginning in 2011 and continuing into the first quarter of 2012, we saw rate levels begin to stabilize on renewal business, with a number of our products experiencing single digit rate level increases on renewal business. 22
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The table below presents our net premiums earned and combined ratios for the periods indicated: Three Months Ended March 31, 2012 2011 (Dollars in thousands) Gross premiums written $ 130,225 $ 134,313 Ceded reinsurance (23,510 ) (24,061 ) Net premiums written 106,715 110,252 Change in unearned premiums, net of ceded 3,410 (5,113 ) Total premiums earned $ 110,125 $ 105,139 Combined Ratios: Loss and LAE ratio (1) 73.1 % 71.0 % Underwriting expense ratio (2) (3) 23.3 % 22.8 % Combined ratio 96.4 % 93.8 % (1) The ratio of losses and LAE to premiums earned.
(2) The ratio of the sum of commissions and other underwriting expenses, other
operating expenses less other income to premiums earned. (3) 2011 results have been retrospectively adjusted for the changes to
accounting for deferred policy acquisition costs required under ASU 2010-26.
Three months endedMarch 31, 2012 compared toMarch 31, 2011 . Our consolidated loss and LAE ratio for the first quarter of 2012 increased 2.1 percentage points to 73.1% compared to 71.0% in the same period in 2011. The loss and LAE ratio for our ongoing operations, which excludes the impact from the runoff of the guaranteedVanliner business, was 73.1% for the three months endedMarch 31, 2012 compared to 67.0% for the same period in 2011. This increase over the prior period is primarily attributable to higher than average claims severity experienced in two historically high-performing products within ourHawaii andAlaska and ART transportation components during the first quarter of 2012, as well as adverse claim development from prior years' loss reserves. For the first quarter of 2012, we had unfavorable development from prior years' loss reserves of$1.9 million , or 1.8 percentage points, compared to unfavorable development of$0.2 million , or 0.2 percentage points, in the first quarter of 2011. This unfavorable development was primarily related to settlements above the established case reserves and revisions to our estimated future settlements on an individual case by case basis. The prior years' loss reserve development for both periods is not considered to be unusual or significant to prior years' reserves based on the history of our business and the timing of events in the claims adjustment process. The consolidated underwriting expense ratio for the first quarter of 2012 increased 0.5 percentage points to 23.3% compared to 22.8% for the same period in 2011. The underwriting expense ratio for our ongoing business remained relatively flat at 23.3% and 23.6% for the three months endedMarch 31, 2012 and 2011, respectively. Net Investment Income Three months endedMarch 31, 2012 compared toMarch 31, 2011 . Net investment income increased$2.3 million , or 33.0%, to$9.2 million in the first quarter of 2012 compared to the same period in 2011, primarily due to a shift into higher-yielding securities, such as state and local government obligations and mortgage-backed securities with a decreased focus on lower yielding U.S. government and government agency obligations which were concentrated in the second half of 2011.
Net Realized Gains (Losses) on Investments
Three months endedMarch 31, 2012 compared toMarch 31, 2011 . Pre-tax net realized gains on investments were$1.7 million for the first quarter of 2012 compared to$1.2 million for the first quarter of 2011. The pre-tax net realized gains for the first quarter of 2012 were primarily generated from net gains associated with equity partnership investments of$1.4 million and realized gains associated with sales of securities totaling$0.4 million . Offsetting these gains were other-than-temporary impairment charges of$0.1 million for the quarter endingMarch 31, 2012 . The pre-tax net realized gains for the first quarter of 2011 were generated from net realized gains from the sales of securities of$1.0 million and gains associated with equity partnership investments of$0.2 million .
Commissions and Other Underwriting Expenses
Three months endedMarch 31, 2012 compared toMarch 31, 2011 . During the first quarter of 2012, commissions and other underwriting expenses of$21.5 million increased$1.0 million , or 5.1%, from$20.5 million in the comparable period in 2011, primarily attributable to a slight change in business mix written during the period. Commissions and other underwriting expenses, as a percentage of premiums earned, were relatively flat at 19.6% and 19.5% for the three months endingMarch 31, 2012 and 2011, respectively. Commissions and other underwriting expenses for the first quarter of 2011 have been retrospectively adjusted for the changes to accounting for deferred policy acquisition costs required under ASU 2010-26. 23
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Other Operating and General Expenses
Three months endedMarch 31, 2012 compared toMarch 31, 2011 . Other operating and general expenses increased$0.4 million , or 8.6%, to$4.9 million during the quarter endedMarch 31, 2012 compared to$4.5 million for the same period in 2011, primarily due to growth in our employee headcount. Other operating and general expenses, as a percentage of premiums earned, were relatively flat at 4.5% and 4.3% for the first quarters of 2012 and 2011, respectively.
Income Taxes
Three months endedMarch 31, 2012 compared toMarch 31, 2011 . The effective tax rate of 29.2% for the three month period endedMarch 31, 2012 decreased 2.4 percentage points, from 31.6%, as compared to the same period in 2011, primarily attributable to an increase in tax-exempt investment income.
Financial Condition
Investments
AtMarch 31, 2012 , our investment portfolio contained$953.9 million in fixed maturity securities and$35.5 million in equity securities, all carried at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity and$30.5 million in other investments, which are limited partnership investments accounted for in accordance with the equity method. AtMarch 31, 2012 , we had pre-tax net unrealized gains of$32.0 million on fixed maturities and$4.6 million on equity securities. Our investment portfolio allocation is based on diversification among primarily high quality fixed maturity investments and guidelines in our investment policy. AtMarch 31, 2012 , 89.2% of the fixed maturities in our portfolio were rated "investment grade" (credit rating of AAA to BBB-) by nationally recognized rating agencies. Investment grade securities generally bear lower degrees of risk and corresponding lower yields than those that are unrated or non-investment grade. Summary information for securities with unrealized gains or losses atMarch 31, 2012 is shown in the following table. Approximately$4.4 million of fixed maturities and$0.6 million of equity securities had no unrealized gains or losses atMarch 31, 2012 . Securities with Securities with Unrealized Gains Unrealized Losses (Dollars in thousands) Fixed Maturities: Fair value of securities $ 823,387 $ 126,105 Amortized cost of securities 787,313 130,142 Gross unrealized gain or (loss) $ 36,074 $ (4,037 ) Fair value as a % of amortized cost 104.6 % 96.9 % Number of security positions held 721 118 Number individually exceeding$50,000 gain or (loss) 254 13 Concentration of gains or losses by type or industry: U.S. Government and government agencies $ 6,191 $ (13 ) Foreign governments 63 - State, municipalities and political subdivisions 13,795 (551 ) Residential mortgage-backed securities 5,186 (2,472 ) Commercial mortgage-backed securities 773 (93 ) Banks, insurance and brokers 3,821 (246 ) Industrial and other 6,245 (662 ) Percent rated investment grade (a) 92.9 % 65.1 % Equity Securities: Fair value of securities $ 29,470 $ 5,447 Cost of securities 24,591 5,776 Gross unrealized gain or (loss) $ 4,879 $ (329 ) Fair value as a % of cost 119.8 % 94.3 % Number individually exceeding$50,000 gain or (loss) 22 1
(a) Investment grade of AAA to BBB- by nationally recognized rating agencies.
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The table below sets forth the scheduled maturities of available for sale fixed maturity securities atMarch 31, 2012 , based on their fair values. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers. Securities with Securities with Unrealized Gains Unrealized Losses Maturity: One year or less 1.8 % 0.0 % After one year through five years 21.0 % 7.7 % After five years through ten years 40.1 % 24.4 % After ten years 14.0 % 14.4 % 76.9 % 46.5 % Mortgage-backed securities 23.1 % 53.5 % 100.0 % 100.00 %
The table below summarizes the unrealized gains and losses on fixed maturities and equity securities by dollar amount.
At March 31, 2012 Aggregate Fair Value Aggregate Unrealized as % of Fair Value Gain (Loss) Cost Basis (Dollars in thousands) Fixed Maturities: Securities with unrealized gains: Exceeding$50,000 and for: Less than one year (199 issues) $ 394,903 $ 20,617 105.5 % More than one year (55 issues) 93,343 7,671 109.0 % Less than $50,000 (467 issues) 335,141 7,786 102.4 % $ 823,387 $ 36,074 Securities with unrealized losses: Exceeding$50,000 and for: Less than one year (5 issues) $ 16,232 $ (431 ) 97.4 % More than one year (8 issues) 10,930 (2,298 ) 82.6 % Less than $50,000 (105 issues) 98,943 (1,308 ) 98.7 % $ 126,105 $ (4,037 ) Equity Securities: Securities with unrealized gains: Exceeding$50,000 and for: Less than one year (14 issues) $ 12,291 $ 2,332 123.4 % More than one year (8 issues) 7,153 1,725 131.8 % Less than $50,000 (58 issues) 10,026 822 108.9 % $ 29,470 $ 4,879 Securities with unrealized losses: Exceeding$50,000 and for: Less than one year (1 issue) $ 1,993 $ (106 ) 94.9 % More than one year (0 issues) - - 0.0 % Less than $50,000 (20 issues) 3,454 (223 ) 93.9 % $ 5,447 $ (329 )
When a decline in the value of a specific investment is considered to be other-than-temporary, a provision for impairment is charged to earnings (accounted for as a realized loss) and the cost basis of that investment is reduced. The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include those discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations-Other-Than-Temporary Impairment."
Liquidity and Capital Resources
The liquidity requirements of our insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and payments of dividends and taxes to us from insurance subsidiaries. Historically and during the first three months of 2012, cash flows from premiums and investment income have provided sufficient funds to meet these requirements, without requiring significant liquidation of investments. If our cash flows change dramatically from historical patterns, for example as a result of a decrease in premiums, an increase in claims paid or operating expenses, or financing an acquisition, we may be required to sell securities before their maturity and possibly at a loss. Our insurance subsidiaries generally hold a 25
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significant amount of highly liquid, short-term investments or cash and cash equivalents to meet their liquidity needs. Our historic pattern of using receipts from current premium writings for the payment of liabilities incurred in prior periods provides us with the option to extend the maturities of our investment portfolio beyond the estimated settlement date of our loss reserves. Funds received in excess of cash requirements are generally invested in additional marketable securities. We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Our principal sources of liquidity are our existing cash, cash equivalents and short-term investments. Cash and cash equivalents increased$3.9 million from$23.7 million atDecember 31, 2011 to$27.6 million atMarch 31, 2012 . We generated net cash from operations of$20.0 million for the three months endedMarch 31, 2012 , compared to$10.7 million during the comparable period in 2011. This increase of$9.3 million primarily relates to a lower estimated federal income tax payment made in the first quarter of 2012 as compared to the same period in 2011, as well as various fluctuations within our operating activities. The first quarter 2011 estimated tax payment included$8.4 million associated with theVanliner acquisition (included in the line item "Increase (decrease) in accounts payable, commissions and other liabilities and assessments and fees payable" on our Consolidated Statement of Cash Flows atMarch 31, 2011 ), which was offset by cash received of an equal amount included in "Collection of amounts refundable on the purchase price ofVanliner " in the investing activities section of our Consolidated Statement of Cash Flows for the three months endedMarch 31, 2011 . Net cash used in investing activities was$14.1 million and$10.9 million for the three months endedMarch 31, 2012 and 2011, respectively. Contributing to the$3.2 million increase in cash used in investing activities was a$44.2 million decrease in the proceeds from maturities and redemptions of fixed maturity investments, mostly offset by a$42.2 million decrease in the purchases of fixed maturity investments. The decreases in investment activity in 2012 was due to a large number of securities obtained as part of theVanliner acquisition maturing during the first quarter of 2011, and the subsequent reinvestment of the proceeds from those securities. The net purchases of fixed maturities during the first quarter of 2012 were primarily concentrated in mortgage-backed securities and state and local government obligations. Also impacting the change in cash used in investing activities was the receipt of the$14.3 million refund in the first quarter of 2011 on the purchase price ofVanliner related to making the election under Section 338(h)(10) of the Internal Revenue Code and the finalization of the tangible book value, an$8.9 million decrease in the purchases of other investments, which are comprised of limited partnership investments, and a$4.8 million decrease in the purchases of equity securities. Net cash used in financing activities was$2.0 million and$1.8 million for the three months endedMarch 31, 2012 and 2011, respectively. This$0.2 million increase in cash used in financing activities was primarily driven by the increase in the quarterly dividends paid on our common shares. Our financing activities also include those related to stock option activity. We have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends and taxes. Funds to meet these obligations will come primarily from parent company cash, dividends and other payments from our insurance company subsidiaries. We have a$50.0 million unsecured Credit Agreement (the "Credit Agreement") that terminates inDecember 2012 , which includes a sublimit of$10.0 million for letters of credit. We have the ability to increase the line of credit to$75.0 million subject to the Credit Agreement's accordion feature. AtMarch 31, 2012 there was$22.0 million drawn on this credit facility. Amounts borrowed bear interest at either (1) a rate per annum equal to the greater of the administrative agent's prime rate or 0.5% in excess of the federal funds effective rate or (2) rates ranging from 0.45% to 0.90% overLIBOR based on ourA.M. Best insurance group rating, or 0.65% atMarch 31, 2012 . As ofMarch 31, 2012 , the interest rate on this debt is equal to the six-monthLIBOR (0.50% atMarch 31, 2012 ) plus 65 basis points, with interest payments due quarterly. The Credit Agreement requires us to maintain specified financial covenants measured on a quarterly basis, including consolidated net worth, fixed charge coverage ratio and debt-to-capital ratio. In addition, the Credit Agreement contains certain affirmative and negative covenants, including negative covenants that limit or restrict our ability to, among other things, incur additional indebtedness, effect mergers or consolidations, make investments, enter into asset sales, create liens, enter into transactions with affiliates and other restrictions customarily contained in such agreements. As ofMarch 31, 2012 , we were in compliance with all financial covenants. We expect to procure a new line of credit during 2012 to replace the current Credit Agreement prior to its expiration, although potentially at a higher cost. Due to the favorable terms of the Credit Agreement relative to those currently available in the commercial lending marketplace, we do not anticipate executing a new credit facility until the latter half of 2012. 26
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We believe that funds generated from operations, including dividends from insurance subsidiaries and parent company cash will provide sufficient resources to meet our liquidity requirements for at least the next 12 months. However, if these funds are insufficient to meet fixed charges in any period, we would be required to generate cash through sale of assets, sale of portfolio securities or similar transactions. If we were required to sell portfolio securities early for liquidity purposes rather than holding them to maturity, we would recognize gains or losses on those securities earlier than anticipated. Our ongoing corporate initiatives include actively evaluating potential acquisitions. At such time that we would execute an agreement to enter into an acquisition, such a transaction, depending upon the structure and size, could have an impact on our liquidity. Since our ability to meet our obligations in the long-term (beyond a 12-month period) is dependent upon factors such as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our long-term operating needs. We are not aware of any trends or uncertainties affecting our liquidity, including any significant future reliance on short-term financing arrangements. Critical Accounting Policies The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change and thus impact amounts reported in the future. Management believes that the establishment of losses and LAE reserves and the determination of "other-than-temporary" impairment on investments are the two areas where the degree of judgment required in determining amounts recorded in the financial statements make the accounting policies critical. For a more detailed discussion of these policies, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual Report on Form 10-K for the year endedDecember 31, 2011 .
Losses and LAE Reserves
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of that loss to us and our final payment of that loss and its related LAE. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. AtMarch 31, 2012 andDecember 31, 2011 , we had$781.8 million and$776.6 million , respectively, of gross loss and LAE reserves, representing management's best estimate of the ultimate loss. Management records, on a monthly and quarterly basis, its best estimate of loss reserves. For purposes of computing the recorded reserves, management utilizes various data inputs, including analysis that is derived from a review of prior quarter results performed by actuaries employed by Great American. In addition, on an annual basis, actuaries from Great American review the recorded reserves for NIIC, VIC, NIIC-HI and TCC utilizing current period data and provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the statutory reserves recorded by these U.S. insurance subsidiaries. The actuarial analysis of NIIC's, VIC's, NIIC-HI's and TCC's net reserves for the year endingDecember 31, 2011 reflected point estimates that were within 2% of management's recorded net reserves as of such dates. Using this actuarial data along with its other data inputs, management concluded that the recorded reserves appropriately reflect management's best estimates of the liability as ofMarch 31, 2012 andDecember 31, 2011 .
The quarterly reviews of unpaid loss and LAE reserves by Great American actuaries are prepared using standard actuarial techniques. These may include (but may not be limited to):
• the Case Incurred Development Method; • the Paid Development Method; • the Bornhuetter-Ferguson Method; and • the Incremental Paid LAE to Paid Loss Methods. The period of time from the occurrence of a loss through the settlement of the liability is referred to as the "tail." Generally, the same actuarial methods are considered for both short-tail and long-tail lines of business because most of them work properly for both. The methods are designed to incorporate the effects of the differing length of time to settle particular claims. For short-tail lines, management tends to give more weight to the Case Incurred andPaid Development methods, although the various methods tend to produce similar results. For long-tail lines, more judgment is involved and more weight may be given to the Bornhuetter-Ferguson method. Liability claims for long-tail lines are more susceptible to litigation and can be significantly affected by changing contract interpretation and the legal environment. Therefore, the estimation of loss reserves for these classes is more complex and subject to a higher degree of variability. 27
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Supplementary statistical information is reviewed to determine which methods are most appropriate and whether adjustments are needed to particular methods. This information includes: • open and closed claim counts; • average case reserves and average incurred on open claims;
• closure rates and statistics related to closed and open claim percentages;
• average closed claim severity; • ultimate claim severity; • reported loss ratios; • projected ultimate loss ratios; and • loss payment patterns.
Other-Than-Temporary Impairment
Our investments are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation risks. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. We evaluate whether impairments have occurred on a case-by-case basis. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause and amount of decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations we use in the impairment evaluation process include, but are not limited to:
• the length of time and the extent to which the market value has been below
amortized cost;
• whether the issuer is experiencing significant financial difficulties;
• economic stability of an entire industry sector or subsection;
• whether the issuer, series of issuers or industry has a catastrophic type
of loss; • the extent to which the unrealized loss is credit-driven or a result of
changes in market interest rates; • historical operating, balance sheet and cash flow data; • internally and externally generated financial models and forecasts; • our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value; and
• other subjective factors, including concentrations and information
obtained from regulators and rating agencies.
Under current other-than-temporary impairment accounting guidance, if management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then an entity may separate the other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is measured by comparing a security's amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are required to be shown in the Consolidated Statements of Income. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge is required to reduce the amortized cost of that security to fair value. Additional disclosures required by this guidance are contained in Note 4-"Investments." 28
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We closely monitor each investment that has a fair value that is below its amortized cost and make a determination each quarter for other-than-temporary impairment for each of those investments. There were no material other-than-temporary impairment charges recorded during the three months endedMarch 31, 2012 and 2011. While it is not possible to accurately predict if or when a specific security will become impaired, given the inherent uncertainty in the market, charges for other-than-temporary impairment could be material to net income in subsequent quarters. Management believes it is not likely that future impairment charges will have a significant effect on our liquidity. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Financial Condition-Investments."
Contractual Obligations/Off-Balance Sheet Arrangements
During the first three months of 2012, our contractual obligations did not change materially from those discussed in our Annual Report on Form 10-K for the year ended
We do not currently have any relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
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GENERAL ELECTRIC CAPITAL CORP – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
GENERAL ELECTRIC CAPITAL CORP FILES (8-K) Disclosing Other Events, Financial Statements and Exhibits
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