e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|
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þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 |
For the quarterly period ended June 30, 2009
OR
|
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|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 001-33077
FIRST MERCURY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
|
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|
Delaware
(State or other jurisdiction of incorporation or organization)
|
|
38-3164336
(I.R.S. Employer Identification No.) |
|
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29110 Inkster Road
Suite 100
Southfield, Michigan
(Address of Principal Executive Offices)
|
|
48034
(Zip Code) |
Registrants telephone number, including area code: (800) 762-6837
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o |
Accelerated filer þ |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
The number of shares of Common Stock, par value $0.01, outstanding on August 7, 2009 was
17,144,818.
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
|
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|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Unaudited) |
|
|
|
|
|
|
|
(Dollars in thousands, |
|
|
|
except share and per share data) |
|
ASSETS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
Debt securities |
|
$ |
581,235 |
|
|
$ |
495,799 |
|
Equity securities and other |
|
|
27,008 |
|
|
|
15,089 |
|
Short-term |
|
|
16,921 |
|
|
|
32,142 |
|
|
|
|
|
|
|
|
Total Investments |
|
|
625,164 |
|
|
|
543,030 |
|
Cash and cash equivalents |
|
|
23,574 |
|
|
|
31,833 |
|
Premiums and reinsurance balances receivable |
|
|
58,504 |
|
|
|
56,398 |
|
Accrued investment income |
|
|
6,327 |
|
|
|
5,400 |
|
Accrued profit sharing commissions |
|
|
12,873 |
|
|
|
11,315 |
|
Reinsurance recoverable on paid and unpaid losses |
|
|
150,819 |
|
|
|
135,617 |
|
Prepaid reinsurance premiums |
|
|
54,207 |
|
|
|
48,921 |
|
Deferred acquisition costs |
|
|
26,917 |
|
|
|
27,369 |
|
Intangible assets, net of accumulated amortization |
|
|
38,201 |
|
|
|
39,351 |
|
Goodwill |
|
|
25,483 |
|
|
|
25,483 |
|
Deferred federal income taxes |
|
|
|
|
|
|
2,161 |
|
Other assets |
|
|
23,625 |
|
|
|
16,775 |
|
|
|
|
|
|
|
|
Total Assets |
|
$ |
1,045,694 |
|
|
$ |
943,653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expense reserves |
|
$ |
426,908 |
|
|
$ |
372,721 |
|
Unearned premium reserves |
|
|
151,283 |
|
|
|
147,849 |
|
Long-term debt |
|
|
67,013 |
|
|
|
67,013 |
|
Funds held under reinsurance treaties |
|
|
61,937 |
|
|
|
49,419 |
|
Premiums payable to insurance companies |
|
|
31,519 |
|
|
|
27,831 |
|
Reinsurance payable on paid losses |
|
|
1,196 |
|
|
|
1,167 |
|
Deferred federal income taxes |
|
|
4,741 |
|
|
|
|
|
Accounts payable, accrued expenses, and other liabilities |
|
|
14,259 |
|
|
|
16,016 |
|
|
|
|
|
|
|
|
Total Liabilities |
|
|
758,856 |
|
|
|
682,016 |
|
|
|
|
|
|
|
|
Stockholders Equity |
|
|
|
|
|
|
|
|
Common stock, $0.01 par value; authorized 100,000,000 shares; issued
and outstanding 17,558,483 and 17,836,337 shares |
|
|
175 |
|
|
|
178 |
|
Paid-in-capital |
|
|
158,426 |
|
|
|
161,957 |
|
Accumulated other comprehensive income (loss) |
|
|
5,642 |
|
|
|
(3,027 |
) |
Retained earnings |
|
|
123,874 |
|
|
|
103,028 |
|
Treasury stock; 93,600 and 33,600 shares |
|
|
(1,279 |
) |
|
|
(499 |
) |
|
|
|
|
|
|
|
Total Stockholders Equity |
|
|
286,838 |
|
|
|
261,637 |
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders Equity |
|
$ |
1,045,694 |
|
|
$ |
943,653 |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
3
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(Unaudited)
|
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|
|
|
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|
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|
|
|
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|
Three Months Ended |
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|
Six Months Ended |
|
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|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands, except share and per share data) |
|
Operating Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
51,432 |
|
|
$ |
46,559 |
|
|
$ |
104,027 |
|
|
$ |
90,130 |
|
Commissions and fees |
|
|
9,577 |
|
|
|
7,086 |
|
|
|
16,471 |
|
|
|
11,139 |
|
Net investment income |
|
|
7,132 |
|
|
|
5,216 |
|
|
|
13,566 |
|
|
|
10,064 |
|
Net realized gains (losses) on investments |
|
|
9,644 |
|
|
|
(1,587 |
) |
|
|
11,437 |
|
|
|
(1,586 |
) |
Other-than-temporary impairment losses on
investments (1) |
|
|
(97 |
) |
|
|
(225 |
) |
|
|
(134 |
) |
|
|
(225 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Operating Revenues |
|
|
77,688 |
|
|
|
57,049 |
|
|
|
145,367 |
|
|
|
109,522 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses, net |
|
|
35,463 |
|
|
|
25,732 |
|
|
|
65,956 |
|
|
|
49,177 |
|
Amortization of deferred acquisition expenses |
|
|
13,600 |
|
|
|
9,096 |
|
|
|
26,930 |
|
|
|
17,310 |
|
Underwriting, agency and other expenses |
|
|
9,526 |
|
|
|
11,615 |
|
|
|
18,750 |
|
|
|
17,598 |
|
Amortization of intangible assets |
|
|
575 |
|
|
|
515 |
|
|
|
1,149 |
|
|
|
913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Operating Expenses |
|
|
59,164 |
|
|
|
46,958 |
|
|
|
112,785 |
|
|
|
84,998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income |
|
|
18,524 |
|
|
|
10,091 |
|
|
|
32,582 |
|
|
|
24,524 |
|
Interest Expense |
|
|
1,417 |
|
|
|
1,476 |
|
|
|
2,833 |
|
|
|
2,940 |
|
Change in Fair Value of Derivative Instruments |
|
|
(123 |
) |
|
|
(262 |
) |
|
|
(230 |
) |
|
|
174 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations Before
Income Taxes |
|
|
17,230 |
|
|
|
8,877 |
|
|
|
29,979 |
|
|
|
21,410 |
|
Income Taxes |
|
|
5,621 |
|
|
|
2,641 |
|
|
|
9,689 |
|
|
|
6,540 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations |
|
|
11,609 |
|
|
|
6,236 |
|
|
|
20,290 |
|
|
|
14,870 |
|
Income From Discontinued Operations,
Net of Income Taxes |
|
|
|
|
|
|
22,467 |
|
|
|
|
|
|
|
23,553 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income |
|
$ |
11,609 |
|
|
$ |
28,703 |
|
|
$ |
20,290 |
|
|
$ |
38,423 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Net Income Per Share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations |
|
$ |
0.65 |
|
|
$ |
0.34 |
|
|
$ |
1.14 |
|
|
$ |
0.82 |
|
Income From Discontinued Operations |
|
|
|
|
|
|
1.23 |
|
|
|
|
|
|
|
1.29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
0.65 |
|
|
$ |
1.57 |
|
|
$ |
1.14 |
|
|
$ |
2.11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Net Income Per Share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations |
|
$ |
0.64 |
|
|
$ |
0.33 |
|
|
$ |
1.11 |
|
|
$ |
0.79 |
|
Income From Discontinued Operations |
|
|
|
|
|
|
1.18 |
|
|
|
|
|
|
|
1.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
0.64 |
|
|
$ |
1.51 |
|
|
$ |
1.11 |
|
|
$ |
2.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Shares Outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
17,700,272 |
|
|
|
18,259,602 |
|
|
|
17,737,708 |
|
|
|
18,182,832 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
18,042,484 |
|
|
|
18,943,262 |
|
|
|
18,075,668 |
|
|
|
18,803,719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
2008 amounts were reclassified to conform to current periods presentation. |
See accompanying notes to condensed consolidated financial statements.
4
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders Equity
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
|
|
|
|
Common |
|
|
Paid-in |
|
|
Comprehensive |
|
|
Retained |
|
|
Treasury |
|
|
|
|
|
|
Stock |
|
|
Capital |
|
|
Income (Loss) |
|
|
Earnings |
|
|
Stock |
|
|
Total |
|
|
|
(Dollars in thousands, except share data) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January 1, 2008 |
|
$ |
180 |
|
|
$ |
165,836 |
|
|
$ |
1,177 |
|
|
$ |
62,187 |
|
|
$ |
|
|
|
$ |
229,380 |
|
Exercise of stock options |
|
|
3 |
|
|
|
597 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
600 |
|
Stock-based compensation expense |
|
|
|
|
|
|
1,026 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,026 |
|
Stock-based compensation excess tax benefits |
|
|
|
|
|
|
1,135 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,135 |
|
Common stock repurchased and held in treasury |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(499 |
) |
|
|
(499 |
) |
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38,423 |
|
|
|
|
|
|
|
38,423 |
|
Other comprehensive loss, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding losses on securities
arising during the period, net of tax of $1,609 |
|
|
|
|
|
|
|
|
|
|
(2,989 |
) |
|
|
|
|
|
|
|
|
|
|
(2,989 |
) |
Change in fair value of interest rate swap, net of tax of ($16) |
|
|
|
|
|
|
|
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
29 |
|
Less reclassification adjustment for
gains included in net income, net of tax of $3 |
|
|
|
|
|
|
|
|
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,965 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
35,458 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2008 |
|
$ |
183 |
|
|
$ |
168,594 |
|
|
$ |
(1,788 |
) |
|
$ |
100,610 |
|
|
$ |
(499 |
) |
|
$ |
267,100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January 1, 2009 |
|
$ |
178 |
|
|
$ |
161,957 |
|
|
$ |
(3,027 |
) |
|
$ |
103,028 |
|
|
$ |
(499 |
) |
|
$ |
261,637 |
|
Issuance of restricted stock |
|
|
1 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense |
|
|
|
|
|
|
1,571 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,571 |
|
Stock-based compensation excess tax benefits |
|
|
|
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(21 |
) |
Common stock repurchased and held in treasury |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(780 |
) |
|
|
(780 |
) |
Common stock repurchased and retired |
|
|
(4 |
) |
|
|
(5,080 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,084 |
) |
Payment of shareholder dividend |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(443 |
) |
|
|
|
|
|
|
(443 |
) |
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,290 |
|
|
|
|
|
|
|
20,290 |
|
Cumulative effect of adoption of FSP FAS 115-2 at April 1, 2009 |
|
|
|
|
|
|
|
|
|
|
(999 |
) |
|
|
999 |
|
|
|
|
|
|
|
|
|
Other comprehensive income, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding losses on securities arising during
the period having credit losses recognized in the condensed
consolidated statements of income, net of tax $257 |
|
|
|
|
|
|
|
|
|
|
(478 |
) |
|
|
|
|
|
|
|
|
|
|
(478 |
) |
Unrealized holding gains on securities arising during the
period having no credit losses recognized in the condensed
consolidated statements of income, net of tax ($5,822) |
|
|
|
|
|
|
|
|
|
|
10,813 |
|
|
|
|
|
|
|
|
|
|
|
10,813 |
|
Change in fair value of interest rate swaps, net of tax of $84 |
|
|
|
|
|
|
|
|
|
|
(156 |
) |
|
|
|
|
|
|
|
|
|
|
(156 |
) |
Less reclassification adjustment for
gains included in net income, net of tax of $275 |
|
|
|
|
|
|
|
|
|
|
(511 |
) |
|
|
|
|
|
|
|
|
|
|
(511 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,668 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29,958 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2009 |
|
$ |
175 |
|
|
$ |
158,426 |
|
|
$ |
5,642 |
|
|
$ |
123,874 |
|
|
$ |
(1,279 |
) |
|
$ |
286,838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
5
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
Cash Flows from Operating Activities |
|
|
|
|
|
|
|
|
Net Income |
|
$ |
20,290 |
|
|
$ |
38,423 |
|
Less: Income from discontinued operations |
|
|
|
|
|
|
23,553 |
|
|
|
|
|
|
|
|
Income from continuing operations |
|
|
20,290 |
|
|
|
14,870 |
|
Adjustments to reconcile income from continuing operations to
net cash provided by operating activities
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
1,969 |
|
|
|
1,656 |
|
Realized (gains) losses on investments |
|
|
(11,437 |
) |
|
|
1,586 |
|
Other-than-temporary impairment losses on investments |
|
|
134 |
|
|
|
225 |
|
Deferrals of acquisition costs, net |
|
|
452 |
|
|
|
(7,595 |
) |
Deferred income taxes |
|
|
6,902 |
|
|
|
(906 |
) |
Stock-based compensation expense |
|
|
1,571 |
|
|
|
1,026 |
|
Increase (decrease) in cash resulting from changes in assets and liabilities
|
|
|
|
|
|
|
|
|
Premiums and reinsurance balances receivable |
|
|
(2,106 |
) |
|
|
(3,717 |
) |
Accrued investment income |
|
|
(927 |
) |
|
|
(251 |
) |
Accrued profit sharing commissions |
|
|
(1,558 |
) |
|
|
4,409 |
|
Reinsurance recoverable on paid and unpaid losses |
|
|
(15,202 |
) |
|
|
(21,985 |
) |
Prepaid reinsurance premiums |
|
|
(5,287 |
) |
|
|
5,122 |
|
Loss and loss adjustment expense reserves |
|
|
54,187 |
|
|
|
47,647 |
|
Unearned premium reserves |
|
|
3,434 |
|
|
|
14,914 |
|
Funds held under reinsurance treaties |
|
|
12,518 |
|
|
|
6,723 |
|
Reinsurance payable on paid losses |
|
|
28 |
|
|
|
(1,156 |
) |
Premiums payable to insurance companies |
|
|
3,689 |
|
|
|
(2,437 |
) |
Other |
|
|
(9,582 |
) |
|
|
(1,509 |
) |
|
|
|
|
|
|
|
Net Cash Provided By Operating Activities Continuing Operations |
|
|
59,075 |
|
|
|
58,622 |
|
Net Cash Provided By Operating Activities Discontinued Operations |
|
|
|
|
|
|
2,376 |
|
|
|
|
|
|
|
|
Net Cash Provided By Operating Activities Total |
|
|
59,075 |
|
|
|
60,998 |
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities |
|
|
|
|
|
|
|
|
Cost of short-term investments acquired |
|
|
(156,301 |
) |
|
|
(291,974 |
) |
Proceeds from disposals of short-term investments |
|
|
171,522 |
|
|
|
262,194 |
|
Cost of debt and equity securities acquired |
|
|
(154,762 |
) |
|
|
(121,635 |
) |
Proceeds from debt and equity securities |
|
|
78,535 |
|
|
|
69,863 |
|
Acquisition, net of cash acquired |
|
|
|
|
|
|
(18,476 |
) |
Cost of fixed asset purchases |
|
|
|
|
|
|
(543 |
) |
|
|
|
|
|
|
|
Net Cash Used In Investing Activities Continuing Operations |
|
|
(61,006 |
) |
|
|
(100,571 |
) |
Net Cash Provided By Investing Activities Discontinued Operations |
|
|
|
|
|
|
41,830 |
|
|
|
|
|
|
|
|
Net Cash Used In Investing Activities Total |
|
|
(61,006 |
) |
|
|
(58,741 |
) |
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities |
|
|
|
|
|
|
|
|
Stock issued on stock options exercised |
|
|
|
|
|
|
600 |
|
Purchase of common stock |
|
|
(5,084 |
) |
|
|
|
|
Payment of shareholder dividend |
|
|
(443 |
) |
|
|
|
|
Cash retained from excess tax benefits |
|
|
(21 |
) |
|
|
|
|
Purchase of treasury stock |
|
|
(780 |
) |
|
|
(499 |
) |
|
|
|
|
|
|
|
Net Cash Provided By (Used In) Financing Activities |
|
|
(6,328 |
) |
|
|
101 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Increase (Decrease) In Cash and Cash Equivalents |
|
|
(8,259 |
) |
|
|
2,358 |
|
Cash and Cash Equivalents, beginning of period |
|
|
31,833 |
|
|
|
18,432 |
|
|
|
|
|
|
|
|
Cash and Cash Equivalents, end of period |
|
$ |
23,574 |
|
|
$ |
20,790 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information: |
|
|
|
|
|
|
|
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
2,734 |
|
|
$ |
3,199 |
|
Income taxes |
|
$ |
4,750 |
|
|
$ |
8,000 |
|
See accompanying notes to condensed consolidated financial statements.
6
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying condensed consolidated financial statements and notes of First Mercury
Financial Corporation and Subsidiaries (FMFC or the Company) have been prepared in accordance
with accounting principles generally accepted in the United States of America for interim financial
information and do not contain all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete financial statements.
Readers are urged to review the Companys 2008 audited consolidated financial statements and
footnotes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2008
for a more complete description of the Companys business and accounting policies. In the opinion
of management, all adjustments necessary for a fair presentation of the consolidated financial
statements have been included. Such adjustments consist only of normal recurring items. Interim
results are not necessarily indicative of results of operations for the full year. The
consolidated balance sheet as of December 31, 2008 was derived from the Companys audited annual
consolidated financial statements.
Significant intercompany transactions and balances have been eliminated.
Use of Estimates
In preparing the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the disclosures of
contingent assets and liabilities as of the date of the consolidated financial statements, and
revenues and expenses reported for the periods then ended. Actual results may differ from those
estimates. Material estimates that are susceptible to significant change in the near term relate
primarily to the determination of the reserves for losses and loss adjustment expenses and
valuation of intangible assets and goodwill.
Recently Issued Accounting Standards
On July 1, 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and
the Hierarchy of Generally Accepted Accounting Principles A Replacement of FASB Statement
No.162 (SFAS 168). SFAS 168 replaces SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles and establishes the Accounting Standards Codification (Codification) as
the single official source of authoritative U.S. accounting and reporting standards for
nongovernmental entities, in addition to guidance issued by the Securities and Exchange Commission
(SEC). Once effective, all other nongrandfathered, non-SEC accounting literature not included in
the Codification becomes nonauthoritative. SFAS 168 supersedes all existing, non-SEC accounting
and reporting standards applied by nongovernmental entities in the preparation of financial
statements in conformity with generally accepted accounting principles (GAAP). SFAS 168 is
effective for interim and annual reporting periods ending after September 15, 2009. As the
Codification does not change GAAP, the Company does not expect SFAS 168 to have a material impact
on its financial statements. Previous references to applicable literature via our disclosures will
be updated with references to the new Codification sections after the effective date of this
standard.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165
establishes general standards of accounting for and disclosure of events that occur after the
balance sheet date but before the financial statements are issued or are available to be issued.
SFAS 165 provides guidance on the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for potential recognition or
disclosure in the financial statements, the circumstances under which an entity should recognize
events or transactions occurring after the balance sheet date in its financial statements and the
disclosures that an entity should make about events or transactions that occurred after the balance
sheet date. We adopted SFAS 165 during the second quarter of 2009, and its application had no
impact on our condensed consolidated financial statements. We evaluate subsequent events through
the date the accompanying financial statements were issued, which was August 10, 2009.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (FSP FAS 115-2). FSP FAS 115-2 modifies the existing
other-than-temporary impairment guidance to require the recognition of an other-than-temporary
impairment when an entity has the intent to sell a debt security or when it is more likely than not
an entity will be required to sell the debt security before its anticipated recovery. Additionally,
FSP FAS 115-2 changes the presentation and amount of other-than-temporary losses recognized in the
income statement for instances when the Company determines that there is a credit loss on a debt
security but it is more likely than not that the entity will not be required to sell the security
prior to the anticipated recovery of its remaining cost basis. For these debt securities, the
amount representing the credit loss will be reported as an impairment loss in the Condensed
Consolidated Statements of Income and the amount related to all other factors will be reported in
accumulated other comprehensive income. FSP FAS 115-2 also requires the presentation of
other-than-temporary impairments separately from realized gains and losses on the face of the
income statement. In addition to the changes in measurement and presentation, FSP FAS 115-2 is
intended to enhance the existing disclosure requirements for other-than-temporary impairments
7
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Concluded)
and requires all disclosures related to other-than-temporary impairments in both interim and annual
periods. The provisions of FSP FAS 115-2/124-2 are effective for interim periods ending after June
15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of
FSP FAS 115-2/124-2 in the second quarter of 2009 resulted in a $1.0 million increase in retained
earnings, which was offset by a corresponding decrease in accumulated other comprehensive income
(loss) of the same amount.
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that
are Not Orderly (FSP FAS 157-4). Under FSP FAS 157-4, if an entity determines that there has
been a significant decrease in the volume and level of activity for the asset or the liability in
relation to the normal market activity for the asset or liability (or similar assets or
liabilities), then transactions or quoted prices may not accurately reflect fair value. In
addition, if there is evidence that the transaction for the asset or liability is not orderly; the
entity shall place little, if any weight on that transaction price as an indicator of fair value. FSP FAS
157-4 is effective for periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The adoption of FSP FAS 157-4 in the second quarter of 2009
did not have a material effect on the Companys results of operations, financial position, or
liquidity.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair
Value of Financial Instruments (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 require
disclosures about fair value of financial instruments in interim and annual financial statements.
FSP FAS 107-1 and APB 28-1 are effective for periods ending after June 15, 2009, with early
adoption permitted for periods ending after March 15, 2009. The adoption of FSP FAS 107-1 and APB
28-1 in the second quarter of 2009 is included in Note 11, Fair Value Measurements to the
condensed consolidated financial statements.
We adopted the following accounting standards in the first quarter 2009, none of which had a
material effect on the Companys results of operations, financial position, or liquidity:
|
|
|
SFAS No. 141(R), Business Combinations; |
|
|
|
|
SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an
amendment of Accounting Research Bulletin No. 51; |
|
|
|
|
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities; |
|
|
|
|
FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment
Transactions are Participating Securities; and |
|
|
|
|
FSP FAS No. 157-2, Effective Date of FASB Statement No. 157. |
2. MERGERS AND ACQUISITIONS
American Management Corporation
On February 1, 2008, we completed the acquisition of all of the issued and outstanding shares
of common stock of American Management Corporation (AMC). AMC is a managing general agency
(MGA) that has focused primarily on the niche fuel-related marketplace for over 20 years. In
addition, AMC owns and operates American Underwriters Insurance Company (AUIC), a single state,
non-standard auto insurance company domiciled in the state of Arkansas, and AMC Re, Inc. (AMC
Re), a captive reinsurer incorporated under the laws of Arkansas. AMC underwrites premiums for
third party carriers and for AUIC. The acquisition gave the Company access to an established and
experienced specialty admitted underwriting franchise with a definable niche market.
The cash purchase price was $38.1 million, which was financed through cash on hand. We
incurred $0.8 million in acquisition related costs, which are included in the initial cost of the
investment of $38.9 million. In connection with the acquisition, the Company and the seller
entered into an escrow agreement whereby $4.0 million of the cash purchase price was escrowed with
a major financial institution to partially secure the majority selling shareholders indemnity
obligations of up to $12.0 million under the stock purchase agreement.
The results of operations of AMC and the estimated fair value of assets acquired and
liabilities assumed are included in our consolidated financial statements beginning on the
acquisition date. The estimated excess of the purchase price over the net tangible and intangible
assets acquired of $13.4 million was recorded as goodwill in the amount of $25.5 million. We have
completed the valuations of certain tangible and intangible assets acquired with the new business
and have finalized the allocation of the excess of the purchase price over the net assets acquired.
The acquired goodwill is not expected to be deductible for income tax purposes.
8
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
2. MERGERS AND ACQUISITIONS (Concluded)
The following table represents the final allocation of the purchase price to assets acquired
and liabilities assumed at the acquisition date:
|
|
|
|
|
|
|
$ in thousands |
|
|
|
|
|
|
Assets Acquired |
|
|
|
|
Investments |
|
$ |
8,988 |
|
Cash and cash equivalents |
|
|
20,012 |
|
Premiums receivable |
|
|
19,570 |
|
Other assets |
|
|
1,133 |
|
Goodwill |
|
|
25,483 |
|
Intangible assets: |
|
|
|
|
Agent relationships |
|
|
9,150 |
|
Tradename |
|
|
2,130 |
|
Customer relationships |
|
|
520 |
|
|
|
|
|
Total Assets Acquired |
|
$ |
86,986 |
|
|
|
|
|
|
|
|
|
|
Liabilities Assumed |
|
|
|
|
Premiums payable to insurance companies |
|
$ |
23,218 |
|
Loss and loss adjustment expense reserves |
|
|
4,490 |
|
Unearned premium reserves |
|
|
1,734 |
|
Deferred federal income taxes |
|
|
3,917 |
|
Accounts payable, accrued expenses, and other liabilities |
|
|
14,745 |
|
|
|
|
|
Total Liabilities Assumed |
|
|
48,104 |
|
|
|
|
|
|
|
|
|
|
Net Assets Acquired |
|
$ |
38,882 |
|
|
|
|
|
Agent relationships are being amortized as the economic benefits of these intangible assets
are utilized over their estimated useful lives of approximately 18 years. The tradename is being
amortized on a straight-line basis over its estimated useful life of 20 years. The customer
relationships are being amortized on a straight-line basis, which approximates the utilization of
the economic benefits of these assets, over their estimated useful lives of 15 years.
In connection with the AMC acquisition, we entered into an operating lease agreement for real
property in Conway, Arkansas with an entity owned by the former majority shareholder and current
president of AMC. The lease term is for ten years, with annual rent of approximately $0.5 million,
payable in monthly installments.
3. DISCONTINUED OPERATIONS
On June 27, 2008, the Company sold all of the outstanding shares of capital stock of ARPCO
Holdings, Inc. and its subsidiaries (ARPCO) for a purchase price of $43.0 million. The net
assets disposed of in the transaction were $7.2 million and were principally intangible assets.
The operating results of discontinued operations included in the accompanying Condensed
Consolidated Statements of Income are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
|
|
(Dollars in thousands) |
Revenues |
|
$ |
|
|
|
$ |
2,908 |
|
|
$ |
|
|
|
$ |
5,884 |
|
Income Before Income
Taxes |
|
$ |
|
|
|
$ |
1,620 |
|
|
$ |
|
|
|
$ |
3,533 |
|
9
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
4. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted-average number
of shares of common stock outstanding for the period. Diluted net income per share reflects the
potential dilution that could occur if common stock equivalents were issued and exercised.
The following is a reconciliation of basic number of common shares outstanding to diluted
common and common equivalent shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands, except share and per share data) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Continuing Operations |
|
$ |
11,609 |
|
|
$ |
6,236 |
|
|
$ |
20,290 |
|
|
$ |
14,870 |
|
Income from Discontinued Operations |
|
|
|
|
|
|
22,467 |
|
|
|
|
|
|
|
23,553 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income as reported |
|
|
11,609 |
|
|
|
28,703 |
|
|
|
20,290 |
|
|
|
38,423 |
|
Net income allocated to unvested restricted stock shares |
|
|
(87 |
) |
|
|
(86 |
) |
|
|
(152 |
) |
|
|
(115 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common |
|
$ |
11,522 |
|
|
$ |
28,617 |
|
|
$ |
20,138 |
|
|
$ |
38,308 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average number of common and common equivalent
shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic number of common shares outstanding |
|
|
17,700,272 |
|
|
|
18,259,602 |
|
|
|
17,737,708 |
|
|
|
18,182,832 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect of stock options |
|
|
342,212 |
|
|
|
678,837 |
|
|
|
337,960 |
|
|
|
616,572 |
|
Dilutive effect of unvested restricted stock |
|
|
|
|
|
|
4,823 |
|
|
|
|
|
|
|
4,315 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive number of common and common equivalent shares
outstanding |
|
|
18,042,484 |
|
|
|
18,943,262 |
|
|
|
18,075,668 |
|
|
|
18,803,719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Net Income Per Common Share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Continuing Operations |
|
$ |
0.65 |
|
|
$ |
0.34 |
|
|
$ |
1.14 |
|
|
$ |
0.82 |
|
Income from Discontinued Operations |
|
|
|
|
|
|
1.23 |
|
|
|
|
|
|
|
1.29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
0.65 |
|
|
$ |
1.57 |
|
|
$ |
1.14 |
|
|
$ |
2.11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Net Income Per Common Share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Continuing Operations |
|
$ |
0.64 |
|
|
$ |
0.33 |
|
|
$ |
1.11 |
|
|
$ |
0.79 |
|
Income from Discontinued Operations |
|
|
|
|
|
|
1.18 |
|
|
|
|
|
|
|
1.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
0.64 |
|
|
$ |
1.51 |
|
|
$ |
1.11 |
|
|
$ |
2.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-dilutive shares excluded from diluted net income
per common share |
|
|
1,103,688 |
|
|
|
932,188 |
|
|
|
1,103,688 |
|
|
|
932,188 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On January 1, 2009, we adopted FASB FSP EITF 03-6-1, Determining Whether Instruments Granted
in Share-Based Payment Transactions are Participating Securities (FSP EITF 03-6-1), which
requires that unvested restricted stock with a nonforfeitable right to receive dividends be
included in the two-class method of computing earnings per share. FSP EITF 03-6-1 did not have a
material impact on our reported earnings per share amounts.
10
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS
The amortized cost, gross unrealized gains and losses, and market value of marketable
investment securities classified as available-for-sale at June 30, 2009 by major security type were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Unrealized |
|
|
|
|
|
|
Amortized Cost |
|
|
Gains |
|
|
Losses |
|
|
Market Value |
|
|
|
(Dollars in thousands) |
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
3,941 |
|
|
$ |
161 |
|
|
$ |
(1 |
) |
|
$ |
4,101 |
|
Government agency mortgage-backed securities |
|
|
93,058 |
|
|
|
3,429 |
|
|
|
(81 |
) |
|
|
96,406 |
|
Government agency obligations |
|
|
1,018 |
|
|
|
38 |
|
|
|
|
|
|
|
1,056 |
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
87,040 |
|
|
|
2,368 |
|
|
|
(5,147 |
) |
|
|
84,261 |
|
Obligations of states and political
subdivisions |
|
|
194,413 |
|
|
|
7,336 |
|
|
|
(380 |
) |
|
|
201,369 |
|
Corporate bonds |
|
|
136,225 |
|
|
|
6,060 |
|
|
|
(1,821 |
) |
|
|
140,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
515,695 |
|
|
|
19,392 |
|
|
|
(7,430 |
) |
|
|
527,657 |
|
Preferred stocks |
|
|
1,416 |
|
|
|
|
|
|
|
(271 |
) |
|
|
1,145 |
|
Short-term investments |
|
|
16,921 |
|
|
|
|
|
|
|
|
|
|
|
16,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
534,032 |
|
|
$ |
19,392 |
|
|
$ |
(7,701 |
) |
|
$ |
545,723 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost, gross unrealized gains and losses, and market value of marketable
investment securities classified as available-for-sale at December 31, 2008 by major security type
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Unrealized |
|
|
|
|
|
|
Amortized Cost |
|
|
Gains |
|
|
Losses |
|
|
Market Value |
|
|
|
(Dollars in thousands) |
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
5,256 |
|
|
$ |
307 |
|
|
$ |
|
|
|
$ |
5,563 |
|
Government agency mortgage-backed securities |
|
|
82,548 |
|
|
|
2,422 |
|
|
|
(39 |
) |
|
|
84,931 |
|
Government agency obligations |
|
|
3,163 |
|
|
|
76 |
|
|
|
|
|
|
|
3,239 |
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
71,378 |
|
|
|
337 |
|
|
|
(7,087 |
) |
|
|
64,628 |
|
Obligations of states and political subdivisions |
|
|
205,425 |
|
|
|
5,634 |
|
|
|
(694 |
) |
|
|
210,365 |
|
Corporate bonds |
|
|
89,383 |
|
|
|
1,499 |
|
|
|
(3,874 |
) |
|
|
87,008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
457,153 |
|
|
|
10,275 |
|
|
|
(11,694 |
) |
|
|
455,734 |
|
Preferred stocks |
|
|
1,416 |
|
|
|
|
|
|
|
(367 |
) |
|
|
1,049 |
|
Short-term investments |
|
|
32,142 |
|
|
|
|
|
|
|
|
|
|
|
32,142 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
490,711 |
|
|
$ |
10,275 |
|
|
$ |
(12,061 |
) |
|
$ |
488,925 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of Investment Securities
Impairment of investment securities results when a market decline below cost is
other-than-temporary. The other-than-temporary write down is separated into an amount representing
the credit loss which is recognized in earnings and the amount related to all other factors which
is recorded in other comprehensive income. Management regularly reviews our fixed maturity
securities portfolio to evaluate the necessity of recording impairment losses for
other-than-temporary declines in the fair value of investments. Factors considered in evaluating
potential impairment include, but are not limited to, the current fair value as compared to cost or
amortized cost of the security, as appropriate, the length of time the investment has been below
cost or amortized cost and by how much, our intent to sell a security and whether it is
more-likely-than-not we will be required to sell the security before the recovery of our amortized
cost basis, and specific credit issues related to the issuer and current economic conditions.
Other-than-temporary impairment losses result in a reduction of the cost basis of the underlying
investment. Significant changes in these factors we consider when evaluating investments for impairment losses could result in a change in impairment losses
reported in the consolidated financial statements.
As mentioned above, the Company considers its intent and ability to hold a security until the
value recovers as part of the process of evaluating whether a securitys unrealized loss represents
an other-than-temporary decline. The Companys ability to hold such securities is supported by
sufficient cash flow from its operations and from maturities within its investment portfolio in
order to meet its claims payment and other disbursement obligations arising from its underwriting
operations without selling such investments. With respect to securities where the decline in value
is determined to be temporary and the securitys value is not written down, a subsequent decision
may be made to sell that security and realize a loss. Subsequent decisions on security sales are
made within the
11
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
context of overall risk monitoring, changing information and market conditions. Management of the
Companys investment portfolio is outsourced to third party investment managers, which is directed
and monitored by the investment committee. While these investment managers may, at a given point in
time, believe that the preferred course of action is to hold securities with unrealized losses that
are considered temporary until such losses are recovered, the dynamic nature of the portfolio
management may result in a subsequent decision to sell the security and realize the loss, based
upon a change in market and other factors described above. The Company believes that subsequent
decisions to sell such securities are consistent with the classification of the Companys portfolio
as available-for-sale.
Investment managers are required to notify management of rating agency downgrades of
securities in their portfolios as well as any potential investment valuation issues no later than
the end of each quarter. Investment managers are also required to notify management, and receive
prior approval, prior to the execution of a transaction or series of related transactions that may
result in a realized loss above a certain threshold. Additionally, investment managers are required
to notify management, and receive approval, prior to the execution of a transaction or series of
related transactions that may result in any realized loss up until a certain period beyond the
close of a quarterly accounting period.
Under current accounting standards, an OTTI write-down of debt securities, where fair value is
below amortized cost, is triggered in circumstances where (1) an entity has the intent to sell a
security, (2) it is more-likely-than-not that the entity will be required to sell the security
before recovery of its amortized cost basis, or (3) the entity does not expect to recover the
entire amortized cost basis of the security. If an entity intends to sell a security or if it is
more-likely-than-not the entity will be required to sell the security before recovery, an OTTI
write-down is recognized in earnings equal to the difference between the securitys amortized cost
and its fair value. If an entity does not intend to sell the security or it is not
more-likely-than-not that it will be required to sell the security before recovery, the OTTI
write-down is separated into an amount representing the credit loss, which is recognized in
earnings, and the amount related to all other factors, which is recognized in other comprehensive
income.
The table below represents the gross and net presentation of other-than-temporary impairment
losses on investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
Other-than-temporary impairment losses on
investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total losses |
|
$ |
(832 |
) |
|
$ |
(225 |
) |
|
$ |
(869 |
) |
|
$ |
(225 |
) |
Portion of losses recognized in accumulated other
comprehensive income |
|
|
735 |
|
|
|
|
|
|
|
735 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses on
investments |
|
|
(97 |
) |
|
|
(225 |
) |
|
|
(134 |
) |
|
|
(225 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
12
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
The following table presents a roll-forward of the credit component of other-than-temporary
impairments (OTTI) on debt securities recognized in the consolidated statement of income for which
a portion of the other-than-temporary impairment was recognized in other comprehensive income for
the period April 1, 2009 through June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April 1, 2009 |
|
Additions for |
|
Additions for |
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
Cumulative |
|
OTTI Securities |
|
OTTI Securities |
|
|
|
|
|
Adjustments to |
|
Cumulative |
|
|
OTTI Credit |
|
Where No Credit |
|
Where Credit |
|
Reductions Due |
|
Book Value of |
|
OTTI Credit |
|
|
Losses |
|
Losses Were |
|
Losses Have |
|
to Sales or Intend/ |
|
Credit-Impaired |
|
Losses |
|
|
Recognized for |
|
Recognized Prior |
|
Been Recognized |
|
Required to Sell of Credit- |
|
Securities due to |
|
Recognized for |
|
|
Securities Still |
|
to |
|
Prior to |
|
Impaired |
|
Changes in Cash |
|
Securities Still |
|
|
Held |
|
April 1, 2009 |
|
April 1, 2009 |
|
Securities |
|
Flows |
|
Held |
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities,
collateralized mortgage
obligations
and passthrough securities |
|
$ |
164 |
|
|
$ |
97 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
261 |
|
All other corporate bonds |
|
|
569 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
569 |
|
|
|
|
Total debt
securities |
|
$ |
733 |
|
|
$ |
97 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
830 |
|
|
|
|
The fair value and amount of unrealized losses segregated by the time period the investment
had been in an unrealized loss position is as follows at June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months |
|
|
Greater than 12 Months |
|
|
|
Fair Value |
|
|
|
|
|
|
Fair Value |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
With |
|
|
Gross |
|
|
With |
|
|
Gross |
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
|
(Dollars in thousands) |
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
108 |
|
|
$ |
(1 |
) |
|
$ |
|
|
|
$ |
|
|
Government agency mortgage-backed securities |
|
|
17,200 |
|
|
|
(71 |
) |
|
|
281 |
|
|
|
(10 |
) |
Government agency obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
7,583 |
|
|
|
(316 |
) |
|
|
20,521 |
|
|
|
(4,831 |
) |
Obligations of states and political
subdivisions |
|
|
3,289 |
|
|
|
(71 |
) |
|
|
12,917 |
|
|
|
(309 |
) |
Corporate bonds |
|
|
9,833 |
|
|
|
(78 |
) |
|
|
15,736 |
|
|
|
(1,743 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
38,013 |
|
|
|
(537 |
) |
|
|
49,455 |
|
|
|
(6,893 |
) |
Preferred Stocks |
|
|
875 |
|
|
|
(35 |
) |
|
|
270 |
|
|
|
(236 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
38,888 |
|
|
$ |
(572 |
) |
|
$ |
49,725 |
|
|
$ |
(7,129 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
13
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
The fair value and amount of unrealized losses segregated by the time period the investment
had been in an unrealized loss position is as follows at December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months |
|
|
Greater than 12 Months |
|
|
|
Fair Value |
|
|
|
|
|
|
Fair Value |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
With |
|
|
Gross |
|
|
With |
|
|
Gross |
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
|
(Dollars in thousands) |
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Government agency mortgage-backed securities |
|
|
3,902 |
|
|
|
(37 |
) |
|
|
326 |
|
|
|
(2 |
) |
Government agency obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
48,125 |
|
|
|
(5,143 |
) |
|
|
5,963 |
|
|
|
(1,944 |
) |
Obligations of states and political
subdivisions |
|
|
14,063 |
|
|
|
(427 |
) |
|
|
8,809 |
|
|
|
(267 |
) |
Corporate bonds |
|
|
42,402 |
|
|
|
(2,549 |
) |
|
|
12,824 |
|
|
|
(1,325 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
108,492 |
|
|
|
(8,156 |
) |
|
|
27,922 |
|
|
|
(3,538 |
) |
Preferred Stocks |
|
|
832 |
|
|
|
(78 |
) |
|
|
216 |
|
|
|
(289 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
109,324 |
|
|
$ |
(8,234 |
) |
|
$ |
28,138 |
|
|
$ |
(3,827 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Below is a table that illustrates the unrecognized impairment loss by sector. The increase in
spread relative to U.S. Treasury Bonds was the primary factor leading to impairment for the periods
ended June 30, 2009. All asset sectors were affected by the overall increase in spreads as can be
seen from the table below. In addition to the general level of rates, we also look at a variety of
other factors such as direction of credit spreads for an individual issue as well as the magnitude
of specific securities that have declined below amortized cost.
|
|
|
|
|
|
|
Amount of |
|
|
|
Unrealized |
|
|
|
Loss at |
|
Sector |
|
June 30, 2009 |
|
|
|
(Dollars in thousands) |
|
Debt Securities |
|
|
|
|
U.S. Treasuries |
|
|
(1 |
) |
U.S. Agencies |
|
|
|
|
|
|
|
|
U.S. government securities |
|
|
(1 |
) |
|
|
|
|
Government agency mortgage-backed securities |
|
|
(81 |
) |
|
|
|
|
Government agency obligations |
|
|
|
|
|
|
|
|
MBS Passthroughs |
|
|
(42 |
) |
CMOs |
|
|
(1,462 |
) |
Asset Backed Securities |
|
|
(577 |
) |
Commercial MBS |
|
|
(3,066 |
) |
|
|
|
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
(5,147 |
) |
|
|
|
|
Obligations of states and political subdivisions |
|
|
(380 |
) |
|
|
|
|
Corporate Bonds |
|
|
(1,807 |
) |
High Yield Bonds |
|
|
(14 |
) |
|
|
|
|
Corporate Bonds |
|
|
(1,821 |
) |
|
|
|
|
Total Debt Securities |
|
|
(7,430 |
) |
Preferred Stocks |
|
|
(271 |
) |
Short-term investments |
|
|
|
|
|
|
|
|
Total |
|
$ |
(7,701 |
) |
|
|
|
|
14
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
At
June 30, 2009, there were 169 unrealized loss positions with a total unrealized loss of
$7.7 million. This represents approximately 1.2% of quarter end invested assets of $625.2 million.
This unrealized loss position is a function of the purchase of specific securities in a lower
interest rate or spread environment than what prevails as of June 30, 2009. Some of these losses
are due to the increase in spreads of select corporate bonds or structured securities. We have
viewed these market value declines as being temporary in nature. Our portfolio is relatively short
as the duration of the core fixed income portfolio excluding cash, convertible securities, limited
partnerships and equity is approximately 3.7 years. We do not intend to sell and it is not
expected we will need to sell these temporarily impaired securities before maturity in the event
that interest rates do not decline from current levels. In light of our significant growth over
the past 24 months, liquidity needs from the portfolio are minimal. As a result, we would not
expect to have to liquidate temporarily impaired securities to pay claims or for any other
purposes. There have been certain instances over the past year, where due to market based
opportunities; we have elected to sell a small portion of the portfolio. These situations were
unique and infrequent occurrences and in our opinion, do not reflect an indication that we intend
to sell or will be required to sell these securities before they mature or recover in value.
The most significant risk or uncertainty inherent in our assessment methodology is that the
current credit rating of a particular issue changes over time. If the rating agencies should
change their rating on a particular security in our portfolio, it could lead to a reclassification
of that specific issue. The vast majority of our unrecognized impairment losses are investment
grade and AAA or AA rated securities. Should the credit quality of individual issues decline
for whatever reason then it would lead us to reconsider the classification of that particular
security. Within the non-investment grade sector, we continue to monitor the particular status of
each issue. Should prospects for any one issue deteriorate, we would potentially alter our
classification of that particular issue.
The table below illustrates the breakdown of impaired securities by investment grade and non
investment grade as well as the duration that these sectors have been trading below amortized cost.
The average duration of the impairment has been greater than 12 months. The unrealized loss of
impaired securities as a percent of the amortized cost of those
securities is 8.0% as of June 30,
2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Total |
|
|
Total |
|
|
Total |
|
|
Average Unrealized Loss |
|
|
% of Loss |
|
|
|
Amortized Cost |
|
|
Amortized Cost |
|
|
Unrealized Losses |
|
|
as % of Amortized Cost |
|
|
> 12 Months |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non Investment Grade |
|
|
4.2 |
% |
|
$ |
4,046 |
|
|
$ |
1,102 |
|
|
|
27.2 |
% |
|
|
99.1 |
% |
Investment Grade |
|
|
95.8 |
|
|
|
92,268 |
|
|
|
6,599 |
|
|
|
7.2 |
|
|
|
91.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
$ |
96,314 |
|
|
$ |
7,701 |
|
|
|
8.0 |
% |
|
|
92.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The majority of these securities are AAA or AA rated. These issues are continually
monitored and may be classified in the future as being other than temporarily impaired.
The largest concentration of temporarily impaired securities is Commercial MBS at
approximately 39.8% of the total unrealized loss. These securities are all AAA rated and have
been affected primarily by the widening of spreads within this sector and/or the general level of
interest rates. The next largest
concentration of temporarily impaired securities is Corporate Bonds at approximately 23.6% of the
total unrealized loss. Within Corporate Bonds 88.0% are rated investment grade BBB or better, and
their temporary impairment results primarily from the widening of
credit spreads. The next highest concentration of temporarily
impaired securities is CMOs at 19.0%
of the total unrealized loss. Within CMOs 96.8% are rated AAA including the 79.8% of the CMO exposure that is agency issued, and have
primarily been affected by the general level of interest rates as well.
For the six months ended June 30, 2009, we sold approximately $3.3 million of market value of
fixed income securities, excluding convertibles, which were trading below amortized cost while
recording a realized loss of $0.1 million. This realized loss represented 3.8% of the amortized
cost of the positions. These sales were unique opportunities to sell specific positions due to
changing market conditions. These situations were exceptions to our general assertion regarding our
ability and intent to hold securities with unrealized losses until they mature or recover in value.
This position is further supported by the insignificant losses as a percentage of amortized cost
for the respective periods.
15
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
5. INVESTMENTS (Concluded)
Hybrid Instruments
As of June 30, 2009 and December 31, 2008, the market value of convertible securities
accounted for as hybrid instruments was $58.9 million and $43.5 million, respectively. Convertible
bonds and bond units had a market value of $52.4 million and $39.0 million and were included in
Debt securities in the Condensed Consolidated Balance Sheets at June 30, 2009 and December 31,
2008, respectively. Convertible preferred stocks had a market value of $6.5 million and $4.5
million and were included in Equity securities and other in the Condensed Consolidated Balance
Sheets at June 30, 2009 and December 31, 2008, respectively. The Company recorded an increase in
the fair value of the hybrid instruments of $4.3 million and $6.9 million in Net realized gains on
investments for the three and six months ended June 30, 2009. As of June 30, 2009 and December 31,
2008, there were no convertible securities that were not accounted for as hybrid instruments in
accordance with SFAS 155.
Alternative Investments
The Company has $10.0 million invested in a limited partnership, which invests in high yield
convertible securities. An additional $2.0 million was invested during January 2009 for a total
cost of $12.0 million. The market value of this investment was $10.0 million at June 30, 2009. In
addition, the Company invested $5.0 million in another limited partnership, which invests in
distressed structured finance products. An additional $5.0 million was invested during March 2009
for a total cost of $10.0 million. The market value of this investment was $10.5 million at June
30, 2009. The Company elected the fair value option for these investments in accordance with SFAS
159. The change in fair value of these investments is recorded in Net investment income and Net
realized gains (losses) on investments in the Condensed Consolidated Statements of Income. These
investments are recorded in Equity securities and other in the Condensed Consolidated Balance
Sheets.
6. INCOME TAXES
At June 30, 2009 and December 31, 2008, FASB Interpretation No. 48 Accounting for Uncertainty
in Income Taxes, an Interpretation of SFAS No. 109 (FIN 48), which clarifies the accounting for
uncertainty in income taxes recognized in an entitys financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes, did not have an impact on our financial position
or results of operations, and we have taken no tax positions which would require disclosure under
FIN 48. Although the IRS is not currently examining any of our income tax returns, tax years 2005,
2006 and 2007 remain open and are subject to examination.
The Company files a consolidated federal income tax return with its subsidiaries. Taxes are
allocated among the Companys subsidiaries based on the Tax Allocation Agreement employed by these
entities, which provides that taxes of the entities are calculated on a separate-return basis at
the highest marginal tax rate.
Income taxes in the accompanying unaudited Condensed Consolidated Statements of Income differ
from the statutory tax rate of 35.0% primarily due to state income taxes, non-deductible expenses,
and the nontaxable portion of dividends received and tax-exempt interest.
16
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
7. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company establishes a reserve for both reported and unreported covered losses, which
includes estimates of both future payments of losses and related loss adjustment expenses. The
following represents changes in those aggregate reserves for the Company during the periods
presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
400,152 |
|
|
$ |
301,314 |
|
|
$ |
372,721 |
|
|
$ |
272,365 |
|
Less reinsurance recoverables |
|
|
138,943 |
|
|
|
103,068 |
|
|
|
128,552 |
|
|
|
91,444 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Balance, beginning of period |
|
|
261,209 |
|
|
|
198,246 |
|
|
|
244,169 |
|
|
|
180,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AUIC net reserves, date of acquisition |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,490 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incurred Related To |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year |
|
|
39,084 |
|
|
|
25,732 |
|
|
|
70,327 |
|
|
|
49,177 |
|
Prior years |
|
|
(3,621 |
) |
|
|
|
|
|
|
(4,371 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Incurred |
|
|
35,463 |
|
|
|
25,732 |
|
|
|
65,956 |
|
|
|
49,177 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paid Related To |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year |
|
|
3,533 |
|
|
|
2,004 |
|
|
|
4,439 |
|
|
|
2,338 |
|
Prior years |
|
|
12,388 |
|
|
|
11,381 |
|
|
|
24,935 |
|
|
|
21,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Paid |
|
|
15,921 |
|
|
|
13,385 |
|
|
|
29,374 |
|
|
|
23,995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Balance |
|
|
280,751 |
|
|
|
210,593 |
|
|
|
280,751 |
|
|
|
210,593 |
|
Plus reinsurance recoverables |
|
|
146,157 |
|
|
|
113,909 |
|
|
|
146,157 |
|
|
|
113,909 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period |
|
$ |
426,908 |
|
|
$ |
324,502 |
|
|
$ |
426,908 |
|
|
$ |
324,502 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8. REINSURANCE
Net written and earned premiums, including reinsurance activity, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Written Premiums |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
77,892 |
|
|
$ |
75,761 |
|
|
$ |
151,012 |
|
|
$ |
151,974 |
|
Assumed |
|
|
4,629 |
|
|
|
4,153 |
|
|
|
9,387 |
|
|
|
9,146 |
|
Ceded |
|
|
(29,079 |
) |
|
|
(27,673 |
) |
|
|
(57,132 |
) |
|
|
(50,376 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Written Premiums |
|
$ |
53,442 |
|
|
$ |
52,241 |
|
|
$ |
103,267 |
|
|
$ |
110,744 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned Premiums |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
74,913 |
|
|
$ |
69,571 |
|
|
$ |
148,218 |
|
|
$ |
138,224 |
|
Assumed |
|
|
4,460 |
|
|
|
4,231 |
|
|
|
8,747 |
|
|
|
7,983 |
|
Ceded |
|
|
(26,773 |
) |
|
|
(27,818 |
) |
|
|
(51,845 |
) |
|
|
(55,497 |
) |
Earned but unbilled premiums |
|
|
(1,168 |
) |
|
|
575 |
|
|
|
(1,093 |
) |
|
|
(580 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Earned Premiums |
|
$ |
51,432 |
|
|
$ |
46,559 |
|
|
$ |
104,027 |
|
|
$ |
90,130 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company manages its credit risk on reinsurance recoverables by reviewing the financial
stability, A.M. Best rating, capitalization, and credit worthiness of prospective and existing
risk-sharing partners. The Company customarily collateralizes reinsurance balances due from
unauthorized reinsurers through funds withheld, grantor trusts, or stand-by letters of credit
issued by highly rated banks.
The Companys 2009 and 2008 ceded reinsurance program includes quota share reinsurance
agreements with authorized reinsurers that were entered into and are accounted for on a funds
withheld basis. Under the funds withheld basis, the Company records the
17
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
8. REINSURANCE (Concluded)
ceded premiums payable to the reinsurer, less ceded paid losses and loss adjustment expenses
receivable from the reinsurer, less any amounts due to the reinsurer for the reinsurers margin, or
cost of the reinsurance contract, as a liability, and reported $61.9 million and $49.4 million as
Funds held under reinsurance treaties in the accompanying Condensed Consolidated Balance Sheets at
June 30, 2009 and December 31, 2008, respectively. As specified under the terms of the agreements,
the Company credits the funds withheld balance at stated interest crediting rates applied to the
funds withheld balance. If the funds withheld liability is exhausted, interest crediting would
cease and additional claim payments would be recoverable from the reinsurer.
Interest cost on reinsurance contracts accounted for on a funds withheld basis is incurred
during all periods in which a funds withheld liability exists or as otherwise specified under the
terms of the contract and is included in Underwriting, agency and other expenses. The amount
subject to interest crediting rates was $22.6 million and $19.3 million at June 30, 2009 and 2008,
respectively.
9. SHARE REPURCHASE PROGRAM
The Board of Directors of the Company authorized a share repurchase plan to purchase up to 1.5
million shares of common stock through open market or privately negotiated transactions. The
repurchase program expires on August 18, 2009. During the three and six months ended June 30, 2009,
the Company repurchased 387,758 shares of common stock for $5.1 million at an average cost of
$13.11 per share. As of June 30, 2009, the Company had 413,665 shares of remaining capacity under
the share repurchase program. Shares purchased under the program are retired and returned to the
status of authorized but unissued shares. Subsequent to June 30,
2009, the Company repurchased the remaining 413,665 shares of common
stock for $5.4 million at an average cost of $13.06 per share. These
purchases fulfilled the remaining capacity of the Companys 1.5
million share repurchase plan.
10. STOCK COMPENSATION PLANS
The 1998 Stock Compensation Plan (the 1998 Plan) was established September 3, 1998. Under
the terms of the plan, directors, officers, employees and key individuals may be granted options to
purchase the Companys common stock. Option and vesting periods and option exercise prices are
determined by the Compensation Committee of the Board of Directors, provided no stock options shall
be exercisable more than ten years after the grant date. All outstanding stock options under the
plan became fully vested on August 17, 2005 under the change in control provision in the plan. Of
the 4,625,000 shares of the Companys common stock initially reserved for future grant under the
1998 Plan, shares available for future grant totaled 2,443,387 at June 30, 2009, however, on May
13, 2009, the Company adopted an amendment to the 1998 Plan prohibiting the issuance of any
additional awards under the 1998 Plan.
The First Mercury Financial Corporation Omnibus Incentive Plan of 2006 (the Omnibus Plan)
was established October 16, 2006. The Company has reserved 1,500,000 shares of its common stock
for future granting of stock options, stock appreciation rights (SAR), restricted stock,
restricted stock units (RSU), deferred stock units (DSU), performance shares, performance cash
awards, and other stock or cash awards to employees and non-employee directors at any time prior to
October 15, 2016. On May 13, 2009, the Companys stockholders approved an amendment to the Omnibus
Plan to increase the number of shares authorized for issuance thereunder by 1,650,000 shares, which
brings the total number of shares reserved under the Omnibus Plant to 3,150,000. All of the terms
of the vesting or other restrictions will be determined by the Companys Compensation Committee of
the Board of Directors. The exercise price will not be less than the fair market value of the
shares on the date of grant. During the three months ended June 30, 2009, the Company did not make
any stock option grants under the Omnibus Plan. During the six months ended June 30, 2009, the
Company granted 197,500 stock options and 93,500 shares of restricted stock to employees under the
Omnibus Plan. The stock options and shares of restricted stock vest in three equal installments
over a period of three years commencing on March 5, 2010. Stock-based compensation will be
recognized over the expected vesting period of the stock options and shares of restricted stock.
During the three and six months ended June 30, 2009, the Company granted 19,704 shares of
restricted stock to non-employee directors under the Omnibus Plan. These shares of restricted stock
vested immediately, but are not transferable for one year after the grant date, and stock-based
compensation was recognized immediately. During the three and six months ended June 30, 2008, the
Company granted 226,000 and 374,500 stock options, respectively, to employees and 30,500 and 45,500
shares of restricted stock, respectively, to employees under the Omnibus Plan. The stock options
and shares of restricted stock vest in three equal installments over a period of three years.
Stock-based compensation will be recognized over the expected vesting period of the stock options
and shares of restricted stock. During the three months ended June 30, 2008, the Company granted
12,124 shares of restricted stock to
non-employee directors under the Omnibus Plan. These shares of restricted stock vested
immediately, but are not transferable for one
year after the grant date, and stock-based compensation expense was recognized immediately. Shares
available for future grants under the Omnibus Plan totaled 1,836,036 at June 30, 2009.
18
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
10. STOCK COMPENSATION PLANS (Continued)
The following table summarizes stock option activity for the six months ended June 30, 2009
and 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1998 Plan |
|
|
Omnibus Plan |
|
|
|
Number of |
|
|
Weighted Average |
|
|
Number of |
|
|
Weighted Average |
|
|
|
Options |
|
|
Exercise Price |
|
|
Options |
|
|
Exercise Price |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oustanding at January 1, 2008 |
|
|
927,775 |
|
|
$ |
2.24 |
|
|
|
573,688 |
|
|
$ |
19.10 |
|
Granted during the period |
|
|
|
|
|
|
|
|
|
|
374,500 |
|
|
|
16.38 |
|
Forfeited during the period |
|
|
|
|
|
|
|
|
|
|
(12,700 |
) |
|
|
18.77 |
|
Exercised during the period |
|
|
(302,575 |
) |
|
|
1.80 |
|
|
|
(3,300 |
) |
|
|
17.00 |
|
Cancelled during the period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2008 |
|
|
625,200 |
|
|
$ |
2.50 |
|
|
|
932,188 |
|
|
$ |
18.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oustanding at January 1, 2009 |
|
|
431,050 |
|
|
$ |
2.82 |
|
|
|
932,188 |
|
|
$ |
17.93 |
|
Granted during the period |
|
|
|
|
|
|
|
|
|
|
197,500 |
|
|
|
13.01 |
|
Forfeited during the period |
|
|
|
|
|
|
|
|
|
|
(15,000 |
) |
|
|
18.78 |
|
Exercised during the period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cancelled during the period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2009 |
|
|
431,050 |
|
|
$ |
2.82 |
|
|
|
1,114,688 |
|
|
$ |
17.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2008 |
|
|
625,200 |
|
|
$ |
2.50 |
|
|
|
152,566 |
|
|
$ |
18.80 |
|
June 30, 2009 |
|
|
431,050 |
|
|
|
2.82 |
|
|
|
453,125 |
|
|
|
18.26 |
|
The aggregate intrinsic value of fully vested options outstanding and exercisable under the
1998 Plan was $4.7 million at June 30, 2009. There was $0.2 million of aggregate intrinsic value
of options expected to vest under the Omnibus Plan at June 30, 2009.
There were no stock options exercised during the three and six months ended June 30, 2009.
The number of stock option awards outstanding and exercisable at June 30, 2009 by range of
exercise prices was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
Options Exercisable |
|
|
|
|
|
|
Weighted-Average |
|
Weighted-Average |
|
|
|
|
|
Weighted-Average |
Range of |
|
Outstanding as of |
|
Remaining |
|
Exercise Price Per |
|
Exercisable as of |
|
Exercise Price Per |
Exercisable Price |
|
June 30, 2009 |
|
Contractual Life |
|
Share |
|
June 30, 2009 |
|
Share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1998 Plan |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$1.51 - $1.95 |
|
|
319,125 |
|
|
3.60 |
Years |
|
$ |
1.71 |
|
|
|
319,125 |
|
|
$ |
1.71 |
|
$4.86 - $6.49 |
|
|
111,925 |
|
|
|
1.30 |
|
|
|
5.97 |
|
|
|
111,925 |
|
|
|
5.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
431,050 |
|
|
|
3.00 |
|
|
|
2.82 |
|
|
|
431,050 |
|
|
|
2.82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Omnibus Plan |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$10.98 - $14.93 |
|
|
347,000 |
|
|
9.28 |
Years |
|
$ |
13.70 |
|
|
|
45,829 |
|
|
$ |
14.93 |
|
$17.00 - $20.75 |
|
|
767,688 |
|
|
|
7.06 |
|
|
|
18.56 |
|
|
|
407,296 |
|
|
|
18.64 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,114,688 |
|
|
|
7.75 |
|
|
|
17.05 |
|
|
|
453,125 |
|
|
|
18.26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2009, there was approximately $4.4 million of total unrecognized compensation
cost related to non-vested share-based compensation arrangements granted under the Omnibus Plan.
That cost is expected to be recognized over a weighted-average period of 2.1 years.
19
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
10. STOCK COMPENSATION PLANS (Concluded)
The fair value of stock options granted during the six months ended June 30, 2009 and 2008
were determined on the dates of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
Omnibus Plan |
|
|
|
|
|
|
|
|
Expected term |
|
|
6.0 |
|
|
|
6.0 |
|
Expected stock price volatility |
|
|
41.11 |
% |
|
|
29.78 |
% |
Risk-free interest rate |
|
|
2.16 |
% |
|
|
3.12 |
% |
Expected dividend yield |
|
|
|
|
|
|
|
|
Estimated fair value per option |
|
$ |
5.53 |
|
|
$ |
5.79 |
|
The expected term of options was determined based on the simplified method from SEC Staff
Accounting Bulletin 107 (SAB 107), as amended by Staff Accounting Bulletin 110 (SAB 110).
Expected stock price volatility was based on an average of the volatility factors utilized by
companies within the Companys peer group with consideration given to the Companys historical
volatility. The risk-free interest rate is based on the yield of U.S. Treasury securities with an
equivalent remaining term. Prior to the second quarter of 2009, the Company had not paid dividends
and therefore no expected dividend yield was included in the Black-Scholes option pricing model.
In the future, expected dividend yield will be an assumption utilized in the Black-Scholes option
pricing model.
The assumptions used to calculate the fair value of options granted are evaluated and revised,
as necessary, to reflect market conditions and the Companys historical experience and future
expectations. The calculated fair value is recognized as compensation cost in the Companys
financial statements over the requisite service period of the entire award. Compensation cost is
recognized only for those options expected to vest, with forfeitures estimated at the date of grant
and evaluated and adjusted periodically to reflect the Companys historical experience and future
expectations. Any change in the forfeiture assumption is accounted for as a change in estimate,
with the cumulative effect of the change on periods previously reported being reflected in the
financial statements of the period in which the change is made. The Company recognized stock-based
compensation expense of $1.0 million and $1.6 million for the three and six months ended June 30,
2009, respectively. The Company recognized stock-based compensation expense of $0.7 million and
$1.0 million for the three and six months ended June 30, 2008, respectively.
11. FAIR VALUE MEASUREMENTS
Our available-for-sale investment portfolio consists of fixed maturity and equity securities
and short-term investments, and is recorded at fair value in the accompanying Condensed
Consolidated Balance Sheets in accordance with FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities (SFAS 115). The change in the fair value of these
investments is recorded as a component of Other comprehensive income (loss).
We adopted FASB Statement No. 159, The Fair Value Option of Financial Assets and Financial
Liabilities (SFAS 159) effective January 1, 2008. Under this standard, we are permitted to elect
to measure financial instruments and certain other items at fair value, with the change in fair
value recorded in earnings. On January 1, 2008, we elected not to measure any eligible items using
the fair value option in accordance with SFAS 159. We believe the current accounting is
appropriate for our available-for-sale investments as we have the intent and ability to hold our
investments, therefore, SFAS 159 did not have any impact on our consolidated financial condition or
results of operations on the adoption date.
We also adopted FASB Statement No. 157, Fair Value Measurements (SFAS 157) effective
January 1, 2008. SFAS 157 defines fair value as the price that would be received to sell an asset
or would be paid to transfer a liability (i.e., the exit price) in an orderly transaction between
market participants at the measurement date, and establishes a framework to make the measurement of
fair value more consistent and comparable. In determining fair value, we primarily use prices and
other relevant information generated by market transactions involving identical or comparable
assets, or market approach as defined by SFAS 157. The implementation of SFAS 157 did not have
any impact on our consolidated financial condition or results of operations. The implementation of
SFAS 157 resulted in expanded disclosures about securities measured at fair value, as discussed
below.
SFAS 157 established a three-level hierarchy for fair value measurements that distinguishes
between market participant assumptions developed based on market data obtained from sources
independent of the reporting entity (observable inputs) and the
20
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
11. FAIR VALUE MEASUREMENTS (Continued)
reporting entitys own assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable inputs). The hierarchy level assigned to
each security in our available-for-sale, hybrid securities, and alternative investments portfolios
is based on our assessment of the transparency and reliability of the inputs used in the valuation
of such instrument at the measurement date. The three hierarchy levels are defined as follows:
|
|
|
Level 1 Valuations based on unadjusted quoted market prices in active markets for
identical securities. The fair values of fixed maturity and equity securities and short-term
investments included in the Level 1 category were based on quoted prices that are readily and
regularly available in an active market. The Level 1 category includes publicly traded equity
securities; highly liquid U.S. Government notes, treasury bills and mortgage-backed securities
issued by the Government National Mortgage Association; highly liquid cash management funds; and
short-term certificates of deposit. |
|
|
|
|
Level 2 Valuations based on observable inputs (other than Level 1 prices), such as quoted
prices for similar assets at the measurement date; quoted prices in markets that are not active; or
other inputs that are observable, either directly or indirectly. The fair value of fixed maturity
and equity securities and short-term investments included in the Level 2 category were based on the
market values obtained from an independent pricing service that were evaluated using pricing models
that vary by asset class and incorporate available trade, bid and other market information and
price quotes from well established independent broker-dealers. The independent pricing service
monitors market indicators, industry and economic events, and for broker-quoted only securities,
obtains quotes from market makers or broker-dealers that it recognizes to be market participants.
The Level 2 category includes corporate bonds, municipal bonds, redeemable preferred stocks and
certain publicly traded common stocks with no trades on the measurement date. |
|
|
|
|
Level 3 Valuations based on inputs that are unobservable and significant to the overall
fair value measurement, and involve management judgment. |
If the inputs used to measure fair value fall in different levels of the fair value hierarchy,
a financial securitys hierarchy level is based upon the lowest level of input that is significant
to the fair value measurement. A number of our investment grade corporate bonds are frequently
traded in active markets and traded market prices for these securities existed at June 30, 2009.
These securities
were classified as Level 2 at June 30, 2009 because our third party pricing service uses valuation
models which use observable market inputs in addition to traded prices.
The following table presents our investments measured at fair value on a recurring basis as of
June 30, 2009 classified by the SFAS No. 157 valuation hierarchy (as discussed above):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using |
|
|
|
|
|
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale
investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities |
|
$ |
528,802 |
|
|
$ |
4,101 |
|
|
$ |
524,041 |
|
|
$ |
660 |
|
Short-term investments |
|
|
16,921 |
|
|
|
16,921 |
|
|
|
|
|
|
|
|
|
Hybrid securities |
|
|
58,948 |
|
|
|
|
|
|
|
58,948 |
|
|
|
|
|
Alternative investments |
|
|
20,493 |
|
|
|
|
|
|
|
10,520 |
|
|
|
9,973 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
625,164 |
|
|
$ |
21,022 |
|
|
$ |
593,509 |
|
|
$ |
10,633 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 3 assets above include one asset-backed security collateralized by home equity loans
with a market value of $0.6 million within fixed maturity securities. Liquidity remains extremely
low in markets for non-agency residential mortgage-backed securities, especially those with ratings
below AAA. This securitys market value was adjusted to a model price that assumed stressed
default assumptions, which generated a 25.3% principal loss, and included a 8.0% discount rate.
Also included within Level 3 assets is a $10.0 million investment in a limited partnership. At
times, this limited partnership will invest in highly illiquid high yield convertible securities
for which observable inputs are not available. The manager of this limited partnership valued this
investment through an internally developed model.
21
FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
11. FAIR VALUE MEASUREMENTS (Concluded)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, 2009 |
|
|
June 30, 2009 |
|
|
|
|
|
|
|
|
|
|
Level 3 investments, beginning of period |
|
$ |
8,512 |
|
|
$ |
6,282 |
|
Purchases |
|
|
|
|
|
|
2,000 |
|
Increase in market value |
|
|
2,121 |
|
|
|
2,351 |
|
|
|
|
|
|
|
|
Level 3 investments as of June 30, 2009 |
|
$ |
10,633 |
|
|
$ |
10,633 |
|
|
|
|
|
|
|
|
The Company uses derivatives to hedge its exposure to interest rate fluctuations. For these
derivatives, the Company uses quoted market prices to estimate fair value and includes the estimate
as a Level 2 measurement.
The Companys financial instruments include investments, cash and cash equivalents, premiums
and reinsurance balances receivable, reinsurance recoverable on paid losses and long-term debt. At
June 30, 2009, the carrying amounts of the Companys financial instruments, including its
derivative financial instruments, approximated fair value, except for the $67.0 million of the
Companys junior subordinated debentures. The fair value of these junior subordinated debentures
is estimated to be $21.9 million at June 30, 2009. The estimate of fair value for the Companys
junior subordinated debentures is a Level 3 measurement. We use a discounted cash flow model based
on the contractual terms of the junior subordinated debentures and a discount rate of 15%, which
was based on yields of comparable securities. The fair values of the Companys investments, as
determined by quoted market prices, are disclosed in Note 5.
12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The Companys accumulated other comprehensive income (loss) included the following:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
Unrealized holding losses on securities having credit losses recognized in the condensed consolidated
statements of income, net of tax |
|
$ |
(478 |
) |
|
$ |
|
|
Unrealized holding gains (losses) on securities having no credit losses recognized in the condensed consolidated
statements of income, net of tax |
|
|
7,852 |
|
|
|
(1,193 |
) |
Fair value of interest rate swaps, net of tax |
|
|
(1,732 |
) |
|
|
(595 |
) |
|
|
|
|
|
|
|
Total accumulated other comprehensive income (loss) |
|
$ |
5,642 |
|
|
$ |
(1,788 |
) |
|
|
|
|
|
|
|
22
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements that relate to future
periods and includes statements regarding our anticipated performance. Generally, the words
anticipates, believes, expects, intends, estimates, projects, plans and similar
expressions identify forward-looking statements. These forward-looking statements involve known
and unknown risks, uncertainties and other important factors that could cause our actual results,
performance or achievements or industry results to differ materially from any future results,
performance or achievements expressed or implied by these forward-looking statements. These risks,
uncertainties and other important factors include, among others: recent and future events and
circumstances impacting financial, stock, and capital markets, and the responses to such events by
governments and financial communities; the impact of catastrophic events and the occurrence of
significant severe weather conditions on our operating results; our ability to maintain or the
lowering or loss of one of our financial or claims-paying ratings; our actual incurred losses
exceeding our loss and loss adjustment expense reserves; the failure of reinsurers to meet their
obligations; our estimates for accrued profit sharing commissions are based on loss ratio
performance and could be reduced if the underlying loss ratios deteriorate; our inability to obtain
reinsurance coverage at reasonable prices; the failure of any loss limitations or exclusions or
changes in claims or coverage; our ability to successfully integrate acquisitions that we make such
as our acquisition of AMC; our lack of long-term operating history in certain specialty classes of
insurance; our ability to acquire and retain additional underwriting expertise and capacity; the
concentration of our insurance business in relatively few specialty classes; the increasingly
competitive property and casualty marketplace; fluctuations and uncertainty within the excess and
surplus lines insurance industry; the extensive regulations to which our business is subject and
our failure to comply with those regulations; our ability to maintain our risk-based capital at
levels required by regulatory authorities; our inability to realize our investment objectives; and
the risks identified in our filings with the Securities and Exchange Commission, including our
Annual Report on Form 10-K. Given these uncertainties, you are cautioned not to place undue
reliance on these forward-looking statements. We assume no obligation to update or revise them or
provide reasons why actual results may differ.
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the condensed consolidated financial statements and the related
notes included elsewhere in this Form 10-Q.
Overview
We are a provider of insurance products and services to the specialty commercial insurance
markets, primarily focusing on niche and underserved segments where we believe that we have
underwriting expertise and other competitive advantages. During our 36 years of underwriting
security risks, we have established CoverX ® as a recognized brand among insurance
agents and brokers and developed significant underwriting expertise and a cost-efficient
infrastructure. Over the last nine years, we have leveraged our brand, expertise and
infrastructure to expand into other specialty classes of business, particularly focusing on smaller
accounts that receive less attention from competitors.
First Mercury Financial Corporation (FMFC) is a holding company for our operating
subsidiaries. Our operations are conducted with the goal of producing overall profits by
strategically balancing underwriting profits from our insurance subsidiaries with the commissions
and fee income generated by our non-insurance subsidiaries. FMFCs principal operating
subsidiaries are CoverX Corporation (CoverX), First Mercury Insurance Company (FMIC), First
Mercury Casualty Company (FMCC), First Mercury Emerald Insurance Services, Inc. (FM Emerald),
and American Management Corporation (AMC).
CoverX produces and underwrites insurance policies for which we retain risk and receive
premiums. As a wholesale insurance broker, CoverX markets our insurance policies through a
nationwide network of wholesale and retail insurance brokers who then distribute these policies
through retail insurance brokers. CoverX also provides underwriting services with respect to the
insurance policies it markets in that it reviews the applications submitted for insurance coverage,
decides whether to accept all or part of the coverage requested and determines applicable premiums.
CoverX receives commissions from affiliated insurance companies, reinsurers, and non-affiliated
insurers as well as policy fees from wholesale and retail insurance brokers.
FM Emerald is a wholesale insurance agency producing commercial lines business on primarily an
excess and surplus lines basis for CoverX via a producer agreement. As a wholesale insurance
agency, FM Emerald markets insurance products for CoverX through a nationwide network of wholesale
and retail insurance brokers who then distribute these products through retail insurance brokers.
FMIC and FMCC are two of our insurance subsidiaries. FMIC writes substantially all the
policies produced by CoverX. FMCC provides reinsurance to FMIC. FMIC and FMCC have entered into
an intercompany pooling reinsurance agreement wherein all premiums, losses and expenses of FMIC and
FMCC, including all past liabilities, are combined and apportioned between FMIC and FMCC in
accordance with fixed percentages. FMIC also provides claims handling and adjustment services for
policies produced by CoverX and directly written by third parties.
23
On June 27, 2008, the Company sold all of the outstanding capital stock of American Risk
Pooling Consultants, Inc. (ARPCO). The results of ARPCOs operations are presented as
Discontinued Operations in the Condensed Consolidated Statements of Income. ARPCO provided third
party administrative services for risk sharing pools of governmental entity risks, including
underwriting, claims, loss control and reinsurance services. ARPCO was solely a fee-based business
and received fees for these services and commissions on excess per occurrence insurance placed in
the commercial market with third party companies on behalf of the pools.
On February 1, 2008, we acquired 100% of the issued and outstanding common stock of American
Management Corporation. AMC is a managing general agency writing primarily commercial lines
package policies focused primarily on the niche fuel-related marketplace. AMC distributes these
insurance policies through a nationwide distribution system of independent general agencies. AMC
underwrites these policies for third party insurance carriers and receives commission income for
its services. AMC also provides claims handling and adjustment services for policies produced by
AMC and directly written for third parties. In addition, AMC owns and operates American
Underwriters Insurance Company (AUIC), a single state, non-standard auto insurance company
domiciled in the state of Arkansas, and AMC Re, Inc. (AMC Re), a captive reinsurer incorporated
under the provisions of the laws of Arkansas. Effective July 1, 2008, FMIC and AUIC entered into
an intercompany reinsurance agreement wherein all premiums and losses of AUIC, including all past
liabilities, are 100% assumed by FMIC.
GAAP and Non-GAAP Financial Performance Metrics
Throughout this report, we present our operations in the way we believe will be most
meaningful, useful, and transparent to anyone using this financial information to evaluate our
performance. In addition to the GAAP (generally accepted accounting principles in the United
States of America) presentation of net income and certain statutory reporting information, we show
certain non-GAAP financial measures that we believe are valuable in managing our business and
drawing comparisons to our peers. These measures are gross written premiums, net written premiums,
and combined ratio.
Following is a list of non-GAAP measures found throughout this report with their definitions,
relationships to GAAP measures, and explanations of their importance to our operations:
Gross written premiums. While net premiums earned is the related GAAP measure used in the
statements of earnings, gross written premiums is the component of net premiums earned that
measures insurance business produced before the impact of ceding reinsurance premiums, but without
respect to when those premiums will be recognized as actual revenue. We use this measure as an
overall gauge of gross business volume in our insurance underwriting operations with some
indication of profit potential subject to the levels of our retentions, expenses, and loss costs.
Net written premiums. While net premiums earned is the related GAAP measure used in the
statements of earnings, net written premiums is the component of net premiums earned that measures
the difference between gross written premiums and the impact of ceding reinsurance premiums, but
without respect to when those premiums will be recognized as actual revenue. We use this measure
as an indication of retained or net business volume in our insurance underwriting operations. It
is an indicator of future earnings potential subject to our expenses and loss costs.
Combined ratio. This ratio is a common industry measure of profitability for any underwriting
operation, and is calculated in two components. First, the loss ratio is losses and settlement
expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum
of policy acquisition costs and insurance operating expenses, net of insurance underwriting
commissions and fees, divided by net premiums earned. The sum of the loss and expense ratios is the
combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of
underwriting income or loss. For example, a combined ratio of 85 implies that for every $100 of
premium we earn, we record $15 of pre-tax underwriting income.
Critical Accounting Policies
The critical accounting policies discussed below are important to the portrayal of our
financial condition and results of operations and require us to exercise significant judgment. We
use significant judgments concerning future results and developments in making these critical
accounting estimates and in preparing our consolidated financial statements. These judgments and
estimates affect the reported amounts of assets, liabilities, revenues and expenses and the
disclosure of material contingent assets and liabilities. We evaluate our estimates on a continual
basis using information that we believe to be relevant. Actual results may differ materially from
the estimates and assumptions used in preparing the consolidated financial statements.
Readers are also urged to review Managements Discussion and Analysis of Financial Condition
and Results of Operations Critical Accounting Policies and Note 1 to the audited consolidated
financial statements thereto included in the Annual Report on
24
Form 10-K for the year ended December
31, 2008 on file with the Securities and Exchange Commission for a more complete description of our
critical accounting policies and estimates.
Use of Estimates
In preparing our consolidated financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosures of
contingent assets and liabilities as of the date of the consolidated financial statements, and
revenues and expenses reported for the periods then ended. Actual results may differ from those
estimates. Material estimates that are susceptible to significant change in the near term relate
primarily to the determination of the reserves for losses and loss adjustment expenses and
valuation of intangible assets and goodwill.
Loss and Loss Adjustment Expense Reserves
The reserves for losses and loss adjustment expenses represent our estimated ultimate costs of
all reported and unreported losses and loss adjustment expenses incurred and unpaid at the balance
sheet date. Our reserves reflect our estimates at a given time of amounts that we expect to pay
for losses that have been reported, which are referred to as Case reserves, and losses that have
been incurred but not reported and the expected development of losses and allocated loss adjustment
expenses on reported cases, which are referred to as IBNR reserves. We do not discount the
reserves for losses and loss adjustment expenses.
We allocate the applicable portion of our estimated loss and loss adjustment expense reserves
to amounts recoverable from reinsurers under ceded reinsurance contracts and report those amounts
separately from our loss and loss adjustment expense reserves as an asset on our balance sheet.
The estimation of ultimate liability for losses and loss adjustment expenses is an inherently
uncertain process, requiring the use of informed estimates and judgments. Our loss and loss
adjustment expense reserves do not represent an exact measurement of liability, but are our
estimates based upon various factors, including:
|
|
|
actuarial projections of what we, at a given time, expect to be the cost of the ultimate
settlement and administration of claims reflecting facts and circumstances then known; |
|
|
|
|
estimates of future trends in claims severity and frequency; |
|
|
|
|
assessment of asserted theories of liability; and |
|
|
|
|
analysis of other factors, such as variables in claims handling procedures, economic
factors, and judicial and legislative trends and actions. |
Most or all of these factors are not directly or precisely quantifiable, particularly on a
prospective basis, and are subject to a significant degree of variability over time. In addition,
the establishment of loss and loss adjustment expense reserves makes no provision for the
broadening of coverage by legislative action or judicial interpretation or for the extraordinary
future emergence of new types of losses not sufficiently represented in our historical experience
or which cannot yet be quantified. Accordingly, the ultimate liability may be more or less than
the current estimate. The effects of changes in the estimated reserves are included in the results
of operations in the period in which the estimate is revised.
Our reserves consist of reserves for property and liability losses, consistent with the
coverages provided for in the insurance policies directly written or assumed by the Company under
reinsurance contracts. In many cases, several years may elapse between the occurrence of an
insured loss, the reporting of the loss to us and our payment of the loss. Although we believe
that our reserve estimates are reasonable, it is possible that our actual loss experience may not
conform to our assumptions and may, in fact, vary significantly from our assumptions. Accordingly,
the ultimate settlement of losses and the related loss adjustment expenses may vary significantly
from the estimates included in our financial statements. We continually review our estimates and
adjust them as we believe appropriate as our experience develops or new information becomes known
to us.
25
Our reserves for losses and loss adjustment expenses at June 30, 2009 and December 31, 2008,
gross and net of ceded reinsurance were as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
Case reserves |
|
$ |
102,448 |
|
|
$ |
91,057 |
|
IBNR and ULAE reserves |
|
|
324,460 |
|
|
|
281,664 |
|
|
|
|
|
|
|
|
Total reserves |
|
$ |
426,908 |
|
|
$ |
372,721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net of reinsurance |
|
|
|
|
|
|
|
|
Case reserves |
|
$ |
71,038 |
|
|
$ |
62,497 |
|
IBNR and ULAE reserves |
|
|
209,714 |
|
|
|
181,672 |
|
|
|
|
|
|
|
|
Total |
|
$ |
280,752 |
|
|
$ |
244,169 |
|
|
|
|
|
|
|
|
Revenue Recognition
Premiums. Premiums are recognized as earned using the daily pro rata method over the terms of
the policies. When premium rates change, the effect of those changes will not immediately affect
earned premium. Rather, those changes will be recognized ratably over the period of coverage.
Unearned premiums represent the portion of premiums written that relate to the unexpired terms of
policies-in-force. As policies expire, we audit those policies comparing the estimated premium
rating units that were used to set the initial premium to the actual premiums rating units for the
period and adjust the premiums accordingly. Premium adjustments identified as a result of these
audits are recognized as earned when identified.
Commissions and Fees. Wholesale agency commissions and fee income from unaffiliated companies
are earned at the effective date of the related insurance policies produced or as services are
provided under the terms of the administrative and service provider contracts. Related commissions
to retail agencies are concurrently expensed at the effective date of the related insurance
policies produced. Profit sharing commissions due from certain insurance and reinsurance
companies, based on losses and loss adjustment expense experience, are earned when determined in
accordance with the applicable contract.
Investments
Our marketable investment securities, including money market accounts held in our investment
portfolio, are classified as available-for-sale and, as a result, are reported at market value.
Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, which resulted in no
material changes in valuation techniques we previously used to measure fair values. See Note 11 to
the Condensed Consolidated Financial Statements for a more complete description. .Convertible
securities were accounted for under FASB Statement No. 155, Accounting for Certain Hybrid
Financial Instruments (SFAS 155) for the three and six months ended June 30, 2009 and 2008.
Alternative investments consist of our investments in limited partnerships, which invest in high
yield convertible securities and distressed structured finance products. These alternative
investments are accounted for under FASB Statement No. 159, The Fair Value Option of Financial
Assets and Financial Liabilities (SFAS 159), for the three and six months ended June 30, 2009
and 2008.
Premiums and discounts are amortized or accreted over the life of the related debt security as
an adjustment to yield using the effective-interest method. Dividend and interest income are
recognized when earned. Realized gains and losses are included in earnings and are derived using
the specific identification method for determining the cost of securities sold.
Impairment of Investment Securities
Impairment of investment securities results when a market decline below cost is
other-than-temporary. The other-than-temporary write down is separated into an amount representing
the credit loss which is recognized in earnings and the amount related to all other factors which
is recorded in other comprehensive income. Management regularly reviews our fixed maturity
securities portfolio to evaluate the necessity of recording impairment losses for
other-than-temporary declines in the fair value of investments. Factors considered in evaluating
potential impairment include, but are not limited to, the current fair value as compared to cost or
amortized
cost of the security, as appropriate, the length of time the investment has been below cost or
amortized cost and by how much, our intent to sell a security and whether it is
more-likely-than-not we will be required to sell the security before the recovery of our amortized
cost basis, and specific credit issues related to the issuer and current economic conditions.
Other-than-temporary
26
impairment losses result in a reduction of the cost basis of the underlying
investment. Significant changes in these factors we consider when evaluating investments for
impairment losses could result in a change in impairment losses reported in the consolidated
financial statements.
As mentioned above, the Company considers its intent and ability to hold a security until the
value recovers as part of the process of evaluating whether a securitys unrealized loss represents
an other-than-temporary decline. The Companys ability to hold such securities is supported by
sufficient cash flow from its operations and from maturities within its investment portfolio in
order to meet its claims payment and other disbursement obligations arising from its underwriting
operations without selling such investments. With respect to securities where the decline in value
is determined to be temporary and the securitys value is not written down, a subsequent decision
may be made to sell that security and realize a loss. Subsequent decisions on security sales are
made within the context of overall risk monitoring, changing information and market conditions.
Management of the Companys investment portfolio is outsourced to third party investment managers,
which is directed and monitored by the investment committee. While these investment managers may,
at a given point in time, believe that the preferred course of action is to hold securities with
unrealized losses that are considered temporary until such losses are recovered, the dynamic nature
of the portfolio management may result in a subsequent decision to sell the security and realize
the loss, based upon a change in market and other factors described above. The Company believes
that subsequent decisions to sell such securities are consistent with the classification of the
Companys portfolio as available-for-sale.
Investment managers are required to notify management of rating agency downgrades of
securities in their portfolios as well as any potential investment valuation issues no later than
the end of each quarter. Investment managers are also required to notify management, and receive
prior approval, prior to the execution of a transaction or series of related transactions that may
result in a realized loss above a certain threshold. Additionally, investment managers are required
to notify management, and receive approval, prior to the execution of a transaction or series of
related transactions that may result in any realized loss up until a certain period beyond the
close of a quarterly accounting period.
Under current accounting standards, an OTTI write-down of debt securities, where fair value is
below amortized cost, is triggered in circumstances where (1) an entity has the intent to sell a
security, (2) it is more-likely-than-not that the entity will be required to sell the security
before recovery of its amortized cost basis, or (3) the entity does not expect to recover the
entire amortized cost basis of the security. If an entity intends to sell a security or if it is
more-likely-than-not the entity will be required to sell the security before recovery, an OTTI
write-down is recognized in earnings equal to the difference between the securitys amortized cost
and its fair value. If an entity does not intend to sell the security or it is not
more-likely-than-not that it will be required to sell the security before recovery, the OTTI
write-down is separated into an amount representing the credit loss, which is recognized in
earnings, and the amount related to all other factors, which is recognized in other comprehensive
income.
Deferred Policy Acquisition Costs
Policy acquisition costs related to direct and assumed premiums consist of commissions,
underwriting, policy issuance, and other costs that vary with and are primarily related to the
production of new and renewal business, and are deferred, subject to ultimate recoverability, and
expensed over the period in which the related premiums are earned. Investment income is included
in the calculation of ultimate recoverability.
Goodwill and Intangible Assets
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and
intangible assets that are not subject to amortization shall be tested for impairment annually, or
more frequently if events or changes in circumstances indicate that the asset might be impaired.
The impairment test for goodwill shall consist of a comparison of the fair value of the goodwill
with the carrying amount of the reporting unit to which it is assigned. The impairment test for
intangible assets shall consist of a comparison of the fair value of the intangible assets with
their carrying amounts. If the carrying amount of the goodwill or intangible assets exceed their
fair value, an impairment loss shall be recognized in an amount equal to that excess.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived
Assets, the carrying value of long-lived assets, including amortizable intangibles and property
and equipment, are evaluated whenever events or changes in circumstances indicate that a potential
impairment has occurred relative to a given asset or assets. Impairment is deemed to have occurred
if projected undiscounted cash flows associated with an asset are less than the carrying value of
the asset. The estimated
cash flows include managements assumptions of cash inflows and outflows directly resulting from
the use of that asset in operations. The amount of the impairment loss recognized is equal to the
excess of the carrying value of the asset over its then estimated fair value.
27
Results of Operations
Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008
The following table summarizes our results for the three months ended June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
51,432 |
|
|
$ |
46,559 |
|
|
|
10 |
% |
Commissions and fees |
|
|
9,577 |
|
|
|
7,086 |
|
|
|
35 |
|
Net investment income |
|
|
7,132 |
|
|
|
5,216 |
|
|
|
37 |
|
Net realized gains (losses) on investments |
|
|
9,644 |
|
|
|
(1,587 |
) |
|
|
708 |
|
Other-than-temporary impairment losses on
investments |
|
|
(97 |
) |
|
|
(225 |
) |
|
|
57 |
|
|
|
|
|
|
|
|
|
|
|
Total Operating Revenues |
|
|
77,688 |
|
|
|
57,049 |
|
|
|
36 |
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses, net |
|
|
35,463 |
|
|
|
25,732 |
|
|
|
38 |
|
Amortization of intangible assets |
|
|
575 |
|
|
|
515 |
|
|
|
12 |
|
Other operating expenses |
|
|
23,126 |
|
|
|
20,711 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
Total Operating Expenses |
|
|
59,164 |
|
|
|
46,958 |
|
|
|
26 |
|
|
|
|
|
|
|
|
|
|
|
Operating Income |
|
|
18,524 |
|
|
|
10,091 |
|
|
|
84 |
|
Interest Expense |
|
|
1,294 |
|
|
|
1,214 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations Before
Income Taxes |
|
|
17,230 |
|
|
|
8,877 |
|
|
|
94 |
|
Income Taxes |
|
|
5,621 |
|
|
|
2,641 |
|
|
|
113 |
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations |
|
|
11,609 |
|
|
|
6,236 |
|
|
|
86 |
|
Income From Discontinued Operations,
Net of Income Taxes |
|
|
|
|
|
|
22,467 |
|
|
|
(100 |
) |
|
|
|
|
|
|
|
|
|
|
Net Income |
|
$ |
11,609 |
|
|
$ |
28,703 |
|
|
|
(60 |
)% |
|
|
|
|
|
|
|
|
|
|
Loss Ratio |
|
|
69.0 |
% |
|
|
55.3 |
% |
|
|
13.7 points |
|
Underwriting Expense Ratio |
|
|
30.9 |
% |
|
|
28.7 |
% |
|
|
2.2 points |
|
|
|
|
|
|
|
|
|
|
|
Combined Ratio |
|
|
99.9 |
% |
|
|
84.0 |
% |
|
|
15.9 points |
|
|
|
|
|
|
|
|
|
|
|
28
Operating Revenue
Net Earned Premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Written premiums |
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
77,892 |
|
|
$ |
75,761 |
|
|
|
3 |
% |
Assumed |
|
|
4,629 |
|
|
|
4,153 |
|
|
|
11 |
|
Ceded |
|
|
(29,079 |
) |
|
|
(27,673 |
) |
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
53,442 |
|
|
$ |
52,241 |
|
|
|
2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
74,913 |
|
|
$ |
69,571 |
|
|
|
8 |
% |
Assumed |
|
|
4,460 |
|
|
|
4,231 |
|
|
|
5 |
|
Ceded |
|
|
(26,773 |
) |
|
|
(27,818 |
) |
|
|
(4 |
) |
Earned but unbilled
premiums |
|
|
(1,168 |
) |
|
|
575 |
|
|
|
(303 |
) |
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
51,432 |
|
|
$ |
46,559 |
|
|
|
10 |
% |
|
|
|
|
|
|
|
|
|
|
Direct written premiums increased $2.1 million, or 3%, primarily due to increases in premium
production from the Companys Contract Underwriting and FM Emerald underwriting platforms offset
somewhat by decreases in production from the Companys Security and Specialty underwriting
platforms during the three months ended June 30, 2009. Direct earned premiums increased $5.3
million in the three months ended June 30, 2009, or 8%, compared to the three months ended June 30,
2008.
Assumed written premiums increased $0.5 million, or 11%, and assumed earned premiums increased
$0.2 million, or 5%. The increase in assumed written premiums is primarily due to an increase in
production for the admitted legal liability business.
Ceded written premiums increased $1.4 million, or 5%, and ceded earned premiums decreased $1.0
million, or 4%, for the three months ended June 30, 2009 compared to the three months ended June
30, 2008. Ceded written premiums increased to 35.2% of direct and assumed written premiums during
the second quarter of 2009 compared to 34.6% of direct and assumed written premiums during the
second quarter of 2008 principally due to purchasing more quota share reinsurance during the second
quarter of 2009 for the Companys primary casualty business compared to the second quarter of 2008.
The increase in quota share cessions was offset somewhat by lower cessions under our excess of
loss treaties during the second quarter of 2009 and the elimination of a 50% quota share on a
contract underwriting class of business during the fourth quarter of 2008, which impacted the
second quarter of 2009. Ceded earned premiums decreased primarily due to ceded written premiums
continuing to be earned on the Companys 2008 quota share reinsurance treaties.
Earned but unbilled premiums decreased $1.7 million, or 303%, primarily due to the net earned
premiums subject to audit during the three months ended June 30, 2009 decreasing compared to the
net premiums earned subject to audit during the three months ended June 30, 2008.
29
Commissions and Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance underwriting commissions and
fees |
|
$ |
1,360 |
|
|
$ |
1,426 |
|
|
|
(5 |
)% |
Insurance services commissions and fees |
|
|
8,217 |
|
|
|
5,660 |
|
|
|
45 |
|
|
|
|
|
|
|
|
|
|
|
Total commissions and fees |
|
$ |
9,577 |
|
|
$ |
7,086 |
|
|
|
35 |
% |
|
|
|
|
|
|
|
|
|
|
Insurance underwriting commissions and fees decreased 5% from the three months ended June 30,
2008 to the three months ended June 30, 2009. Insurance services commissions and fees, which were
principally AMC income and not related to gross written premiums, increased $2.6 million, as the
result of increased AMC commission and fee income of $0.9 million during the second quarter of 2009
compared to the second quarter of 2008 and the favorable settlement of a contingent commission
adjustment due to an unaffiliated carrier for $1.3 million. In addition, commission income related
to our workers compensation service program increased $0.4 million.
Net Investment Income and Realized Gains (Losses) on Investments. During the three months
ended June 30, 2009, net investment income was $7.1 million, a $1.9 million, or 37%, increase from
$5.2 million reported for the three months ended June 30, 2008 primarily due to the increase in
invested assets over the period. At June 30, 2009, invested assets were $625.2 million, a $100.9
million, or 19%, increase over $524.3 million of invested assets at June 30, 2008. This increase
was due to cash flows from net written premiums, and from the cash retained on our quota share
reinsurance contracts on a funds withheld basis. The annualized investment yield on total
investments (net of investment expenses) was 4.7% and 4.0% at June 30, 2009 and 2008, respectively.
The annualized taxable equivalent yield on total investments (net of investment expenses) was 5.3%
and 4.7% at June 30, 2009 and 2008, respectively.
During the three months ended June 30, 2009, net realized gains were $9.6 million compared to
net realized losses of $1.6 million during the three months ended June 30, 2008. The second
quarter 2009 net realized gains were due to the mark to market increase in securities carried at
market in accordance with SFAS 155 and SFAS 159 during the three months ended June 30, 2009 of
approximately $6.6 million and gains on the sale of certain securities of $3.0 million.
Other-than-temporary Impairment Losses on Investments. During the three months ended June 30,
2009 other-than-temporary impairment losses on investments were $0.1 million compared to
other-than-temporary impairment losses on investments of $0.2 million during the three months ended
June 30, 2008.
Operating Expenses
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred increased
$9.7 million, or 38%, in the three months ended June 30, 2009 compared to the three months ended
June 30, 2008. This increase was primarily due to the increase in net earned exposures reflected
in the 10% increase in net earned premiums, an increase in the accident year loss and loss
adjustment expense ratio from decreased premium rates, $2.4 million of storm-related losses
experienced during the second quarter of 2009, and $5.2 million of higher than anticipated 2009
commercial property fire and other losses and loss adjustment expenses. Losses and loss adjustment
expenses for the three months ended June 30, 2009 included approximately $3.6 million of favorable
development of December 31, 2008 prior years loss and loss adjustment expense reserves. Favorable
development of $1.9 million in our security general liability classes in the 2006-2007 accident
years and $1.5 million in our specialty general liability classes in the 2007 accident year was due
to lower than expected claim frequency along with lower than expected severity. Net favorable
development of $0.2 million in unallocated loss and loss adjustment expenses was recorded for the
2006-2007 accident years. There was no development of December 31, 2007 prior years loss and loss
adjustment expense reserves for the three months ended June 30, 2008.
30
Other Operating Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
June 30 |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred acquisition
expenses |
|
$ |
13,600 |
|
|
$ |
9,096 |
|
|
|
50 |
% |
Ceded reinsurance commissions |
|
|
(8,550 |
) |
|
|
(8,313 |
) |
|
|
3 |
|
Other underwriting and operating expenses |
|
|
18,076 |
|
|
|
19,928 |
|
|
|
(9 |
) |
|
|
|
|
|
|
|
|
|
|
Other operating expenses |
|
$ |
23,126 |
|
|
$ |
20,711 |
|
|
|
12 |
% |
|
|
|
|
|
|
|
|
|
|
During the three months ended June 30, 2009, other operating expenses increased $2.4 million,
or 12%, from the three months ended June 30, 2008. Amortization of deferred acquisition expenses
increased by $4.5 million, or 50% due to the impact of purchasing less quota share reinsurance and
increased acquisition expenses on new underwriting initiatives. Ceded reinsurance commissions
increased $0.2 million, or 3%, principally due to the effect of purchasing approximately the same
amount of quota share reinsurance during the second quarter of 2009 compared to the second quarter
of 2008. Other underwriting and operating expenses, which consist of commissions, other
acquisition costs, and general and underwriting expenses, net of acquisition cost deferrals
decreased by $1.9 million, or 9%. The decrease was principally due to lower corporate expenses of
$1.8 million, and a decrease of $0.1 million in general and underwriting expenses related to our
insurance services operations.
Interest Expense. Interest expense increased 7% from the three months ended June 30, 2008
compared to the three months ended June 30, 2009. This increase was primarily due to a $0.1
million increase in the change in fair value of the interest rate swaps on junior subordinated
debentures as discussed in Liquidity and Capital Resources below.
Income Taxes. Our effective tax rates were approximately 32.6% for the three months ended
June 30, 2009 and 29.8% for the three months ended June 30, 2008 and differed from the federal
statutory rate primarily due to state income taxes, non-deductible expenses, and the nontaxable
portion of dividends received and tax-exempt interest.
Discontinued Operations. On June 27, 2008, the Company sold all of the outstanding capital
stock of American Risk Pooling Consultants, Inc. (ARPCO). The results of ARPCOs operations are
presented as Discontinued Operations in the Condensed Consolidated Statements of Income. For the
three months ended June 30, 2008, income from discontinued operations consisted principally of
ARPCOs operating income, net of taxes, and a gain on the sale of $21.4 million.
31
Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008
The following table summarizes our results for the six months ended June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
104,027 |
|
|
$ |
90,130 |
|
|
|
15 |
% |
Commissions and fees |
|
|
16,471 |
|
|
|
11,139 |
|
|
|
48 |
|
Net investment income |
|
|
13,566 |
|
|
|
10,064 |
|
|
|
35 |
|
Net realized gains (losses) on investments |
|
|
11,437 |
|
|
|
(1,586 |
) |
|
|
(821 |
) |
Other-than-temporary impairment losses on investments |
|
|
(134 |
) |
|
|
(225 |
) |
|
|
(40 |
) |
|
|
|
|
|
|
|
|
|
|
Total Operating Revenues |
|
|
145,367 |
|
|
|
109,522 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses, net |
|
|
65,956 |
|
|
|
49,177 |
|
|
|
34 |
|
Amortization of intangible assets |
|
|
1,149 |
|
|
|
913 |
|
|
|
26 |
|
Other operating expenses |
|
|
45,680 |
|
|
|
34,908 |
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
Total Operating Expenses |
|
|
112,785 |
|
|
|
84,998 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
Operating Income |
|
|
32,582 |
|
|
|
24,524 |
|
|
|
33 |
|
Interest Expense |
|
|
2,603 |
|
|
|
3,114 |
|
|
|
(16 |
) |
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations Before
Income Taxes |
|
|
29,979 |
|
|
|
21,410 |
|
|
|
40 |
|
Income Taxes |
|
|
9,689 |
|
|
|
6,540 |
|
|
|
48 |
|
|
|
|
|
|
|
|
|
|
|
Income From Continuing Operations |
|
|
20,290 |
|
|
|
14,870 |
|
|
|
36 |
|
Income From Discontinued Operations,
Net of Income Taxes |
|
|
|
|
|
|
23,553 |
|
|
|
(100 |
) |
|
|
|
|
|
|
|
|
|
|
Net Income |
|
$ |
20,290 |
|
|
$ |
38,423 |
|
|
|
(47 |
)% |
|
|
|
|
|
|
|
|
|
|
Loss Ratio |
|
|
63.4 |
% |
|
|
54.6 |
% |
|
8.8 points |
|
Underwriting Expense Ratio |
|
|
30.6 |
% |
|
|
25.1 |
% |
|
5.5 points |
|
|
|
|
|
|
|
|
|
|
|
Combined Ratio |
|
|
94.0 |
% |
|
|
79.7 |
% |
|
14.3 points |
|
|
|
|
|
|
|
|
|
|
|
32
Operating Revenue
Net Earned Premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
Written
premiums |
Direct |
|
$ |
151,012 |
|
|
$ |
151,974 |
|
|
|
(1 |
)% |
Assumed |
|
|
9,387 |
|
|
|
9,146 |
|
|
|
3 |
|
Ceded |
|
|
(57,132 |
) |
|
|
(50,376 |
) |
|
|
13 |
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
103,267 |
|
|
$ |
110,744 |
|
|
|
(7 |
)% |
|
|
|
|
|
|
|
|
|
|
Earned
premiums |
Direct |
|
$ |
148,218 |
|
|
$ |
138,224 |
|
|
|
7 |
% |
Assumed |
|
|
8,747 |
|
|
|
7,983 |
|
|
|
10 |
|
Ceded |
|
|
(51,845 |
) |
|
|
(55,497 |
) |
|
|
(7 |
) |
Earned but unbilled
premiums |
|
|
(1,093 |
) |
|
|
(580 |
) |
|
|
88 |
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
104,027 |
|
|
$ |
90,130 |
|
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
Direct written premiums decreased $1.0 million, or 1%, primarily due to decreases in premium
production from the Companys Security and Specialty underwriting platforms offset somewhat by
increases in production from the Companys FM Emerald and Contract Underwriting platforms during
the six months ended June 30, 2009. Direct earned premiums increased $10.0 million in the six
months ended June 30, 2009, or 7%, compared to the six months ended June 30, 2008.
Assumed written premiums increased $0.2 million, or 3%, and assumed earned premiums increased
$0.8 million, or 10%. The increase in assumed written premiums is primarily due to an increase in
production for the admitted legal liability business.
Ceded written premiums increased $6.8 million, or 13%, and ceded earned premiums decreased
$3.7 million, or 7%, for the six months ended June 30, 2009 compared to the six months ended June
30, 2008. Ceded written premiums increased to 36% of direct and assumed written premiums during
the second quarter of 2009 compared to 31% of direct and assumed written premiums during the second
quarter of 2008 principally due to purchasing more quota share reinsurance during the second
quarter of 2009 for the Companys primary casualty business compared to the second quarter of 2008.
The increase in quota share cessions was offset somewhat by lower cessions under our excess of
loss treaties during the second quarter of 2009 and the elimination of a 50% quota share on a
contract underwriting class of business during the fourth quarter of 2008. Ceded earned premiums
decreased primarily due to ceded written premiums continuing to be earned on the Companys 2008
quota share reinsurance treaties.
Earned but unbilled premiums decreased $0.5 million, or 88%, primarily due to the net earned
premiums subject to audit during the six months ended June 30, 2009 decreasing compared to the net
premiums earned subject to audit during the six months ended June 30, 2008.
33
Commissions and Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
June 30, |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance underwriting commissions and
fees |
|
$ |
2,717 |
|
|
$ |
2,755 |
|
|
|
(1 |
)% |
Insurance services commissions and fees |
|
|
13,754 |
|
|
|
8,384 |
|
|
|
64 |
|
|
|
|
|
|
|
|
|
|
|
Total commissions and fees |
|
$ |
16,471 |
|
|
$ |
11,139 |
|
|
|
48 |
% |
|
|
|
|
|
|
|
|
|
|
Insurance underwriting commissions and fees were flat from the six months ended June 30, 2008
to the six months ended June 30, 2009. Insurance services commissions and fees, which were
principally AMC income and not related to gross written premiums, increased $5.4 million, as the
result of six months of commission and fee income during the second half of 2009 compared to five
months during the second half of 2008, the favorable settlement of a contingent adjustment due to
an unaffiliated carrier for $1.3 million, and $0.9 million increase in commission income related to
our workers compensation service program.
Net Investment Income and Realized Gains (Losses) on Investments. During the six months ended
June 30, 2009, net investment income was $13.6 million, a $3.5 million, or 35%, increase from $10.1
million reported for the six months ended June 30, 2008 primarily due to the increase in invested
assets over the period. At June 30, 2009, invested assets were $625.2 million, a $100.9 million,
or 19%, increase over $524.3 million of invested assets at June 30, 2008. This increase was due to
cash flows from net written premiums and from the cash retained on our quota share reinsurance
contracts on a funds withheld basis. The annualized investment yield on total investments (net
of investment expenses) was 4.7% and 4.0% at June 30, 2009 and 2008, respectively. The annualized
taxable equivalent yield on total investments (net of investment expenses) was 5.3% and 4.7% at
June 30, 2009 and 2008, respectively.
During the six months ended June 30, 2009, net realized gains were $11.4 million compared to
net realized losses of $1.6 million during the six months ended June 30, 2008. The second quarter
2009 net realized gains were principally due to the mark to market increase in securities carried
at market in accordance with SFAS 155 and SFAS 159 during the six months ended June 30, 2009 of
approximately $8.8 million and gains on the sale of certain securities of $2.6 million.
Other-than-temporary Impairment Losses on Investments. During the six months ended June 30,
2009 other-than-temporary impairment losses on investments were $0.1 million compared to
other-than-temporary impairment losses on investments of $0.2 million during the six months ended
June 30, 2008.
Operating Expenses
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred increased
$16.8 million, or 34%, in the six months ended June 30, 2009 compared to the six months ended June
30, 2008. This increase was primarily due to the increase in net earned exposures reflected in the
15% increase in net earned premiums, an increase in the accident year loss and loss adjustment
expense ratio from decreased premium rates, $2.4 million of storm-related losses experienced during
the second quarter of 2009, and $5.2 million of higher than anticipated 2009 commercial property
fire and other losses and loss adjustment expenses. Losses and loss adjustment expenses for the
six months ended June 30, 2009 included approximately $4.4 million of favorable development of
December 31, 2008 prior years loss and loss adjustment expense reserves. Favorable development of
$1.9 million in our Security general liability classes in 2006-2007 accident years and $2.3 million
in our Specialty general liability classes in the 2006-2007 accident years was due to lower than
expected claim frequency and lower than expected severity. Net favorable development of $0.2
million in unallocated loss and loss adjustment expenses was recorded for the 2006-2007 accident
years. There was no development of December 31, 2007 prior years loss and loss adjustment expense
reserves for the six months ended June 30, 2008.
34
Other Operating Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
June 30 |
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
Change |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred acquisition
expenses |
|
$ |
26,930 |
|
|
$ |
17,310 |
|
|
|
56 |
% |
Ceded reinsurance commissions |
|
|
(16,427 |
) |
|
|
(16,795 |
) |
|
|
(2 |
) |
Other underwriting and operating expenses |
|
|
35,177 |
|
|
|
34,393 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses |
|
$ |
45,680 |
|
|
$ |
34,908 |
|
|
|
31 |
% |
|
|
|
|
|
|
|
|
|
|
During the six months ended June 30, 2009, other operating expenses increased $10.8 million,
or 31%, from the six months ended June 30, 2008. Amortization of deferred acquisition expenses
increased by $9.6 million, or 56% due to the impact of purchasing less quota share reinsurance and
increased acquisition expenses on new underwriting initiatives. Ceded reinsurance commissions
decreased $0.4 million, or 2%, principally due to the effect of purchasing more quota share
reinsurance during the six months ended June 30, 2009 compared to the six months ended June 30,
2008, and lower ceding commissions related to profit sharing on ceded written premiums. Other
underwriting and operating expenses, which consist of commissions, other acquisition costs, and
general and underwriting expenses, net of acquisition cost deferrals, increased by $0.8 million, or
2%. The increase was principally due to an increase of $2.0 million in general and underwriting
expenses related to our insurance services operations principally due to having six months of AMC
results compared to five months during the six months ended June 30, 2008 due to the closing of the
AMC acquisition on February 1, 2008, and a decrease in corporate expenses of $2.8 million during
the six months ended June 30, 2009.
Interest Expense. Interest expense decreased 16% from the six months ended June 30, 2008
compared to the six months ended June 30, 2009. This decrease was primarily due to a $0.5 million
decrease in the change in fair value of the interest rate swaps on junior subordinated debentures
as discussed in Liquidity and Capital Resources below.
Income Taxes. Our effective tax rates were approximately 32.3% for the six months ended June
30, 2009 and 30.5% for the six months ended June 30, 2008 and differed from the federal statutory
rate primarily due to state income taxes, non-deductible expenses, and the nontaxable portion of
dividends received and tax-exempt interest.
Discontinued Operations. On June 27, 2008, the Company sold all of the outstanding capital
stock of American Risk Pooling Consultants, Inc. (ARPCO). The results of ARPCOs operations are
presented as Discontinued Operations in the Condensed Consolidated Statements of Income. For the
six months ended June 30, 2008, income from discontinued operations consisted principally of
ARPCOs operating income, net of taxes, and the gain on the sale of ARPCO of $21.4 million.
Liquidity and Capital Resources
Sources and Uses of Funds
FMFC. FMFC is a holding company with all of its operations being conducted by its
subsidiaries. Accordingly, FMFC has continuing cash needs for primarily administrative expenses,
debt service and taxes. Funds to meet these obligations come primarily from management and
administrative fees from all of our subsidiaries, and dividends from our non-insurance
subsidiaries.
Insurance Subsidiaries. The primary sources of our insurance subsidiaries cash are net
written premiums, claims handling fees, amounts earned from investments and the sale or maturity of
invested assets. Additionally, FMFC has in the past and may in the future contribute capital to
its insurance subsidiaries.
The primary uses of our insurance subsidiaries cash include the payment of claims and related
adjustment expenses, underwriting fees and commissions and taxes and making investments. Because
the payment of individual claims cannot be predicted with certainty, our insurance subsidiaries
rely on our paid claims history and industry data in determining the expected payout of claims and
estimated loss reserves. To the extent that FMIC, FMCC, and AUIC have an unanticipated shortfall
in cash, they may either liquidate securities held in their investment portfolios or obtain capital
from FMFC. However, given the cash generated by our insurance subsidiaries operations and the
relatively short duration of their investment portfolios, we do not currently foresee any such
shortfall.
Non-insurance Subsidiaries. The primary sources of our non-insurance subsidiaries cash are
commissions and fees, policy fees, administrative fees and claims handling and loss control fees.
The primary uses of our non-insurance subsidiaries cash are
35
commissions paid to brokers, operating expenses, taxes and dividends paid to FMFC. There are
generally no restrictions on the payment of dividends by our non-insurance subsidiaries, except as
may be set forth in our borrowing arrangements.
Cash Flows
Our sources of funds have consisted primarily of net written premiums, commissions and fees,
investment income and proceeds from the issuance of equity securities and debt. We use operating
cash primarily to pay operating expenses and losses and loss adjustment expenses and for purchasing
investments. A summary of our cash flows is as follows:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents provided by (used
in): |
|
|
|
|
|
|
|
|
Operating activities continuing operations |
|
$ |
59,075 |
|
|
$ |
58,622 |
|
Operating activities discontinued operations |
|
|
|
|
|
|
2,376 |
|
Investing activities continuing operations |
|
|
(61,006 |
) |
|
|
(100,571 |
) |
Investing activities discontinued operations |
|
|
|
|
|
|
41,830 |
|
Financing activities |
|
|
(6,328 |
) |
|
|
101 |
|
|
|
|
|
|
|
|
Change in cash and cash equivalents |
|
$ |
(8,259 |
) |
|
$ |
2,358 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities from continuing operations for the six months ended
June 30, 2009 and 2008 was primarily from cash received on net written premiums and less cash
disbursed for operating expenses and losses and loss adjustment expenses. Cash received from net
written premiums for the six months ended June 30, 2009 and 2008 were retained on a funds
withheld basis in accordance with the quota share reinsurance contracts.
Net cash provided by operating activities from discontinued operations for the six months
ended June 30, 2008 was primarily from cash received on commissions and service fees less cash
disbursed for operating expenses.
Net cash used in investing activities from continuing operations for the six months ended June
30, 2009 primarily resulted from our net investment in short-term, debt and equity securities. Net
cash used in investing activities from continuing operations for the six months ended June 30, 2008
primarily resulted from our net investment in short-term, debt and equity securities, and for the
acquisition of AMC.
Net cash provided by investing activities from discontinued operations for the six months
ended June 30, 2008 was from cash received on the sale of ARPCO less cash disbursed for transaction
costs.
Net cash used in financing activities for the six months ended June 30, 2009 was primarily
from the purchase of common stock under the Companys Share Repurchase Plan (Note 9), the payment
of the shareholders dividend, and the purchase of common stock by the Company to be held in a
rabbi trust for the benefit of the Companys Supplemental Executive Retirement Plan.
Net cash provided by financing activities for the six months ended June 30, 2008 resulted from
the issuance of common stock as a result of the exercise of stock options offset by the purchase of
common stock by the Company to be held in a rabbi trust for the benefit of the Companys
Supplemental Executive Retirement Plan.
Based on historical trends, market conditions, and our business plans, we believe that our
existing resources and sources of funds will be sufficient to meet our liquidity needs in the next
twelve months. Because economic, market and regulatory conditions may change, however, there can
be no assurances that our funds will be sufficient to meet our liquidity needs. In addition,
competition, pricing, the frequency and severity of losses, and interest rates could significantly
affect our short-term and long-term liquidity needs.
36
Stockholders Equity
Our total stockholders equity was $286.8 million, or $16.34 per outstanding share, as of June
30, 2009 compared to $261.6 million, or $14.67 per outstanding share, as of December 31, 2008. Our
tangible stockholders equity attributable to common shareholders was $236.2 million, or $13.45 per
outstanding share, as of June 30, 2009 compared to $210.2 million, or $11.79 per outstanding share
as of December 31, 2008. Below is a reconciliation of our total stockholders equity to our
tangible stockholders equity attributable to common shareholders:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands, |
|
|
|
except share and per share data) |
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
$ |
286,838 |
|
|
$ |
261,637 |
|
Intangible assets, net |
|
|
(38,201 |
) |
|
|
(39,351 |
) |
Deferred tax liability intangible assets, net |
|
|
12,997 |
|
|
|
13,399 |
|
Goodwill |
|
|
(25,483 |
) |
|
|
(25,483 |
) |
|
|
|
|
|
|
|
Tangible stockholders equity attributable to
common shareholders |
|
$ |
236,151 |
|
|
$ |
210,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common shares outstanding |
|
|
17,558,483 |
|
|
|
17,836,337 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Book value per share |
|
$ |
16.34 |
|
|
$ |
14.67 |
|
|
|
|
|
|
|
|
Tangible book value per share |
|
$ |
13.45 |
|
|
$ |
11.79 |
|
|
|
|
|
|
|
|
Book value per share is total common stockholders equity divided by the number of common
shares outstanding. Tangible book value per share is book value per share excluding the value of
intangible assets, goodwill, and the deferred tax liability related to intangible assets divided by
the number of common shares outstanding.
Long-term debt
Junior Subordinated Debentures. We have $67.0 million cumulative principal amount of floating
rate junior subordinated debentures outstanding. The debentures were issued in connection with the
issuance of trust preferred stock by our wholly-owned, non-consolidated trusts. Cumulative
interest on $46.4 million cumulative principal amount of the debentures is payable quarterly in
arrears at a variable annual rate, reset quarterly, equal to the three month LIBOR plus 3.75% for
$8.2 million, the three month LIBOR plus 4.00% for $12.4 million, and the three month LIBOR plus
3.0% for $25.8 million principal amount of the debentures. Cumulative interest on $20.6 million of
the cumulative principal amount of the debentures is payable quarterly in arrears at a fixed annual
rate of 8.25% through December 15, 2012, and a variable annual rate, reset quarterly, equal to the
three month LIBOR plus 3.30% thereafter. For our floating rate junior subordinated debentures, we
have entered into interest rate swap agreements to pay a fixed rate of interest. See Derivative
Financial Instruments for further discussion. At June 30, 2009, the three month LIBOR rate was
0.60%. We may defer the payment of interest for up to 20 consecutive quarterly periods; however,
no such deferral has been made.
Credit Facility. In October 2006, we entered into a credit facility which provided for
borrowings of up to $30.0 million. Borrowings under the credit facility bear interest at our
election as follows: (i) at a rate per annum equal to the greater of the lenders prime rate and
the federal funds rate less 0.5%, each minus 0.75%; or, (ii) a rate per annum equal to LIBOR plus
an applicable margin which is currently 0.75% or 1.0% based on our leverage ratio. The obligations
under the credit facility are guaranteed by our material non-insurance subsidiaries. The maturity
date of borrowings made under the credit facility is September 2011. The credit facility contains
covenants which, among other things, restrict our ability to incur indebtedness, grant liens, make
investments and sell assets. The credit facility also has certain financial covenants. At June 30,
2009, there were no borrowings under the agreement. We are not required to comply with the
financial-related covenants until we borrow under the credit facility. However, at June 30, 2009,
the Company was in compliance with all of the covenants related to the credit facility.
Derivative Financial Instruments. Financial derivatives are used as part of the overall asset
and liability risk management process. We use interest rate swap agreements with a combined
notional amount of $65.0 million in order to reduce our exposure to
37
interest rate fluctuations with respect to our junior subordinated debentures. In June 2009, the
Company entered into two new interest rate swap agreements to replace the swaps expiring in August
of 2009. Both of these new swap agreements expire in August 2014; under one of the swap agreements
we pay interest at a fixed rate of 3.695% and under the other swap agreement we pay interest at a
fixed rate of 3.710%. Under the two swap agreements which expire in August 2009, we pay interest
at a fixed rate of 4.12%; under our other swap agreement, which expires in December 2011, we pay
interest at a fixed rate of 5.013%. Under all five swap agreements, we receive interest at the
three month LIBOR, which is equal to the contractual rate under the junior subordinated debentures.
At June 30, 2009, we had no exposure to credit loss on the interest rate swap agreements.
Cash and Invested Assets
Our cash and invested assets consist of fixed maturity securities, convertible securities,
equity securities, and cash and cash equivalents. At June 30, 2009, our investments had a market
value of $625.2 million and consisted of the following investments:
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
|
Market |
|
|
% of |
|
|
|
Value |
|
|
Portfolio |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
Short Term Investments |
|
$ |
16,921 |
|
|
|
2.7 |
% |
U.S. Treasuries |
|
|
4,101 |
|
|
|
0.7 |
% |
U.S. Agencies |
|
|
1,056 |
|
|
|
0.2 |
% |
Municipal Bonds |
|
|
201,369 |
|
|
|
32.3 |
% |
Corporate Bonds |
|
|
122,759 |
|
|
|
19.6 |
% |
High Yield Bonds |
|
|
17,705 |
|
|
|
2.8 |
% |
MBS Passthroughs |
|
|
60,315 |
|
|
|
9.6 |
% |
CMOs |
|
|
46,215 |
|
|
|
7.4 |
% |
Asset Backed Securities |
|
|
23,258 |
|
|
|
3.7 |
% |
Commercial MBS |
|
|
50,879 |
|
|
|
8.1 |
% |
Convertible Securities |
|
|
58,948 |
|
|
|
9.4 |
% |
High Yield Convertible Fund |
|
|
9,973 |
|
|
|
1.6 |
% |
Structured Finance Fund |
|
|
10,520 |
|
|
|
1.7 |
% |
Preferred Stocks |
|
|
1,145 |
|
|
|
0.2 |
% |
Common Stocks |
|
|
|
|
|
|
0.0 |
% |
|
|
|
|
|
|
|
Total |
|
$ |
625,164 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
The following table shows the composition of the investment portfolio by remaining time to
maturity at June 30, 2009. Actual maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties. Additionally, the expected maturities of our investments in putable bonds fluctuate
inversely with interest rates and therefore may also differ from contractual maturities.
|
|
|
|
|
|
|
% of Total |
Average Life |
|
Investment |
|
|
|
|
|
Less than one year |
|
|
13.8 |
% |
One to two years |
|
|
14.3 |
% |
Two to three years |
|
|
16.4 |
% |
Three to four years |
|
|
14.2 |
% |
Four to five years |
|
|
14.4 |
% |
Five to seven years |
|
|
9.5 |
% |
More than seven years |
|
|
17.4 |
% |
|
|
|
|
|
Total |
|
|
90.5 |
% |
|
|
|
|
|
The effective duration of the portfolio as of June 30, 2009 is approximately 3.4 years and the
taxable equivalent duration is 3.1 years. Excluding cash and cash equivalents, equity and
convertible securities, the portfolio duration and taxable equivalent duration are 3.7 years and
3.3 years, respectively. The shorter taxable equivalent duration reflects the significant portion
of the portfolio in municipal securities. The annualized investment yield on total investments
(net of investment expenses) was 4.7% at June 30, 2009 and 4.0% at June 30, 2008. The annualized
taxable equivalent yield on total investments (net of investment
expenses) was 5.3% at June 30,
2009 and 4.7% at June 30, 2008.
38
The majority of our portfolio consists of AAA or AA rated securities with a Standard and
Poors weighted average credit quality of AA- at June 30, 2009. The fixed income portfolio had a
weighted average credit quality of AA at June 30, 2009. The majority of the investments rated BBB
and below are convertible securities. Consistent with our investment policy, we review any
security if it falls below BBB- and assess whether it should be held or sold. The following table
shows the ratings distribution of our investment portfolio as of June 30, 2009 as a percentage of
total market value.
|
|
|
|
|
|
|
% of Total |
S&P Rating |
|
Investments |
|
|
|
|
|
AAA |
|
|
47.6 |
% |
AA |
|
|
17.2 |
% |
A |
|
|
15.5 |
% |
BBB |
|
|
10.6 |
% |
BB |
|
|
4.9 |
% |
B |
|
|
0.8 |
% |
C |
|
|
0.1 |
% |
CCC |
|
|
1.6 |
% |
NR |
|
|
1.7 |
% |
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
|
|
|
Within Mortgages, the Company invests in residential collateralized mortgage obligations
(CMO) that typically have high credit quality and are expected to provide an advantage in yield
compared to U.S. Treasury securities. The Companys investment strategy is to purchase CMO
tranches which offer the most favorable return given the risks involved. One significant risk
evaluated is prepayment sensitivity. While prepayment risk (either shortening or lengthening of
duration) and its effect on total return cannot be fully controlled, particularly when interest
rates move dramatically, the investment process generally favors securities that control this risk
within expected interest rate ranges. The Company does not purchase residual interests in CMOs.
At June 30, 2009, the Company held CMOs classified as available-for-sale with a fair value of
$46.2 million. Approximately 80.0% of those CMO holdings were guaranteed by or fully
collateralized by securities issued by a full faith and credit agency such as GNMA, or government
sponsored enterprises (GSE) such as FNMA or FHLMC. In addition, at June 30, 2009, the Company
held $59.5 million of mortgage-backed pass-through securities issued by one of the GSEs and
classified as available-for-sale.
The Company held commercial mortgage-backed securities (CMBS) of $50.9 million, of which
88.9% are pre-2006 vintage, at June 30, 2009. The weighted average credit support (adjusted for
defeasance) of our CMBS portfolio was 42.7% and comprised mainly of super senior structures. The
average loan to value at origination was 67.7%. The average credit rating of these securities was
AAA. The CMBS portfolio was supported by loans that were diversified across economic sectors and
geographical areas. It is not believed that this portfolio exposes the Company to a material
adverse impact on its results of operations, financial position or liquidity, due to the underlying
credit strength of these securities.
The Companys fixed maturity investment portfolio included asset-backed securities and
collateralized mortgage obligations collateralized by sub-prime mortgages and alternative
documentation mortgages (Alt-A) with market values of $0.1 million and $1.3 million at June 30,
2009, respectively. The Company defines sub-prime mortgage-backed securities as investments with
weighted average FICO scores below 650. Alt-A securities are defined by above-prime interest
rates, high loan-to-value ratios, high debt-to-income ratios, low loan documentation (e.g., limited
or no verification of income and assets), or other characteristics that are inconsistent with
conventional underwriting standards employed by government-sponsored mortgage entities. The
average credit rating on these securities and obligations held by the Company at June 30, 2009 was
BB.
The Companys fixed maturity investment portfolio at June 30, 2009 included securities issued
by numerous municipalities with a total carrying value of $201.4 million. Approximately $21.4
million, or 10.6%, were pre-refunded (escrowed with Treasuries). Approximately $101.5 million, or
50.4%, of the securities were enhanced by third-party insurance for the payment of principal and
interest in the event of an issuer default. Such insurance, prior to the downgrades of many of the
monolines, results in a rating of AAA being assigned by independent rating agencies to those
securities. The downgrade of credit ratings of insurers of these securities could result in a
corresponding downgrade in the ratings of the securities from AAA to the underlying rating of the
respective security without giving effect to the benefit of insurance. Of the total $101.5 million
of insured municipal securities in the Companys investment portfolio at June 30, 2009, 99.0% were
rated at A- or above, and approximately 78.5% were rated AA- or above, without the benefit of
insurance. The average underlying credit rating of the entire municipal bond portfolio was AA+ at
June 30, 2009. The
39
Company believes that a loss of the benefit of insurance would not result in a material
adverse impact on the Companys results of operations, financial position or liquidity, due to the
underlying credit strength of the issuers of the securities, as well as the Companys ability and
intent to hold the securities.
The Companys investment portfolio does not contain any exposure to Collateralized Debt
Obligations (CDO) or investments collateralized by CDOs. In addition, the Companys investment
portfolio does not contain any exposure to auction-rate securities.
Cash and cash equivalents consisted of cash on hand of $23.6 million at June 30, 2009.
The amortized cost, gross unrealized gains and losses, and market value of marketable
investment securities classified as available-for-sale at June 30, 2009 by major security type were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized |
|
|
Gross Unrealized |
|
|
|
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Market Value |
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
3,941 |
|
|
$ |
161 |
|
|
$ |
(1 |
) |
|
$ |
4,101 |
|
Government agency mortgage-backed securities |
|
|
93,058 |
|
|
|
3,429 |
|
|
|
(81 |
) |
|
|
96,406 |
|
Government agency obligations |
|
|
1,018 |
|
|
|
38 |
|
|
|
|
|
|
|
1,056 |
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
87,040 |
|
|
|
2,368 |
|
|
|
(5,147 |
) |
|
|
84,261 |
|
Obligations of states and political subdivisions |
|
|
194,413 |
|
|
|
7,336 |
|
|
|
(380 |
) |
|
|
201,369 |
|
Corporate bonds |
|
|
136,225 |
|
|
|
6,060 |
|
|
|
(1,821 |
) |
|
|
140,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
515,695 |
|
|
|
19,392 |
|
|
|
(7,430 |
) |
|
|
527,657 |
|
Preferred stocks |
|
|
1,416 |
|
|
|
|
|
|
|
(271 |
) |
|
|
1,145 |
|
Short-term investments |
|
|
16,921 |
|
|
|
|
|
|
|
|
|
|
|
16,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
534,032 |
|
|
$ |
19,392 |
|
|
$ |
(7,701 |
) |
|
$ |
545,723 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
June 30, 2009, there were 169 unrealized loss positions with a total unrealized loss of
$7.7 million. This represents approximately 1.2% of quarter end invested assets of $625.2 million.
This unrealized loss position is a function of the purchase of specific securities in a lower
interest rate or spread environment than what prevails as of June 30, 2009. Some of these losses
are due to the increase in spreads of select corporate bonds or structured securities. We have
viewed these market value declines as being temporary in nature. Our portfolio is relatively short
as the duration of the core fixed income portfolio excluding cash, convertible securities, limited
partnerships and equity is approximately 3.7 years. We do not intend to sell and it is not
expected we will need to sell these temporarily impaired securities before maturity in the event
that interest rates do not decline from current levels. In light of our significant growth over
the past 24 months, liquidity needs from the portfolio are minimal. As a result, we would not
expect to have to liquidate temporarily impaired securities to pay claims or for any other
purposes. There have been certain instances over the past year, where due to market based
opportunities; we have elected to sell a small portion of the portfolio. These situations were
unique and infrequent occurrences and in our opinion, do not reflect an indication that we intend
to sell or will be required to sell these securities before they mature or recover in value.
40
The fair value and amount of unrealized losses segregated by the time period the investment
had been in an unrealized loss position is as follows at June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months |
|
|
Greater than 12 Months |
|
|
|
Fair Value |
|
|
|
|
|
|
Fair Value |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
With |
|
|
Gross |
|
|
With |
|
|
Gross |
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
108 |
|
|
$ |
(1 |
) |
|
$ |
|
|
|
$ |
|
|
Government agency mortgage-backed securities |
|
|
17,200 |
|
|
|
(71 |
) |
|
|
281 |
|
|
|
(10 |
) |
Government agency obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
7,583 |
|
|
|
(316 |
) |
|
|
20,521 |
|
|
|
(4,831 |
) |
Obligations of states and political
subdivisions |
|
|
3,289 |
|
|
|
(71 |
) |
|
|
12,917 |
|
|
|
(309 |
) |
Corporate bonds |
|
|
9,833 |
|
|
|
(78 |
) |
|
|
15,736 |
|
|
|
(1,743 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
38,013 |
|
|
|
(537 |
) |
|
|
49,455 |
|
|
|
(6,893 |
) |
Preferred Stocks |
|
|
875 |
|
|
|
(35 |
) |
|
|
270 |
|
|
|
(236 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
38,888 |
|
|
$ |
(572 |
) |
|
$ |
49,725 |
|
|
$ |
(7,129 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value and amount of unrealized losses segregated by the time period the investment
had been in an unrealized loss position is as follows at December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months |
|
|
Greater than 12 Months |
|
|
|
Fair Value |
|
|
|
|
|
|
Fair Value |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
With |
|
|
Gross |
|
|
With |
|
|
Gross |
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
Losses |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Debt Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Government agency mortgage-backed securities |
|
|
3,902 |
|
|
|
(37 |
) |
|
|
326 |
|
|
|
(2 |
) |
Government agency obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations and other
asset-backed securities |
|
|
48,125 |
|
|
|
(5,143 |
) |
|
|
5,963 |
|
|
|
(1,944 |
) |
Obligations of states and political
subdivisions |
|
|
14,063 |
|
|
|
(427 |
) |
|
|
8,809 |
|
|
|
(267 |
) |
Corporate bonds |
|
|
42,402 |
|
|
|
(2,549 |
) |
|
|
12,824 |
|
|
|
(1,325 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt Securities |
|
|
108,492 |
|
|
|
(8,156 |
) |
|
|
27,922 |
|
|
|
(3,538 |
) |
Preferred Stocks |
|
|
832 |
|
|
|
(78 |
) |
|
|
216 |
|
|
|
(289 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
109,324 |
|
|
$ |
(8,234 |
) |
|
$ |
28,138 |
|
|
$ |
(3,827 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Below is a table that illustrates the unrecognized impairment loss by sector. The increase in
spread relative to U.S. Treasury Bonds was the primary factor leading to impairment for the year
ended June 30, 2009. All asset sectors were affected by the overall increase in spreads as can be
seen from the table below. In addition to the general level of rates, we also look at a variety of
other factors such as direction of credit spreads for an individual issue as well as the magnitude
of specific securities that have declined below amortized cost.
41
|
|
|
|
|
|
|
Amount of |
|
|
|
Unrealized Loss |
|
Sector |
|
at June 30, 2009 |
|
|
|
(Dollars in thousands) |
|
Short Term Investments |
|
$ |
|
|
U.S. Treasuries |
|
|
(1 |
) |
U.S. Agencies |
|
|
|
|
Municipal Bonds |
|
|
(380 |
) |
Corporate Bonds |
|
|
(1,807 |
) |
High Yield Bonds |
|
|
(14 |
) |
MBS Passthroughs |
|
|
(105 |
) |
CMOs |
|
|
(1,480 |
) |
Asset Backed Securities |
|
|
(577 |
) |
Commercial MBS |
|
|
(3,066 |
) |
Convertible Securities |
|
|
|
|
High Yield Convertible Fund |
|
|
|
|
Structured Finance Fund |
|
|
|
|
Preferred Stocks |
|
|
(271 |
) |
Common Stocks |
|
|
|
|
|
|
|
|
|
|
$ |
(7.701 |
) |
|
|
|
|
The most significant risk or uncertainty inherent in our assessment methodology is that the
current credit rating of a particular issue changes over time. If the rating agencies should
change their rating on a particular security in our portfolio, it could lead to a reclassification
of that specific issue. The vast majority of our unrecognized impairment losses are investment
grade and AAA or AA rated securities. Should the credit quality of individual issues decline
for whatever reason then it would lead us to reconsider the classification of that particular
security. Within the non-investment grade sector, we continue to monitor the particular status of
each issue. Should prospects for any one issue deteriorate, we would potentially alter our
classification of that particular issue.
The table below illustrates the breakdown of impaired securities by investment grade and non
investment grade as well as the duration that these sectors have been trading below amortized cost.
The average duration of the impairment has been greater than 12 months. The unrealized loss of
impaired securities as a percent of the amortized cost of those
securities is 8.0% as of June 30,
2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Total |
|
|
Total |
|
|
Total |
|
|
Average Unrealized Loss |
|
|
% of Loss |
|
|
|
Amortized Cost |
|
|
Amortized Cost |
|
|
Unrealized Losses |
|
|
as % of Amortized Cost |
|
|
> 12 Months |
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
Non Investment Grade |
|
|
4.2 |
% |
|
$ |
4,046 |
|
|
$ |
1,102 |
|
|
|
27.2 |
% |
|
|
99.1 |
% |
Investment Grade |
|
|
95.8 |
|
|
|
92,268 |
|
|
|
6,599 |
|
|
|
7.2 |
|
|
|
91.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
$ |
96,314 |
|
|
$ |
7,701 |
|
|
|
8.0 |
% |
|
|
92.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The majority of these securities are AAA or AA rated. These issues are continually
monitored and may be classified in the future as being other than temporarily impaired.
The largest concentration of temporarily impaired securities is Commercial MBS at
approximately 39.8% of the total loss. These securities are all AAA rated and have been affected
primarily by the widening of spreads within this sector and/or the general level of interest rates.
The next
largest concentration of temporarily impaired securities is Corporate
Bonds at approximately 23.6%
of the total loss. Within Corporate Bonds 88.0% are rated investment grade BBB or better, and
their temporary impairment results primarily from the widening of credit spreads.
The next highest concentration of temporarily impaired securities is
CMOs at 19.2% of the total
loss. Within CMOs 96.8% are rated AAA including the 79.8% of the CMO exposure that is agency
issued, and have primarily been affected by the general level of interest rates as well.
For the six months ended June 30, 2009, we sold approximately $3.3 million of market value of
fixed income securities excluding convertibles, which were trading below amortized cost while
recording a realized loss of $0.1 million. This loss represented 3.8% of the amortized cost of the
positions. These sales were unique opportunities to sell specific positions due to changing market
conditions. These situations were exceptions to our general assertion regarding our ability and
intent to hold securities with unrealized losses until
42
they mature or recover in value. This position is further supported by the insignificant
losses as a percentage of amortized cost for the respective periods.
During the six months ended June 30, 2009 net realized gains on investments were $11.4 million
compared to net realized losses of $1.6 million during the six months ended June 30, 2008. Net
realized gains for the six months ended June 30, 2009 were principally due to mark to market
increases in securities carried at market in accordance with SFAS 155 and SFAS 159 of approximately
$8.8 million, offset somewhat by losses on the sale of certain securities.
Deferred Policy Acquisition Costs
We defer a portion of the costs of acquiring insurance business, primarily commissions and
certain policy underwriting and issuance costs, which vary with and are primarily related to the
production of insurance business. For the six months ended June 30, 2009, $27.1 million of the
costs were deferred. Deferred policy acquisition costs totaled $26.9 million, or 27.7% of unearned
premiums (net of reinsurance), at June 30, 2009.
Reinsurance
The following table illustrates our direct written premiums and premiums ceded for the three
months ended June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
Direct written premiums |
|
$ |
151,012 |
|
|
$ |
151,974 |
|
Ceded written premiums |
|
|
57,132 |
|
|
|
50,376 |
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
93,880 |
|
|
$ |
101,598 |
|
|
|
|
|
|
|
|
Ceded written premiums as percentage of
direct written premiums |
|
|
37.8 |
% |
|
|
33.1 |
% |
|
|
|
|
|
|
|
The following table illustrates the effect of our reinsurance ceded strategies on our results
of operations:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
Ceded written premiums |
|
$ |
57,132 |
|
|
$ |
50,376 |
|
Ceded premiums earned |
|
|
51,845 |
|
|
|
55,497 |
|
Losses and loss adjustment expenses ceded |
|
|
37,507 |
|
|
|
29,347 |
|
Ceding commissions |
|
|
14,183 |
|
|
|
19,716 |
|
Our net cash flows relating to ceded reinsurance activities (premiums paid less losses
recovered and ceding commissions received) were approximately $12.8 million net cash paid for the
six months ended June 30, 2009 compared to net cash paid of $22.3 million for the six months ended
June 30, 2008.
The assuming reinsurer is obligated to indemnify the ceding company to the extent of the
coverage ceded. The inability to recover amounts due from reinsurers could result in significant
losses to us. To protect us from reinsurance recoverable losses, FMIC seeks to enter into
reinsurance agreements with financially strong reinsurers. Our senior executives evaluate the
credit risk of each reinsurer before entering into a contract and monitor the financial strength of
the reinsurer. On June 30, 2009, substantially all reinsurance contracts to which we were a party
were with companies with A.M. Best ratings of A or better. One reinsurance contract to which we
were a party was with a reinsurer that does not carry an A.M. Best rating. For this contract, we
required full collateralization of our recoverable via a grantor trust and an irrevocable letter of
credit. In addition, ceded reinsurance contracts contain trigger clauses through which FMIC can
initiate cancellation including immediate return of all ceded unearned premiums at its option, or
which result in immediate collateralization of ceded reserves by the assuming company in the event
of a financial strength rating downgrade, thus limiting credit exposure. On June 30, 2009, there
was no allowance for uncollectible reinsurance, as all reinsurance balances were current and there
were no disputes with reinsurers.
43
On June 30, 2009 and December 31, 2008, FMFC had a net amount of recoverables from reinsurers
of $201.6 million and $181.2 million, respectively, on a consolidated basis.
Recent Accounting Pronouncements
On July 1, 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and
the Hierarchy of Generally Accepted Accounting Principles A Replacement of FASB Statement
No.162 (SFAS 168). SFAS 168 replaces SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles and establishes the Accounting Standards Codification (Codification) as
the single official source of authoritative U.S. accounting and reporting standards for
nongovernmental entities, in addition to guidance issued by the Securities and Exchange Commission
(SEC). Once effective, all other nongrandfathered, non-SEC accounting literature not included in
the Codification becomes nonauthoritative. SFAS 168 supersedes all existing, non-SEC accounting
and reporting standards applied by nongovernmental entities in the preparation of financial
statements in conformity with generally accepted accounting principles (GAAP). SFAS 168 is
effective for interim and annual reporting periods ending after September 15, 2009. As the
Codification does not change GAAP, the Company does not expect SFAS 168 to have a material impact
on its financial statements. Previous references to applicable literature via our disclosures will
be updated with references to the new Codification sections.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165
establishes general standards of accounting for and disclosure of events that occur after the
balance sheet date but before the financial statements are issued or are available to be issued.
SFAS 165 provides guidance on the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for potential recognition or
disclosure in the financial statements, the circumstances under which an entity should recognize
events or transactions occurring after the balance sheet date in its financial statements and the
disclosures that an entity should make about events or transactions that occurred after the balance
sheet date. We adopted SFAS 165 during the second quarter of 2009, and its application had no
impact on our condensed consolidated financial statements. We evaluate subsequent events through
the date the accompanying financial statements were issued, which was August 10, 2009.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (FSP FAS 115-2). FSP FAS 115-2 modifies the existing
other-than-temporary impairment guidance to require the recognition of an other-than-temporary
impairment when an entity has the intent to sell a debt security or when it is more likely than not
an entity will be required to sell the debt security before its anticipated recovery. Additionally,
FSP FAS 115-2 changes the presentation and amount of other-than-temporary losses recognized in the
income statement for instances when the Company determines that there is a credit loss on a debt
security but it is more likely than not that the entity will not be required to sell the security
prior to the anticipated recovery of its remaining cost basis. For these debt securities, the
amount representing the credit loss will be reported as an impairment loss in the Condensed
Consolidated Statement of Income and the amount related to all other factors will be reported in
accumulated other comprehensive income. FSP FAS 115-2 also requires the presentation of
other-than-temporary impairments separately from realized gains and losses on the face of the
income statement. In addition to the changes in measurement and presentation, FSP FAS 115-2 is
intended to enhance the existing disclosure requirements for other-than-temporary impairments and
requires all disclosures related to other-than-temporary impairments in both interim and annual
periods. The provisions of FSP FAS 115-2 are effective for interim periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of FSP
FAS 115-2/124-2 in the second quarter of 2009 resulted in a $1.0 million increase in retained
earnings which was offset by a corresponding decrease in accumulated other comprehensive income
(loss) of the same amount.
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that
are Not Orderly (FSP FAS 157-4). Under FSP FAS 157-4, if an entity determines that there has
been a significant decrease in the volume and level of activity for the asset or the liability in
relation to the normal market activity for the asset or liability (or similar assets or
liabilities), then transactions or quoted prices may not accurately reflect fair value. In
addition, if there is evidence that the transaction for the asset or liability is not orderly; the
entity shall place little, if any weight on that transaction price as an indicator of fair value.
FSP FAS 157-4 is effective for periods ending after June 15, 2009, with early adoption permitted
for periods ending after March 15, 2009. The adoption of FSP FAS 157-4 in the second quarter of
2009 did not have a material effect on the Companys results of operations, financial position, or
liquidity.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair
Value of Financial Instruments (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 require
disclosures about fair value of financial instruments in interim and annual financial statements.
FSP FAS 107-1 and APB 28-1 are effective for periods ending after June 15, 2009, with early
adoption permitted for periods ending after March 15, 2009. The adoption of FSP FAS 107-1 and APB
28-1 in the second quarter of 2009 is included in Note 11, Fair Value Measurements to the
condensed consolidated financial statements.
44
We adopted the following accounting standards in the first quarter 2009, none of which had a
material effect on the Companys results of operations, financial position, or liquidity:
|
|
|
SFAS No. 141(R), Business Combinations; |
|
|
|
|
SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an
amendment of Accounting Research Bulletin No. 51; |
|
|
|
|
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities; |
|
|
|
|
FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment
Transactions are Participating Securities; and |
|
|
|
|
FSP FAS No. 157-2, Effective Date of FASB Statement No. 157. |
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Refer to the Companys Annual Report on Form 10-K for the year ended December 31, 2008 for a
complete discussion of the Companys market risk. There have been no material changes to the
market risk information included in the Companys Annual Report on Form 10-K.
Item 4. Controls and Procedures
The Companys chief executive officer and chief financial officer have concluded, based on
their evaluation as of the end of the period covered by this report, that the Companys disclosure
controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and
15d-15(e)) are effective to ensure that information required to be disclosed in the reports that
the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms, and that such information is accumulated and communicated to our
management, including our chief executive officer and chief financial officer, as appropriate, to
allow timely decisions regarding financial disclosures. There was no change in the Companys
internal control over financial reporting that occurred during the quarter ended June 30, 2009 that
has materially affected or is reasonably likely to materially affect, the Companys internal
control over financial reporting.
45
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended September 30, 2008, the Board of Directors of the Company
authorized a share repurchase plan to purchase up to 1.5 million shares of common stock through
open market or privately negotiated transactions. The repurchase program expires on August 18,
2009.
During the three months ended June 30, 2009, the Company repurchased 387,758 shares of common
stock for $5.1 million at an average cost of $13.11 per share. Shares purchased under the program
are retired and returned to the status of authorized but unissued shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maximum Number (or |
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
Approximate Dollar |
|
|
|
|
|
|
|
|
|
|
Shares (or Units) |
|
Value) of Shares |
|
|
|
|
|
|
|
|
|
|
Purchased as Part |
|
(or Units) that May |
|
|
Total Number of |
|
Average Price as |
|
of Publicly |
|
Yet Be Purchased |
|
|
Shares (or Units) |
|
Paid per Share (or |
|
Announced Plans or |
|
Under the Plan or |
Month |
|
Purchased |
|
Unit) |
|
Programs |
|
Programs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
801,423 |
|
May |
|
|
186,405 |
|
|
|
12.99 |
|
|
|
186,405 |
|
|
|
615,018 |
|
June |
|
|
201,353 |
|
|
|
13.23 |
|
|
|
201,353 |
|
|
|
413,665 |
|
|
|
|
Total |
|
|
387,758 |
|
|
$ |
13.11 |
|
|
|
387,758 |
|
|
|
413,665 |
|
|
|
|
Item 4. Submission of Matters to a Vote of Security Holders
On May 13, 2009, the Company held its annual meeting of stockholders at which stockholders:
|
(i) |
|
elected to the Board of Directors of First Mercury Financial Corporation two class II
directors; and |
|
|
(ii) |
|
approved the amendment and restatement of the First Mercury Financial Corporation Omnibus
Incentive Plan of 2006 (the Omnibus Plan) to increase the number of shares authorized for
issuance thereunder by 1,650,000 shares (which will bring the total number of shares reserved
under the Omnibus Plan to 3,150,000) and to made certain other changes to the Omnibus Plan;
and |
|
|
(iii) |
|
approved the Omnibus Plan for purposes of complying with the requirements of Section
162(m) of the Internal Revenue Code, as amended; and |
|
|
(iv) |
|
ratified the appointment of BDO Seidman, LLP as independent registered public accounting
firm of the Company for the year ending December 31, 2009. |
Voting results were as follows:
|
|
|
|
|
|
|
|
|
Director Nominee |
|
Votes For |
|
Votes Withheld |
|
|
|
|
|
|
|
|
|
Thomas B. Kearney |
|
|
8,102,001 |
|
|
|
9,456,387 |
|
William C. Tyler |
|
|
16,749,127 |
|
|
|
809,261 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against |
|
Abstain |
|
Non Votes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approve amendment
and restatement of
Omnibus Plan: |
|
|
13,389,414 |
|
|
|
3,659,992 |
|
|
|
2,961 |
|
|
|
506,021 |
|
46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against |
|
Abstain |
Approve Omnibus
Plan for purposes
of complying with
Section 162(m): |
|
|
17,148,241 |
|
|
|
405,741 |
|
|
|
4,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against |
|
Abstain |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratification of
appointment of BDO
Seidman, LLP |
|
|
17,480,335 |
|
|
|
62,142 |
|
|
|
15,911 |
|
Item 6. Exhibits
See Index of Exhibits following the signature page, which is incorporated herein by reference.
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
FIRST MERCURY FINANCIAL CORPORATION
|
|
|
By: |
/s/ RICHARD H. SMITH
|
|
|
|
Richard H. Smith |
|
|
|
Chairman, President and Chief Executive Officer |
|
|
|
|
|
|
By: |
/s/ JOHN A. MARAZZA
|
|
|
|
John A. Marazza |
|
|
|
Executive Vice President and Chief Financial Officer |
|
|
|
|
Date: August 10, 2009 |
|
48
INDEX OF EXHIBITS
|
|
|
|
|
|
|
Exhibit |
|
|
|
|
Number |
|
Note |
|
Description |
|
|
|
|
|
|
|
31 (a)
|
|
|
(1 |
) |
|
Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934 |
31 (b)
|
|
|
(1 |
) |
|
Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934 |
32 (a)
|
|
|
(1 |
) |
|
Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the
Securities Exchange Act of 1934 |
32 (b)
|
|
|
(1 |
) |
|
Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the
Securities Exchange Act of 1934 |
49