e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-K
|
|
|
þ
|
|
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
For the fiscal year ended December 31,
2009
|
or
|
o
|
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF
1934
|
Commission File
Number: 1-14094
Meadowbrook Insurance Group,
Inc.
(Exact name of Registrant as
specified in its charter)
|
|
|
Michigan
|
|
38-2626206
|
(State of
Incorporation)
|
|
(IRS Employer Identification
No.)
|
|
|
|
26255 American Drive, Southfield, MI
|
|
48034-6112
|
(Address of principal executive
offices)
|
|
(Zip Code)
|
Registrants telephone number, including area code:
(248) 358-1100
Securities registered pursuant to Section 12(b) of the
Act:
|
|
|
Title of Each Class
|
|
Name of Exchange on Which Registered
|
|
Common Stock, $.01 par value per share
|
|
New York Stock Exchange
|
Securities registered pursuant to Section 12(g) of the
Act: None
Indicate by check mark if the Registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act.
Yes o No þ
Indicate by check mark if the Registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 Website, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
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 if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of Registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. 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. (Check one):
|
|
|
|
Large
accelerated
filer o
|
Accelerated
filer þ
|
Non-accelerated
filer o
|
Smaller
reporting
company o
|
(Do not check if a smaller reporting company)
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
The aggregate market value of the voting and non-voting common
stock held by non-affiliates computed by reference to the price
at which the common equity was last sold, or the average bid and
asked price of such common equity, as of June 30, 2009 was
$347,543,421. As of March 10, 2010, there were
55,201,542 shares of the Companys common stock
($.01 par value) outstanding.
Documents
Incorporated by Reference
Certain portions of the Registrants Proxy Statement for
the 2010 Annual Shareholders Meeting scheduled for
May 18, 2010 are incorporated by reference into
Part III of this report.
MEADOWBROOK
INSURANCE GROUP, INC.
PART I
The
Company
Meadowbrook Insurance Group, Inc. (We,
Our, Us, or Meadowbrook)
(NYSE: MIG) is a holding company organized as a Michigan
corporation in 1985. Meadowbrook was founded in 1955 as
Meadowbrook Insurance Agency and was subsequently incorporated
in Michigan in 1965. Our principal executive offices are located
at 26255 American Drive, Southfield, Michigan
48034-6112
(telephone number:
(248) 358-1100.
We serve as a holding company for our wholly owned subsidiary
Star Insurance Company (Star), and Stars
wholly owned subsidiaries, Savers Property and Casualty
Insurance Company (Savers), Williamsburg National
Insurance Company (Williamsburg), and Ameritrust
Insurance Corporation (Ameritrust), as well as,
American Indemnity Insurance Company, Ltd. (American
Indemnity). We also serve as a holding company for
Meadowbrook, Inc. (Meadowbrook), Crest Financial
Corporation, and their respective subsidiaries. In addition, as
described below, we also serve as a holding company for
ProCentury Corporation (ProCentury) and its wholly
owned subsidiaries. ProCenturys wholly owned subsidiaries
consist of Century Surety Company (Century) and its
wholly owned subsidiary ProCentury Insurance Company
(PIC). In addition, ProCentury Risk Partners
Insurance Co. (Propic) is a wholly owned subsidiary
of ProCentury.
Star, Savers, Williamsburg, Ameritrust, Century, and PIC are
collectively referred to as the Insurance Company Subsidiaries.
Pursuant to accounting guidance, Accounting Standards
Codification (ASC) 810
Consolidations (ASC 810), we do not
consolidate our subsidiaries, Meadowbrook Capital Trust I
and II (the Trusts), as they are not variable
interest entities and we are not the primary beneficiary of the
Trusts. Our consolidated financial statements, however, include
the equity earnings of the Trusts. In addition and in accordance
with ASC 810, we do not consolidate our subsidiary American
Indemnity. While we and our subsidiary Star are the common
shareholders, neither are the primary beneficiaries of American
Indemnity. Our consolidated financial statements, however,
include the equity earnings of American Indemnity. The equity
earnings in our Trusts and American Indemnity are reflected in
our Consolidated Statement of Income as equity earnings of
unconsolidated subsidiaries.
ProCentury
Merger
On July 31, 2008, the merger of Meadowbrook Insurance
Group, Inc. and ProCentury Corporation (ProCentury)
was completed (Merger). Under the terms of the
merger agreement, ProCentury shareholders were entitled to
receive, for each ProCentury common share, either $20.00 in cash
or Meadowbrook common stock based on a 2.5000 exchange ratio,
subject to adjustment as described within the merger agreement.
In accordance with the merger agreement, the stock price used in
determining the final cash and share consideration portion of
the purchase price was based on the volume-weighted average
sales price of a share of Meadowbrook common stock for the
30-day
trading period ending on the sixth trading day before the
completion of the Merger, or $5.7326. Based upon the proration,
the total purchase price was $227.2 million, of which
$99.1 million consisted of cash, $122.7 million in
newly issued common stock, and approximately $5.4 million
in transaction related costs. The total number of common shares
issued for purposes of the stock portion of the purchase price
was 21.1 million shares. Refer to Note 2
ProCentury Merger in the Notes to the Consolidated
Financial Statements for additional discussion of the Merger and
a pro forma presentation of financial results for the combined
company.
ProCentury is a specialty insurance company, which primarily
underwrites general liability, commercial property,
environmental, garage, commercial multi-peril, commercial auto,
surety, and marine insurance primarily in the excess and surplus
lines, or non-admitted, market through a select
group of general agents.
2
MEADOWBROOK
INSURANCE GROUP, INC.
The excess and surplus lines market provides insurance coverage
for customers with
hard-to-place
risks that standard or admitted insurers typically choose not to
insure.
Five months of earnings of ProCentury are included in our
financial statements as of and for the year ended
December 31, 2008. Twelve months of earnings are included
for the year ended December 31, 2009.
Since the completion of the Merger, we have been executing on
numerous revenue enhancement opportunities and leveraging the
infrastructure as summarized below:
|
|
|
|
|
Revenue enhancement opportunities:
|
|
|
|
|
|
launching a new wholesale relationship in the Midwest;
|
offering a surplus lines market for an existing
workers compensation partner in New England; and
|
|
|
|
|
utilization of existing program capabilities for Century general
agents.
|
|
|
|
|
|
Leveraging shared infrastructure and increased size:
|
|
|
|
|
|
developing Centers of Expertise for claims management;
|
|
|
|
increased size and diversity benefit costs of reinsurance;
|
|
|
|
enhanced marketing capabilities through joint business
development functions; and
|
|
|
|
geographic expansion of Century offerings through existing
admitted markets.
|
|
|
|
|
|
Executing on opportunities to leverage other niche capabilities;
|
|
|
|
|
|
combined capabilities allow us to receive and evaluate more
opportunities; and
|
|
|
|
independently, neither company would have been able to meet the
comprehensive risk management solutions that some opportunities
require.
|
Other
Significant Acquisitions
|
|
|
|
|
In April 2007, we acquired the business of U.S. Specialty
Underwriters, Inc. (USSU). USSU is a specialty
program manager that produces fee based income by underwriting
targeted classes within excess workers compensation
coverage for a select group of insurance companies.
|
|
|
|
In November 2005, we acquired the business of
Insurance & Benefit Consultants (IBC) of
Sarasota, Florida. IBC is a retail and wholesale agency
specializing in group and individual health insurance products
and personal financial planning services.
|
|
|
|
In August 1999, we acquired the assets of TPA Associates, Inc.,
all the outstanding stock of TPA Insurance Agency, Inc., and
Preferred Insurance Agency, Inc. (collectively,
TPA). TPA is a program-oriented risk management
company that provides risk management services to self-insured
clients, manages alternative risk management programs, performs
underwriting, and loss control services for unaffiliated
insurance companies.
|
|
|
|
In July 1998, we acquired Florida Preferred Administrators, Inc.
(Florida Preferred), a third party administrator and
Ameritrust. In December 2002, Ameritrust became a wholly owned
subsidiary of Star. Florida Preferred provides a broad range of
risk management services for Ameritrust and other third parties.
|
|
|
|
In July 1997, we acquired Crest Financial Corporation
(Crest), a California-based holding company, which
formerly owned Williamsburg. Crest provides risk management
services primarily to Williamsburg. On December 31, 1999,
Williamsburg became a wholly owned subsidiary of Star.
|
|
|
|
In July 1990, we acquired Savers.
|
3
MEADOWBROOK
INSURANCE GROUP, INC.
Recent
Equity Investment
In July 2009, our subsidiary, Star, purchased a 28.5% ownership
interest in an insurance holding limited liability company for
$14.8 million in cash. We are not required to consolidate
this investment as we are not the primary beneficiary of the
business. Our ownership interest is significant, but is less
than a majority ownership and, therefore, we are accounting for
this investment under the equity method of accounting.
Therefore, Star will recognize 28.5% of the profits and losses
as a result of this equity interest ownership.
Employees
At March 5, 2010, we employed approximately 918 associates
to service our clients and provide management services to our
Insurance Company Subsidiaries as described below. We believe we
have good relationships with our associates.
Overview
and Operational Structure
For over thirty years, we have specialized in providing full
service risk management and insurance solutions for our clients.
By forming risk-sharing partnerships, we align our financial
objectives with our clients. By utilizing our products and
services, small to medium-sized client groups gain access to
more sophisticated risk management techniques previously
available only to larger corporations. This enables our clients
to control insurance costs and achieve more predictable
underwriting results.
We were founded in 1955 as a retail insurance
agency. We earn commission revenue through the
operation of our retail property and casualty insurance
agencies, located in Michigan, California, and Florida.
We define our business segments as specialty insurance
operations and agency operations. These two distinct business
operations derive revenue from the following sources:
|
|
|
|
|
Specialty Insurance Operations:
|
|
|
|
|
|
Net earned premiums derived from admitted and
non-admitted products and programs, as well as risk sharing
vehicles.
|
|
|
|
Fee-for-service
revenue derived from managed program revenue, as
well as municipality and association clients.
|
|
|
|
Investment income.
|
|
|
|
|
|
Commission revenue agency commission from
non-affiliated carriers.
|
Our specialty insurance operations and agency operations are
entirely supported by our full-service processing capabilities,
which provide the essential functions necessary in a risk
management organization.
Specialty
Insurance Operations
Our specialty insurance operations provide underwriting and
insurance administration services. We market and underwrite
specialty property and casualty insurance programs and products
on both an admitted and non-admitted basis through a broad and
diverse network of independent retail, wholesale program
administrators and general agents, who value service,
specialized knowledge, and focused expertise. Our primary focus
is on niche or specialty products and program business and risk
management solutions for our customers. The services and
coverages we provide are tailored to meet specific requirements
of defined client groups and their members, which may include
specialty program underwriting; admitted and excess and surplus
lines insurance products; alternative risk transfer solutions,
and insurance administration services. Program business refers
to an aggregation of individually underwritten risks that have
some unique characteristic and are distributed through a select
group of general agencies, retail agencies and program
administrators. We provide various
4
MEADOWBROOK
INSURANCE GROUP, INC.
types of property and casualty insurance coverage, primarily to
associations or similar groups of members and to the specified
classes of business of our agents. With our specialty programs
and products, we seek to combine profitable underwriting,
investment returns and efficient capital management to deliver
consistent long-term growth in shareholder value.
As an admitted carrier we provide a market for more traditional
lines of business and coverages that are offered by standard
markets. Traditional admitted markets typically serve businesses
that:
|
|
|
|
|
are low to medium hazard;
|
|
|
|
have more predictable underwriting results;
|
|
|
|
are adequately rated and priced by rates and policy forms that
are filed and approved by state regulatory agencies;
|
|
|
|
require the protection of state guaranty funds; and
|
|
|
|
are required to purchase admitted insurance products.
|
As an excess and surplus lines provider we market to customers
with
hard-to-place
risks, for which standard or admitted insurers typically choose
not to insure. In the excess and surplus lines market, we serve
businesses that are unable to obtain coverage from standard or
admitted carriers for a variety of reasons, including the
following:
|
|
|
|
|
the unique nature of the insured business is outside the risk
profile of standard lines carriers;
|
|
|
|
the risk associated with an insured is higher than the risk
anticipated by a standard lines carrier when it filed its rates
and forms for regulatory approval, which prevents it from
charging a premium that is thought to be appropriate for the
heightened risk;
|
|
|
|
many geographic regions are considered to be adverse or more
risky markets in which to operate due to legal, regulatory or
claims issues or because they are too remote to warrant a
marketing effort and, as a result, agents in theses areas have a
limited choice of admitted insurers; and
|
|
|
|
small agent organizations who do not generate enough premium
volume to qualify for direct relationships with standard lines
carriers.
|
Our insurance programs are diversified geographically, by class
and line of business, type of insured and distribution. Within
the workers compensation line of business, we have a
regional focus in California and New England. Within the
commercial auto and commercial multiple peril line of business,
we have a regional focus in the Southeast and California. Within
the general liability line of business we have a focus in Texas.
Our
fee-for-service
business is managed on a regional basis with an emphasis in the
Midwest, New England, and southeastern regions of the United
States. Our corporate strategy emphasizes a regional focus and
diverse sources of revenue between underwritten premiums,
service fee revenue, and commissions. This allows us to leverage
fixed costs over a larger revenue base and take advantage of new
opportunities.
We recognize revenue related to the services and coverages from
our specialty insurance operations within seven categories: net
earned premiums, management fees, claims fees, loss control
fees, reinsurance placement, investment income, and net realized
gains (losses).
Specialty
Insurance Operations Programs and Products
The admitted programs that we write as part of our specialty
insurance operations are characterized by risks that are
homogeneous within programs but have a diverse geographic
profile. Generally, the average account premium is small and due
to the specialized nature of the program and distribution style,
our admitted programs have high premium retention levels. This
helps create stability in our business amid the cyclicality of
the insurance industry. Two examples of admitted programs we
write are coverages for picture framers and music equipment
stores. We seek to write rollover programs that have a history
of proven profitable
5
MEADOWBROOK
INSURANCE GROUP, INC.
performance. The admitted programs that we write and retain are
the result of long-term, stable relationships with distribution
partners that have a targeted and specialized distribution style.
The excess and surplus lines business we write is characterized
by broad classes of Main Street commercial risks
that are ineligible for coverage by the standard market. Similar
to our admitted programs, the average account premium size for
the excess and surplus lines risks we write is small. Two
examples of markets we serve with our excess and surplus lines
offering are restaurants and habitational classes, such as
apartments and hotels. The excess and surplus lines regulatory
environment allows rate and form freedom, which gives us the
flexibility to design tailored coverage forms that are often
more restrictive than those available in the admitted market.
The high degree of flexibility contributes to heightened
competition during soft markets and creates the potential for
rapid expansion during hard markets.
The non-admitted programs we write have characteristics that are
similar to our admitted programs, however, the commercial risks
we provide coverage for are ineligible for coverage by the
standard or admitted market. With this focus on non-admitted
program underwriting, we are able to provide coverage for
start-up
organizations and relatively low volume programs that other
markets are unable or unwilling to serve. Two examples of
non-admitted programs we offer are coverages for pet-sitters and
oil and gas contractors.
We also offer coverage for specialty markets, where specific and
unique underwriting expertise is required. We develop solutions
for specific market segments that may leverage either our
admitted market or non-admitted market product capabilities, or
both, depending on the market need. The specific and unique
underwriting expertise that is required to write business
profitably in the segments we serve creates barriers to entry
for new competitors. Two examples of specialty markets we serve
are the transportation and environmental markets.
Description
of Specialty Insurance Operations
Based upon the particular risk management goals of our clients,
market conditions and our assessment of the opportunity for
operating profit, our specialty insurance operations offer
solutions on a
fully-insured
basis, a risk-sharing basis, or a managed basis, in response to
a specific market opportunity. In a managed program, we earn
service fee revenue by providing certain operational functions
and other services to a clients risk-bearing entity, but
generally do not share in the operating results. In a
risk-sharing program, we share the operating results with the
client through a reinsurance agreement with an insurance
company, captive, or
rent-a-captive.
In a profit-sharing structure, we pay an agent a commission that
is adjusted based on the operating results of the program. These
structures, other than the profit-sharing commission structure,
are licensed insurance or reinsurance companies and are
accounted for in accordance with accounting guidance as it
relates to reinsurance and insurance products. In risk-sharing
programs, we derive revenue from net earned premiums,
fee-for-service
revenue and commissions, and investment income. In addition, we
may benefit from the fees our risk management subsidiary earns
for services we perform on behalf of our Insurance Company
Subsidiaries. These fees are eliminated upon consolidation.
However, the fees associated with the captives portion of
the program are reimbursed through a ceding commission. For a
fully-insured program, we provide insurance products without a
risk-bearing mechanism and derive revenue from net earned
premiums and investment income.
Fully-Insured
Programs and Products:
With a fully-insured program, we provide our insurance products
and derive revenue from net earned premiums and investment
income. Fully-insured programs are generally developed in
response to specific market opportunities and may evolve into a
risk-sharing relationship.
Risk-Sharing
Programs:
Quota Sharing: With a client
risk-sharing program, our Insurance Company Subsidiaries
underwrite individual primary insurance policies for members of
a group or association, or a specific industry and then
6
MEADOWBROOK
INSURANCE GROUP, INC.
share the operating results with the client or client group
through a reinsurance agreement with an insurance company,
captive, or
rent-a-captive.
In some instances, a captive owned by a client or client group
reinsures a portion of the risk on a quota-share basis. A
captive is an insurance company or reinsurance company, which is
formed for the purpose of insuring or reinsuring risks related
to the businesses of its shareholders or members. A
rent-a-captive
allows organizations to obtain the benefits of a captive
insurance company, without the initial costs and capital
investment required to form their own captive. This is often an
interim step utilized by groups and associations prior to
forming their own captive. As part of its participation in a
rent-a-captive,
the client group purchases redeemable preferred stock of our
unconsolidated subsidiary. These shares entitle the client group
to participate in profits and losses of the program through a
dividend or additional capital contribution. Dividends or
additional capital contributions are determined and accrued on
the basis of underwriting profits or losses plus investment
income on trust accounts less costs. These structures are
licensed insurance or reinsurance companies, which have a
self-sustaining integrated set of activities and assets, and are
in the reinsurance business for the purpose of providing a
return to their investors, who are the shareholders
(primary beneficiaries) of the captive company. The
primary beneficiaries have their own equity at risk, decision
making authority, and the ability to absorb losses. The
transactions associated with these structures are accounted for
in accordance with accounting guidance as it relates to
reinsurance and insurance products.
In addition to premium revenue and investment income from the
net retained portion of our operating results, we may also be
compensated through the receipt of fees for policy issuance
services and acquisition costs, captive administration,
reinsurance placement, loss prevention services, and claims
administrative and handling services. However, the fees
associated with the captives portion of the program are
reimbursed through a ceding commission. For financial reporting
purposes, ceding commissions are treated as a reduction in
underwriting expenses. In addition, we may benefit from the fees
our risk management subsidiary earns for services we perform on
behalf of our Insurance Company Subsidiaries. These fees are
eliminated upon consolidation.
Our experience has been that the number of claims and the cost
of losses tend to be lower in risk-sharing programs than with
traditional forms of insurance. We believe that client
risk-sharing motivates participants to focus on underwriting
selection, loss prevention, risk control measures and adherence
to stricter underwriting guidelines.
7
MEADOWBROOK
INSURANCE GROUP, INC.
The following schematic illustrates the basic elements in many
of our client risk-sharing programs.
QUOTA
SHARE REINSURANCE RISK-SHARING STRUCTURE
|
|
|
(1)
|
|
We account for transactions with
these risk-sharing clients as reinsurance, in accordance with
accounting guidance as it relates to reinsurance and insurance
products.
|
The captives shareholders, which may or may not include
the insured, and its board of directors make the decision to
form the captive or terminate the captive, based upon either
their own analysis or the analysis performed by an independent
third party consultant they hire. The shareholders of the
captive make the decision whether to invest and how much to
invest in the captive. This decision may be based upon advice
from third party consultants.
The agent of the business will make the decision to submit the
risk to the insurance company for underwriting and the
policyholders make the decision to purchase the quoted policy.
The captive administrator provides administrative services to
the captive in exchange for a fee. This fee is usually a fixed
amount, but can be a variable amount based upon premium volume,
and is negotiated on an annual basis with the captives
board of directors. Such services may include bookkeeping,
providing regulatory information, and other administrative
services. We also may provide loss prevention, claims handling,
underwriting, and other insurance services directly to certain
of our captives. However, our risk management services
subsidiary provides these services to our Insurance Company
Subsidiaries for a fee, which is eliminated upon consolidation.
The costs associated with these services are included within the
premium quoted to the policyholder.
8
MEADOWBROOK
INSURANCE GROUP, INC.
In accordance with ASC 810, our variable interest in the captive
is limited to administrative fees based upon a fixed amount or a
percentage of premiums and the credit risk associated with any
reinsurance recoverables recognized.
The captives are generally capitalized with common stock and may
use preferred stock in isolated instances. The captives
variability is: (1) created based upon the experience of
their portion of business directly written through our Insurance
Company Subsidiaries and ceded to the captive on a quota share
basis; and (2) absorbed by the captives shareholders.
In general, the captives common
and/or
preferred shareholders are either the agents or producers of the
business, a sponsoring group or association, a group of
policyholders, a policyholder, or a general agent. The
captives shareholders are not related parties of ours
pursuant to related accounting guidance.
By design, the capital base of the captive is structured to
absorb the projected losses of the program, and the
captives shareholders bear the risk of loss. Through a
trust agreement, we protect ourselves from potential credit risk
related to reinsurance recoverables from the captive by a
collateral requirement of up to 110% of the estimated reserves
for losses and unearned premiums. In addition, we monitor the
capital adequacy and financial leverage ratios of the captive to
mitigate future credit risk.
In another variation of client risk-sharing, we establish
retrospectively rated programs for individual accounts. With
this type of program, we work with the client to develop the
appropriate self-insured retention and loss fund amount and then
help arrange for
excess-of-loss
reinsurance. The client reimburses us for all claim payments
within the clients retention. We generally earn a
management fee (which includes claims and loss control fees). In
most of these programs, we also share in the operating results
with the client and receive a ceding commission in the
excess-of-loss
reinsurance contract to reimburse us for expenses, including a
fee for services.
Profit-Sharing: In a profit-sharing
commission program, we provide our agent the opportunity to
accept an upfront provisional commission rate that is then
adjusted either upward or downward, based on the actual
underwriting results as compared to predetermined metrics.
Managed
Programs:
With a
fee-for-service
or managed program, we earn revenue by providing certain
operational and administrative functions and other services to a
clients risk-bearing entity, but generally do not share in
the operating results of the program. We believe our
fee-for-service
or managed programs provide a consistent source of revenue, as
well as opportunities for revenue growth without a proportionate
increase in capital requirements. Revenue growth may occur
through the sale of existing products to additional members of
the group, the expansion of coverages and services provided to
existing programs and the creation of programs for new client
groups.
Services for which we receive revenue from
fee-for-service
or managed programs include:
|
|
|
|
|
program design and development;
|
|
|
|
underwriting;
|
|
|
|
reinsurance placement;
|
|
|
|
policy administration;
|
|
|
|
loss prevention and control;
|
|
|
|
claims administration and handling;
|
|
|
|
litigation management;
|
|
|
|
information technology and processing;
|
9
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
accounting functions; and
|
|
|
|
general operational functions and oversight of the program.
|
The fees we receive from these managed programs are generally
either a fixed amount or based on a percentage of premium
serviced or by claim count.
We also provide insurance management services to public entity
associations and currently provide services to public entity
pools and other insurance entities, which provide insurance
coverage for participants, including city, county, township,
villages and other quasi governmental entities in three states,
as well as other diverse industry groups.
Description
of Major Specialty Insurance Services
Our risk management subsidiary provides the following services
to our
fee-for-service
clients and to our Insurance Company Subsidiaries for a fee. The
fees associated with services provided to our Insurance Company
Subsidiaries are eliminated upon consolidation. The costs
associated with these services are charged to our insureds in
the form of premiums.
Program and Product Design. Before
implementing a new program, we generally review:
(1) financial projections for the contemplated program,
(2) historical loss experience, (3) actuarial studies
of the underlying risks, (4) the credit worthiness of the
potential agent or client, and (5) the availability of
reinsurance. Our senior management team and associates
representing each of the risk-management disciplines work
together to design, market, and implement new programs. Our due
diligence process is structured to provide a risk assessment of
the program and how the program fits within our entity wide
business plan and risk profile.
Underwriting Risk Selection and Policy
Issuance. Through our risk management
subsidiary, we perform underwriting services for our Insurance
Company Subsidiaries that meet our corporate underwriting
guidelines. We retain ultimate underwriting authority and
monitor adherence to our corporate underwriting guidelines
through periodic audits. Our underwriting personnel help develop
the proper criteria for selecting risks, while actuarial and
reinsurance personnel evaluate and recommend the appropriate
levels of rate and risk retention. The program is then tailored
according to the requirements and qualifications of each client.
With managed programs, we may also perform underwriting services
based upon the profile of the specific program for a fee.
Claims Administration and
Handling. Through our risk management
subsidiary, we provide substantially all claims management and
handling services for workers compensation and most other
lines, such as property, professional liability, and general
liability. Our claims handling standards are set by our
corporate claims department and are monitored through
self-audits, corporate claim audits, internal controls, and
other executive oversight reports. We handle substantially all
claims functions for the majority of the programs we manage. Our
involvement in claims administration and handling provides
feedback to program managers in assessing the clients risk
environment and the overall structure of the program.
Loss Prevention and Control. Through
our risk management subsidiary, we provide loss control
services, which are designed to help clients prevent or limit
the impact of certain loss events. Through an evaluation of the
clients workplace environment, our loss control
specialists assist the client in planning and implementing a
loss prevention program and, in certain cases, provide
educational and training programs. With our managed programs, we
provide these same services for a fee based upon the profile of
the specific program.
Administration of Risk-Bearing
Entities. We generate fee revenue by
assisting in the formation and administration of risk-bearing
entities for clients and agents. Through our subsidiaries in
Bermuda and Washington D.C., we provide administrative services
for certain captives
and/or
rent-a-captives.
Reinsurance Placement. Through our reinsurance
intermediary subsidiary, we earn commissions from placing
excess-of-loss
reinsurance and insurance coverage with high deductibles for
insurance companies, captives, and managed self-insured
programs. Reinsurance is also placed for clients who do not have
other business relationships with us.
10
MEADOWBROOK
INSURANCE GROUP, INC.
Sales, Marketing, and Public
Relations. We market our programs and
services to associations, professional and trade groups, local,
regional and national insurance agents, and insurance
consultants. Sales and marketing efforts include personal
contact through independent agents, direct mail, telemarketing,
association publications/newsletters, advertising,
Internet-based marketing including our corporate website
(www.meadowbrook.com), and subsidiary branch/division websites.
We access or manage a range of distribution systems and regional
agency networks on a program-specific basis.
Business Processing Technology
Platform. We provide a select set of
internet-based business processing systems to our agents to
automate the capability to rate, quote, bind and service
insurance policies in a timely and efficient manner. Advantage
is a processing system for quoting and binding workers
compensation insurance policies. CenturyOnLine (COL) is a
processing system for quoting and binding general liability,
property and garage insurance policies underwritten by our
excess and surplus lines facility, Century. Further, we provide
additional systems on a network-accessible basis for processing
select package and commercial auto programs. In addition to
reducing our internal administrative processing costs, these
systems enhance underwriting practices by automating risk
selection criteria.
We also participate in seminars, trade and industry conventions
such as Target Markets Program Administrators Association,
American Association of Managing General Agents, American
Society of Association Executives, Self Insurance Institute of
America, National Association of Professional Surplus Lines
Offices, Public Risk Management Association, and various
individual state independent agent associations.
Agency
Operations
Our agency operations segment earns commission revenue through
the operation of its retail property and casualty insurance
agencies, located in Michigan, California, and Florida. These
agencies produce commercial, personal lines, life and accident
and health insurance, with more than fifty unaffiliated
insurance carriers. These agencies produce an immaterial amount
of business for our affiliated Insurance Company Subsidiaries.
Customer
Concentration
In our opinion, no material part of our business is dependent
upon a single customer or group of customers. The loss of any
one customer would not have a material adverse effect on our
results of operations or financial condition. No one customer or
group of affiliated customers accounts for 10% or more of the
Companys consolidated revenues.
Objective
and Strategy
Our corporate objective is to generate predictable earnings
across the market cycle, with a long term targeted return on
average equity range of 10%-17%. Our strategy is to maximize the
unique characteristics of our balanced business model to:
Generate profitable underwriting results from our
insurance operations;
|
|
|
|
|
Generate consistent investment income with a low-risk,
high-quality, primarily fixed income portfolio;
|
Leverage invested assets to equity;
|
|
|
|
|
Generate stable, consistent fee and commission income through
our agency and specialty insurance operations; and
|
|
|
|
Generate free cash flow from dividends from our Insurance
Company Subsidiaries and non-regulated insurance administration
services.
|
Our overall objectives and strategies may be influenced by
interest rates, insurance market cycle conditions, and general
economic conditions.
11
MEADOWBROOK
INSURANCE GROUP, INC.
Approach
on Underwriting Discipline
As an underwriter, we underwrite for predictability and
profitability by adhering to the following business practices as
they relate to our corporate underwriting discipline:
Re-underwrite excess and surplus lines business
for accuracy and completeness;
Limit exposure to catastrophe-prone areas and
purchase reinsurance;
Our associates have a broad and deep underwriting
experience and expertise;
Our actuarial team supports underwriting with
pricing and loss analysis;
New opportunities undergo a thorough new business
due diligence process;
Robust program controls help monitor all programs
for performance; and
We maintain long-term agent relationships, which
are matched with high quality reinsurance partners.
Insurance
Company Subsidiaries
Our Insurance Company Subsidiaries issue insurance policies.
Through our Insurance Company Subsidiaries, we provide specialty
insurance programs and products where we market and underwrite
specialty property and casualty insurance products on both an
admitted and non-admitted basis through a broad and diverse
network of independent retail, wholesale program administrators
and general agents. Our Insurance Company Subsidiaries primarily
focus is on specialty products and program business for our
customers, which consist of select independent, general agents,
and wholesale agents with either a defined geographic specialty
and / or product specialty. These programs are
generally designed specifically for trade groups and
associations, whose members are homogeneous in nature. Members
are typically
small-to-medium
sized businesses. We compensate our distribution network
primarily on a flat commission rate based upon premiums written,
or other risk-sharing mechanism, as previously described.
Through our excess and surplus lines insurance carriers, we
provide coverage for risks that either do not fit the
underwriting criteria of standard carriers with which the retail
agent has a direct relationship, or they are of a class or risk
that the standard market generally avoids since the regulated
nature of that market does not allow for customized terms or
rates. Non-standard risks can be underwritten profitably,
however, by the excess and surplus market, by using highly
specific coverage forms with terms based on individual risk
assessment, rather than the risk profile of the most desirable
members of the class. When a certain risk has been excluded from
the standard market, the retail agents need quick placement with
the excess and surplus lines market in order to maintain
coverage for the insured. As a result, the primary basis for
competition within the excess and surplus lines industry can be
focused more on service and availability rather than rate.
Our programs focus on select classes of property and casualty
business which, through our due diligence process, we believe
have demonstrated a fundamentally sound prospect for generating
underwriting profits. We occasionally do offer our programs on a
multi-state basis; but more generally, our programs operate on a
regional or state-specific basis. We provide underwriting
authority to our regional offices based upon underwriting
guidelines established by our corporate underwriting department,
which we monitor through underwriting audits and a series of
executive underwriting and rate monitor reports. We seek to
avoid geographic concentration of risks that might lead to
aggregation of exposure to losses from natural or intentionally
caused catastrophic events. We also handle the majority of our
claims through our regional offices based upon standards set
forth by our corporate claims office and monitored through a
series of self-audits and corporate claims audit, internal
control audits, and executive claims monitoring reports.
American Indemnity, a Bermuda-based insurance company which
offers our clients a captive or
rent-a-captive
option, complements our Insurance Company Subsidiaries.
12
MEADOWBROOK
INSURANCE GROUP, INC.
In addition, we may at times place risks directly with third
party insurance carriers and participate in the risk as a
reinsurer. Such arrangements typically generate management fee
revenue and provide a means to manage premium leverage ratios.
Our Insurance Company Subsidiaries primarily offer workers
compensation, commercial multiple peril, general liability,
marine and other liability coverages on both an admitted and
non-admitted basis. Our Insurance Company Subsidiaries maintain
a variety of licenses in order for us to write on an admitted
and / or a non-admitted basis in all fifty states,
including the District of Columbia.
Our insurance operations are subject to various leverage tests
(e.g., premium to statutory surplus ratios), which are evaluated
by regulators and rating agencies. Our targets for gross and net
written premium to statutory surplus are 2.75 to 1.0 and 2.25 to
1.0, respectively. As of December 31, 2009, on a statutory
consolidated basis, gross and net premium leverage ratios were
2.0 to 1.0 and 1.6 to 1.0, respectively.
The following table summarizes gross written premiums, net
earned premiums, and net written premiums for the years ended
December 31, 2009, 2008, 2007, 2006, and 2005 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Written Premium
|
|
2009
|
|
|
%
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
233,269
|
|
|
|
33.87
|
%
|
|
$
|
137,503
|
|
|
|
30.04
|
%
|
|
$
|
116,717
|
|
|
|
33.69
|
%
|
|
$
|
118,794
|
|
|
|
35.90
|
%
|
|
$
|
133,732
|
|
|
|
40.26
|
%
|
Commercial Multi-Peril Liability
|
|
|
43,428
|
|
|
|
6.31
|
%
|
|
|
29,114
|
|
|
|
6.36
|
%
|
|
|
69,970
|
|
|
|
20.20
|
%
|
|
|
67,764
|
|
|
|
20.48
|
%
|
|
|
59,928
|
|
|
|
18.04
|
%
|
Commercial Multi-Peril Property
|
|
|
54,901
|
|
|
|
7.97
|
%
|
|
|
37,519
|
|
|
|
8.20
|
%
|
|
|
30,394
|
|
|
|
8.77
|
%
|
|
|
26,591
|
|
|
|
8.04
|
%
|
|
|
26,050
|
|
|
|
7.84
|
%
|
Other Liability
|
|
|
169,968
|
|
|
|
24.68
|
%
|
|
|
116,988
|
|
|
|
25.56
|
%
|
|
|
28,550
|
|
|
|
8.24
|
%
|
|
|
20,001
|
|
|
|
6.04
|
%
|
|
|
16,167
|
|
|
|
4.87
|
%
|
Commercial Auto Liability
|
|
|
92,632
|
|
|
|
13.45
|
%
|
|
|
73,952
|
|
|
|
16.16
|
%
|
|
|
61,119
|
|
|
|
17.64
|
%
|
|
|
59,308
|
|
|
|
17.92
|
%
|
|
|
59,144
|
|
|
|
17.80
|
%
|
All Other Lines
|
|
|
94,489
|
|
|
|
13.72
|
%
|
|
|
62,607
|
|
|
|
13.68
|
%
|
|
|
39,701
|
|
|
|
11.46
|
%
|
|
|
38,414
|
|
|
|
11.61
|
%
|
|
|
37,188
|
|
|
|
11.19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
688,687
|
|
|
|
100.00
|
%
|
|
$
|
457,683
|
|
|
|
100.00
|
%
|
|
$
|
346,451
|
|
|
|
100.00
|
%
|
|
$
|
330,872
|
|
|
|
100.00
|
%
|
|
$
|
332,209
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Earned Premium
|
|
2009
|
|
|
%
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
163,834
|
|
|
|
30.36
|
%
|
|
$
|
109,312
|
|
|
|
29.57
|
%
|
|
$
|
102,256
|
|
|
|
38.13
|
%
|
|
$
|
108,085
|
|
|
|
42.40
|
%
|
|
$
|
119,423
|
|
|
|
47.78
|
%
|
Commercial Multi-Peril Liability
|
|
|
37,133
|
|
|
|
6.88
|
%
|
|
|
46,326
|
|
|
|
12.53
|
%
|
|
|
50,031
|
|
|
|
18.65
|
%
|
|
|
45,192
|
|
|
|
17.73
|
%
|
|
|
38,541
|
|
|
|
15.42
|
%
|
Commercial Multi-Peril Property
|
|
|
45,660
|
|
|
|
8.46
|
%
|
|
|
31,847
|
|
|
|
8.61
|
%
|
|
|
21,018
|
|
|
|
7.84
|
%
|
|
|
17,946
|
|
|
|
7.04
|
%
|
|
|
16,288
|
|
|
|
6.52
|
%
|
Other Liability
|
|
|
140,486
|
|
|
|
26.04
|
%
|
|
|
74,470
|
|
|
|
20.14
|
%
|
|
|
15,571
|
|
|
|
5.81
|
%
|
|
|
10,433
|
|
|
|
4.09
|
%
|
|
|
8,072
|
|
|
|
3.23
|
%
|
Commercial Auto Liability
|
|
|
79,802
|
|
|
|
14.79
|
%
|
|
|
62,306
|
|
|
|
16.85
|
%
|
|
|
53,469
|
|
|
|
19.94
|
%
|
|
|
49,341
|
|
|
|
19.36
|
%
|
|
|
45,374
|
|
|
|
18.15
|
%
|
All Other Lines
|
|
|
72,687
|
|
|
|
13.47
|
%
|
|
|
45,460
|
|
|
|
12.30
|
%
|
|
|
25,852
|
|
|
|
9.64
|
%
|
|
|
23,923
|
|
|
|
9.38
|
%
|
|
|
22,261
|
|
|
|
8.91
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
539,602
|
|
|
|
100.00
|
%
|
|
$
|
369,721
|
|
|
|
100.00
|
%
|
|
$
|
268,197
|
|
|
|
100.00
|
%
|
|
$
|
254,920
|
|
|
|
100.00
|
%
|
|
$
|
249,959
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Written Premium
|
|
2009
|
|
|
%
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
206,246
|
|
|
|
35.56
|
%
|
|
$
|
120,507
|
|
|
|
32.12
|
%
|
|
$
|
105,003
|
|
|
|
37.47
|
%
|
|
$
|
104,846
|
|
|
|
39.92
|
%
|
|
$
|
117,287
|
|
|
|
45.44
|
%
|
Commercial Multi-Peril Liability
|
|
|
38,825
|
|
|
|
6.69
|
%
|
|
|
24,690
|
|
|
|
6.58
|
%
|
|
|
52,815
|
|
|
|
18.85
|
%
|
|
|
48,737
|
|
|
|
18.55
|
%
|
|
|
42,157
|
|
|
|
16.33
|
%
|
Commercial Multi-Peril Property
|
|
|
45,462
|
|
|
|
7.84
|
%
|
|
|
30,270
|
|
|
|
8.07
|
%
|
|
|
23,465
|
|
|
|
8.37
|
%
|
|
|
18,767
|
|
|
|
7.14
|
%
|
|
|
17,713
|
|
|
|
6.86
|
%
|
Other Liability
|
|
|
131,921
|
|
|
|
22.75
|
%
|
|
|
87,760
|
|
|
|
23.39
|
%
|
|
|
18,915
|
|
|
|
6.75
|
%
|
|
|
12,384
|
|
|
|
4.71
|
%
|
|
|
8,004
|
|
|
|
3.10
|
%
|
Commercial Auto Liability
|
|
|
82,499
|
|
|
|
14.22
|
%
|
|
|
64,678
|
|
|
|
17.24
|
%
|
|
|
52,798
|
|
|
|
18.84
|
%
|
|
|
52,950
|
|
|
|
20.16
|
%
|
|
|
49,122
|
|
|
|
19.03
|
%
|
All Other Lines
|
|
|
75,065
|
|
|
|
12.94
|
%
|
|
|
47,289
|
|
|
|
12.60
|
%
|
|
|
27,215
|
|
|
|
9.71
|
%
|
|
|
24,984
|
|
|
|
9.51
|
%
|
|
|
23,851
|
|
|
|
9.24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
580,018
|
|
|
|
100.00
|
%
|
|
$
|
375,194
|
|
|
|
100.00
|
%
|
|
$
|
280,211
|
|
|
|
100.00
|
%
|
|
$
|
262,668
|
|
|
|
100.00
|
%
|
|
$
|
258,134
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously indicated, the Merger with ProCentury was
completed following the close of business on July, 31, 2008.
Therefore, the above table includes only five months of premium
for ProCentury for the year ended December 31, 2008 and
twelve months for the year ended December 31, 2009.
13
MEADOWBROOK
INSURANCE GROUP, INC.
In 2009, we had an increase in our premium writings specific to
our workers compensation line of business, which was
primarily related to our new relationship with a general agent
who specializes in non-contractors workers compensation in
the Midwest, California, and other western states, as well as
new programs which included a general agent that focuses on the
food service industry and a general agent who focuses on
heterogeneous workers compensation in the Southeast region
of the United States. For 2009, our workers compensation
rates were down approximately 2.5%, which was primarily due to
declines in mandated rate levels in select states.
Prior to 2008, we had a shift in our mix of business, which was
intended to diversify our product line and produce more
predictable and stable results. We had a decline in
workers compensation premium from 2005 primarily because
we exited a limited number of small programs that were no longer
meeting our underwriting standards. Also, we experienced an
overall reduction in audit-related premiums, and a decline in
the amount of residual market assignments we receive relative to
workers compensation premiums. The residual market
assignments are in essence a form of a tax whereby
any workers compensation risk that cannot be written in
the voluntary market is assigned to carriers underwriting
workers compensation business in that state. In addition,
workers compensation declined over the past few years due
to a reduction in premium writings because of competition and
past mandatory rate deceases, specifically in Florida,
Massachusetts and Nevada.
The Merger with ProCentury contributed to the overall
diversification of our business mix. Specifically within our
other liability line of business which accounted for 25% and 26%
in 2009 and 2008, respectively, compared to less than 10% in the
prior years, as noted above. The majority of our other liability
line of business is primarily related to shorter tail classes of
business, such as habitational risks of hotels, motels and
apartments, and mercantile operations. The majority of our
primary liability insurance policies have limits between
$500,000 and $1.0 million.
Additionally, prior to the Merger we had relatively low property
related premium and exposure to property perils. Historically,
approximately 35% of ProCenturys production was property
related. Property classes include fire and allied lines,
non-liability portions of commercial multi-peril, and inland and
ocean marine. Our property business has an inherently short
tail, but has exposure to catastrophe perils. The majority of
the property business has limits of less than $2.0 million.
Through the use of treaty, automatic facultative and certificate
facultative reinsurance, we retain the first $1.0 million
of each risk up to $4.0 million for any one loss
occurrence. We attempt to minimize catastrophic risk through
reinsurance and geographic diversification. We write a limited
amount of property coverage for the peril of wind on fixed
properties in Florida, counties along the Gulf of Mexico and in
states along the eastern seaboard.
Overall, we had growth in new business from programs implemented
in 2008 and 2009. The increase in premium volume in lines other
than workers compensation has been driven by new programs
we have implemented with both existing and new program agents,
all of which have a history of profitability and for which we
believe we are receiving adequate pricing to produce our
targeted return on equity. Rates in other lines of business
declined by only less than 1% and our excess and surplus lines
rates were down by approximately 4%. While the market for excess
and surplus lines remained competitive in 2009, our Century
operations traditional business production was only down
slightly.
A.M. Best Company (A.M. Best), which rates
insurance companies based on factors of concern to
policyholders, maintains a letter scale rating system ranging
from A++ (Superior) to F (In
Liquidation). In evaluating a companys financial and
operating performance, A.M. Best reviews the companys
profitability, leverage and liquidity, as well as its book of
business, the adequacy and soundness of its reinsurance, the
quality and estimated market value of its assets, the adequacy
of its loss and loss expense reserves, the adequacy of its
surplus, its capital structure, the experience and competence of
its management and its market presence. A.M. Best ratings
are directed toward the concerns of policyholders and insurance
agencies and are not intended for the protection of investors or
as a recommendation to buy, hold or sell securities. Currently
our financial strength rating by A.M. Best for our
Insurance Company Subsidiaries is an A−
(Excellent) rating.
14
MEADOWBROOK
INSURANCE GROUP, INC.
Reserves
The following table shows the development of reserves for unpaid
losses and loss adjustment expenses (LAE) from 2000
through 2009 for our Insurance Company Subsidiaries, and the
deconsolidation impact of American Indemnity. Development on the
ProCentury acquired reserves is not included for the years prior
to 2008, which was the year of the Merger. The lower portion of
the table reflects the impact of reinsurance for the years 2000
through 2009, reconciling the net reserves shown in the upper
portion of the table to gross reserves.
Additional information relating to our reserves is included
within the Losses and Loss Adjustment Expenses and
Reinsurance Recoverables section of Note 1
Summary of Significant Accounting Policies and
Note 5 Liability for Losses and Loss
Adjustment Expenses of the Notes to the Consolidated
Financial Statements, as well as to the Critical Accounting
Policies section and the Reserves section of
Item 7, Managements Discussion and Analysis.
Analysis
of Loss and Loss Adjustment Expense Development (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2000
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
|
(In thousands)
|
|
|
Reserves for losses and LAE at end of period
|
|
$
|
172,862
|
|
|
$
|
198,653
|
|
|
$
|
193,116
|
|
|
$
|
192,019
|
|
|
$
|
226,996
|
|
|
$
|
271,423
|
|
|
$
|
302,655
|
|
|
$
|
341,541
|
|
|
$
|
625,331
|
|
|
$
|
682,376
|
|
Deconsolidation of subsidiary(1)
|
|
|
(3,744
|
)
|
|
|
(5,572
|
)
|
|
|
(2,973
|
)
|
|
|
(2,989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted reserves for losses and LAE at end of period
|
|
$
|
169,118
|
|
|
$
|
193,081
|
|
|
$
|
190,143
|
|
|
$
|
189,030
|
|
|
$
|
226,996
|
|
|
$
|
271,423
|
|
|
$
|
302,655
|
|
|
$
|
341,541
|
|
|
$
|
625,331
|
|
|
$
|
682,376
|
|
Cumulative paid as of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year later
|
|
|
70,952
|
|
|
|
77,038
|
|
|
|
78,023
|
|
|
|
71,427
|
|
|
|
79,056
|
|
|
|
83,271
|
|
|
|
81,779
|
|
|
|
95,393
|
|
|
|
173,525
|
|
|
|
|
|
2 years later
|
|
|
115,669
|
|
|
|
130,816
|
|
|
|
122,180
|
|
|
|
118,729
|
|
|
|
124,685
|
|
|
|
133,809
|
|
|
|
140,308
|
|
|
|
155,745
|
|
|
|
|
|
|
|
|
|
3 years later
|
|
|
146,548
|
|
|
|
157,663
|
|
|
|
151,720
|
|
|
|
145,279
|
|
|
|
153,780
|
|
|
|
170,226
|
|
|
|
207,227
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4 years later
|
|
|
160,673
|
|
|
|
176,172
|
|
|
|
167,288
|
|
|
|
159,220
|
|
|
|
171,946
|
|
|
|
210,110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 years later
|
|
|
171,992
|
|
|
|
186,847
|
|
|
|
174,778
|
|
|
|
169,980
|
|
|
|
195,328
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 years later
|
|
|
179,010
|
|
|
|
191,936
|
|
|
|
180,489
|
|
|
|
184,663
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 years later
|
|
|
182,954
|
|
|
|
196,486
|
|
|
|
190,133
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 years later
|
|
|
186,198
|
|
|
|
204,386
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9 years later
|
|
|
192,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves re-estimated as of end of year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year later
|
|
|
182,976
|
|
|
|
199,171
|
|
|
|
193,532
|
|
|
|
193,559
|
|
|
|
231,880
|
|
|
|
268,704
|
|
|
|
295,563
|
|
|
|
330,416
|
|
|
|
596,661
|
|
|
|
|
|
2 years later
|
|
|
186,191
|
|
|
|
205,017
|
|
|
|
196,448
|
|
|
|
203,394
|
|
|
|
227,462
|
|
|
|
263,069
|
|
|
|
286,647
|
|
|
|
327,862
|
|
|
|
|
|
|
|
|
|
3 years later
|
|
|
189,632
|
|
|
|
207,379
|
|
|
|
202,126
|
|
|
|
205,650
|
|
|
|
226,437
|
|
|
|
261,319
|
|
|
|
283,583
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4 years later
|
|
|
190,305
|
|
|
|
211,394
|
|
|
|
203,738
|
|
|
|
202,748
|
|
|
|
226,492
|
|
|
|
260,373
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 years later
|
|
|
196,158
|
|
|
|
213,802
|
|
|
|
202,028
|
|
|
|
202,716
|
|
|
|
229,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 years later
|
|
|
199,520
|
|
|
|
212,274
|
|
|
|
201,786
|
|
|
|
203,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 years later
|
|
|
198,500
|
|
|
|
212,292
|
|
|
|
201,355
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 years later
|
|
|
198,670
|
|
|
|
211,550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9 years later
|
|
|
198,481
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative (deficiency) redundancy:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollars
|
|
$
|
(29,363
|
)
|
|
$
|
(18,469
|
)
|
|
$
|
(11,212
|
)
|
|
$
|
(14,697
|
)
|
|
$
|
(2,750
|
)
|
|
$
|
11,050
|
|
|
$
|
19,072
|
|
|
$
|
13,679
|
|
|
$
|
28,670
|
|
|
|
|
|
Percentage
|
|
|
17.4
|
%
|
|
|
9.6
|
%
|
|
|
5.9
|
%
|
|
|
7.8
|
%
|
|
|
1.2
|
%
|
|
|
4.1
|
%
|
|
|
6.3
|
%
|
|
|
4.0
|
%
|
|
|
4.6
|
%
|
|
|
|
|
Net reserves
|
|
|
169,118
|
|
|
|
193,081
|
|
|
|
190,143
|
|
|
|
189,030
|
|
|
|
226,996
|
|
|
|
271,423
|
|
|
|
302,655
|
|
|
|
341,541
|
|
|
|
625,331
|
|
|
|
682,376
|
|
Ceded reserves
|
|
|
168,962
|
|
|
|
195,943
|
|
|
|
181,817
|
|
|
|
147,446
|
|
|
|
151,161
|
|
|
|
187,254
|
|
|
|
198,422
|
|
|
|
198,461
|
|
|
|
260,366
|
|
|
|
266,801
|
|
Gross reserves
|
|
|
338,080
|
|
|
|
389,024
|
|
|
|
371,960
|
|
|
|
336,476
|
|
|
|
378,157
|
|
|
|
458,677
|
|
|
|
501,077
|
|
|
|
540,002
|
|
|
|
885,697
|
|
|
|
949,177
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net re-estimated
|
|
|
198,481
|
|
|
|
211,550
|
|
|
|
201,355
|
|
|
|
203,727
|
|
|
|
229,746
|
|
|
|
260,373
|
|
|
|
283,583
|
|
|
|
327,862
|
|
|
|
596,661
|
|
|
|
|
|
Ceded re-estimated
|
|
|
262,111
|
|
|
|
287,474
|
|
|
|
257,730
|
|
|
|
246,445
|
|
|
|
206,281
|
|
|
|
210,880
|
|
|
|
207,605
|
|
|
|
208,825
|
|
|
|
256,828
|
|
|
|
|
|
Gross re-estimated
|
|
|
460,592
|
|
|
|
499,024
|
|
|
|
459,085
|
|
|
|
450,172
|
|
|
|
436,027
|
|
|
|
471,253
|
|
|
|
491,188
|
|
|
|
536,687
|
|
|
|
853,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cumulative (deficiency) redundancy
|
|
$
|
(122,512
|
)
|
|
$
|
(110,000
|
)
|
|
$
|
(87,125
|
)
|
|
$
|
(113,696
|
)
|
|
$
|
(57,870
|
)
|
|
$
|
(12,576
|
)
|
|
$
|
9,889
|
|
|
$
|
3,315
|
|
|
$
|
32,208
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
We performed an evaluation of our
business relationships and determined our wholly owned
subsidiary, American Indemnity, did not meet the tests for
consolidation, as neither us, nor our subsidiary Star, are the
primary beneficiaries of American Indemnity. Therefore,
|
15
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
effective January 1, 2004, we
deconsolidated American Indemnity on a prospective basis in
accordance with related accounting guidance. Accordingly, we
adjusted the reserves and development within the above table.
|
The following table sets forth the difference between generally
accepted accounting principles (GAAP) reserves for
loss and loss adjustment expenses and statutory reserves for
loss and loss adjustment expenses at December 31 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
GAAP reserves for losses and LAE
|
|
$
|
949,177
|
|
|
$
|
885,697
|
|
Reinsurance recoverables for unpaid losses
|
|
|
(266,801
|
)
|
|
|
(260,366
|
)
|
Allowances against reinsurance recoverables*
|
|
|
|
|
|
|
(481
|
)
|
|
|
|
|
|
|
|
|
|
Statutory reserves for losses and LAE
|
|
$
|
682,376
|
|
|
$
|
624,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
|
The GAAP allowance for reinsurance
recoverables is reported as a Schedule F penalty or a
non-admitted asset for the purpose of statutory accounting.
|
For the year ended December 31, 2009, we reported a
decrease of $32.2 million in gross ultimate loss estimates
for accident years 2008 and prior, or 3.6% of
$885.7 million of gross loss and LAE reserves at
January 1, 2009. We reported a $28.7 million decrease
in net ultimate loss and LAE estimates for accident years 2008
and prior, or 4.6% of $625.3 million of net loss and LAE
reserves at January 1, 2009.
For the year ended December 31, 2008, we reported a
decrease of $103,000 in gross ultimate loss estimates for
accident years 2007 and prior, or 0.02% of $540.0 million
of gross losses and LAE reserves at January 1, 2008. The
gross development excludes development on ProCentury reserves
acquired on August 1, 2008. We reported an
$11.1 million decrease in net ultimate loss and LAE
estimates for accident years 2007 and prior, or 3.3% of
$341.5 million of Meadowbrook only net loss and LAE
reserves at January 1, 2008, because the table reflects
reserves as of January 1, 2008, which was pre-Merger. The
ProCentury acquired reserves of $247.7 million had prior
year favorable development of $5.7 million. Thus, total net
development on prior accident year reserves is
$16.8 million.
Reinsurance
Information relating to our reinsurance structure and treaty
information is included within Note 6
Reinsurance of the Notes to the Consolidated Financial
Statements.
Investments
Information relating to our investment portfolio is included
within Note 3 Investments of the Notes
to the Consolidated Financial Statements and the Investments
section of Item 7, Managements Discussion and
Analysis, as well as Item 7A Quantitative and
Qualitative Disclosures about Market Risk.
Competition
and Pricing
We compete with other providers of specialty insurance programs,
products, and risk management services, as well as, with
traditional providers of commercial insurance. Both the
specialty program segment and the traditional property and
casualty insurance markets are highly competitive. Our specialty
programs, products and services compete with products and
services offered by insurance companies, other providers of
insurance services (including domestic and foreign insurers and
reinsurers and insurance agents), as well as with self-insurance
plans, captives managed by others, and a variety of other
risk-financing vehicles and mechanisms. These competitive
products are offered by other companies that may have greater
financial resources than we do. Our agency operations compete
with other local, regional, and national insurance agencies for
individual client insurance needs.
16
MEADOWBROOK
INSURANCE GROUP, INC.
The market for specialty insurance programs, products and
services is significantly influenced by market conditions
affecting the traditional property and casualty insurance
industry. Insurance market conditions historically have been
subject to significant variability due to premium rate
competition, natural disasters and other catastrophic events,
judicial trends, changes in the investment and interest rate
environment, regulation, general economic conditions, and
unemployment rates. Pricing is a primary means of competition in
the commercial insurance market. Competition is also based on
the availability and quality of products, quality and speed of
service (including claims service), financial strength, ratings,
distribution systems and technical expertise. The primary basis
for competition among risk management providers varies with the
financial and insurance needs and resources of each potential
insured. Principal factors that are considered by insureds
include an analysis of the net present-value (after-tax) of the
cost of financing the insureds expected level of losses;
the amount of excess coverage provided in the event losses
exceed expected levels; cash flow and tax planning
considerations; and the expected quality and consistency of the
services to be provided. We believe that we are able to compete
based on our experience, the quality of our products and
services, our processing technology platforms, and our
program-oriented approach. However, our ability to successfully
compete is dependent upon a number of factors, including market
and competitive conditions, many of which are outside of our
control.
Regulation
Insurance
Company Regulation
Our Insurance Company Subsidiaries are subject to regulation in
the states where they conduct business. State insurance
regulations generally are designed to protect the interests of
policyholders, state insurance consumers or claimants rather
than shareholders or other investors. The nature and extent of
such state regulation varies by jurisdiction, but generally
involves:
|
|
|
|
|
prior approval of the acquisition of control of an insurance
company or of any company controlling an insurance company;
|
|
|
|
regulation of certain transactions entered into by an insurance
company with any of its affiliates;
|
|
|
|
approval of premium rates, forms and policies used for many
lines of insurance;
|
|
|
|
standards of solvency and minimum amounts of capital and surplus
that must be maintained;
|
|
|
|
establishment of reserves required to be maintained for unearned
premium, loss and loss adjustment expense, or for other purposes;
|
|
|
|
limitations on types and amounts of investments;
|
|
|
|
underwriting and claims settlement practices;
|
|
|
|
restrictions on the size of risks that may be insured by a
single company;
|
|
|
|
licensing of insurers and agents;
|
|
|
|
deposits of securities for the benefit of policyholders; and
|
|
|
|
the filing of periodic reports with respect to financial
condition and other matters.
|
In addition, state regulatory examiners perform periodic
examinations of insurance companies. The results of these
examinations can give rise to regulatory orders requiring
remedial, injunctive or other corrective action.
Insurance
Holding Company Regulation
We operate as an insurance holding company system and are
subject to regulation in the jurisdictions in which we conduct
business. These regulations require that each insurance company
in the system register with
17
MEADOWBROOK
INSURANCE GROUP, INC.
the insurance department of its state of domicile and furnish
information concerning the operations of companies within the
holding company system that may materially affect the
operations, management or financial condition of the insurers
within the system domiciled in that state. The insurance laws
similarly provide that all transactions among members of a
holding company system must be fair and reasonable. Transactions
between insurance subsidiaries and their parents and affiliates
generally must be disclosed to the state regulators, and prior
approval of the applicable state insurance regulator generally
is required for any material or extraordinary transaction. In
addition, a change of control of a domestic insurer or of any
controlling person requires the prior approval of the state
insurance regulator. Generally, any person who acquires ten
percent or more of the outstanding voting securities of the
insurer or its parent company is presumed to have acquired
control of the domestic insurer.
Various
State and Federal Regulation
Insurance companies are also affected by a variety of state and
federal legislative and regulatory measures and judicial
decisions that define and extend the risks and benefits for
which insurance is sought and provided. These include
redefinition of risk exposure in areas such as product
liability, environmental damage, and workers compensation.
In addition, individual state insurance departments may prevent
premium rates for some classes of insureds from reflecting the
level of risk assumed by the insurer for those classes. Such
developments may adversely affect the profitability of various
lines of insurance. In some cases, these adverse effects on
profitability can be minimized through repricing, if permitted
by applicable regulations, of coverages or limitations or
cessation of the affected business.
Reinsurance
Intermediary
Our reinsurance intermediary is also subject to regulation.
Under applicable regulations, the intermediary is responsible,
as a fiduciary, for funds received on account of the parties to
the reinsurance transaction and is required to hold such funds
in appropriate bank accounts subject to restrictions on
withdrawals and prohibitions on commingling.
Licensing
and Agency Contracts
We, or certain of our designated employees, must be licensed to
act as agents by state regulatory authorities in the states in
which we conduct business. Regulations and licensing laws vary
in individual states and are often complex.
Insurance licenses are issued by state insurance regulators upon
application and may be of perpetual duration or may require
periodic renewal. We must apply for and obtain appropriate new
licenses before we can expand into a new state on an admitted
basis or offer new lines of insurance that require separate or
additional licensing.
Insurers operating on an admitted basis must file premium rate
schedules and policy or coverage forms for review and approval
by the insurance regulators. In many states, rates and policy
forms must be approved prior to use, and insurance regulators
have broad discretion in judging whether an insurers rates
are adequate, not excessive and not unfairly discriminatory.
The applicable licensing laws and regulations in all states are
subject to amendment or reinterpretation by state regulatory
authorities, and such authorities are vested in most cases with
relatively broad discretion as to the granting, revocation,
suspension and renewal of licenses. The possibility exists that
we, or our employees, could be excluded, or temporarily
suspended, from continuing with some or all of our activities
in, or otherwise subjected to penalties by, a particular state.
18
MEADOWBROOK
INSURANCE GROUP, INC.
Insurance
Regulation Concerning Change or Acquisition of
Control
Star, Williamsburg, and Ameritrust are domestic property and
casualty insurance companies organized under the insurance laws
(the Insurance Codes) of Michigan, while Savers,
Century, PIC, and Propic are organized under the Insurance Codes
of Missouri, Ohio, Texas, and Washington D.C., respectively. The
Insurance Codes provide that acquisition or change of control of
a domestic insurer or of any person that controls a domestic
insurer cannot be consummated without the prior approval of the
relevant insurance regulatory authority. A person seeking to
acquire control, directly or indirectly, of a domestic insurance
company or of any person controlling a domestic insurance
company must generally file with the relevant insurance
regulatory authority an application for change of control
(commonly known as a Form A) containing
information required by statute and published regulations and
provide a copy of such Form A to the domestic insurer. In
Michigan and Missouri, control is generally presumed to exist if
any person, directly or indirectly, owns, controls, holds with
the power to vote or holds proxies representing ten percent or
more of the voting securities of the company.
In addition, many state insurance regulatory laws contain
provisions that require pre-notification to state agencies of a
change in control of a non-domestic admitted insurance company
in that state. While such pre-notification statutes do not
authorize the state agency to disapprove the change of control,
such statutes do authorize issuance of a cease and desist order
with respect to the non-domestic admitted insurer if certain
conditions exist, such as undue market concentration.
Any future transactions that would constitute a change in
control would also generally require prior approval by the
Insurance Departments of Michigan, Missouri, Ohio, Texas, and
Washington D.C. and would require pre-acquisition notification
in those states that have adopted pre-acquisition notification
provisions and in which the insurers are admitted. Such
requirements may deter, delay or prevent certain transactions
that could be advantageous to our shareholders.
Membership
in Insolvency Funds and Associations and Mandatory
Pools
Most states require admitted property and casualty insurers to
become members of insolvency funds or associations, which
generally protect policyholders against the insolvency of such
insurers. Members of the fund or association must contribute to
the payment of certain claims made against insolvent insurers.
Maximum contributions required by law in any one year vary
between 1% and 2% of annual premium written by a member in that
state. For 2009, 2008, and 2007, assessments from insolvency
funds were $491,000, $196,000, and $156,000, respectively. Most
of these payments are recoverable through future policy
surcharges and premium tax reductions. Except for New Jersey,
business written on a surplus lines basis is not subject to
state guaranty fund assessments.
Our Insurance Company Subsidiaries are also required to
participate in various mandatory insurance facilities or in
funding mandatory pools, which are generally designed to provide
insurance coverage for consumers who are unable to obtain
insurance in the voluntary insurance market. Among the pools
participated in are those established in certain states to
provide windstorm and other similar types of property coverage.
These pools typically require all companies writing applicable
lines of insurance in the state for which the pool has been
established to fund deficiencies experienced by the pool based
upon each companys relative premium writings in that
state, with any excess funding typically distributed to the
participating companies on the same basis. To the extent that
reinsurance treaties do not cover these assessments, they may
adversely affect us. For 2009, 2008, and 2007, total assessments
paid to all such facilities were $2.7 million,
$2.4 million, and $2.6 million, respectively.
Restrictions
on Dividends and Risk-Based Capital
For information on Restrictions on Dividends and Risk-based
Capital which affect us please refer to Note 10
Regulatory Matters and Rating Issues of the Notes to the
Consolidated Financial Statements and the Regulatory and
Rating Issues section within Item 7,
Managements Discussion and Analysis.
19
MEADOWBROOK
INSURANCE GROUP, INC.
NAIC-IRIS
Ratios
The National Association of Insurance Commissioners
(NAIC) Insurance Regulatory Information System
(IRIS) was developed by a committee of state
insurance regulators and is primarily intended to assist state
insurance departments in executing their statutory mandates to
oversee the financial condition of insurance companies operating
in their respective states. IRIS identifies thirteen industry
ratios and specifies usual values for each ratio.
Departure from the usual values on four or more ratios generally
leads to inquiries or possible further review from individual
state insurance commissioners. Refer to the Regulatory and
Rating Issues section of Item 7, Managements
Discussion and Analysis.
Effect of
Federal Legislation
The Terrorism Risk Insurance Act of 2002 (TRIA)
established a program under which the United States federal
government will provide governmental support for businesses that
suffer damages from certain acts of international terrorism. In
2007, TRIA was extended through December 31, 2014. The
terms of the legislation enacted now also include domestic
terrorist acts. TRIA serves as an additional high layer of
reinsurance against losses that may arise from a terrorist
incident. The impact to us resulting from TRIA is minimal as we
generally do not underwrite risks that are considered targets
for terrorism, avoid concentration of exposures in both property
and workers compensation, and have terrorism coverage
included in our reinsurance treaties to cover the most likely
exposure.
Update on
SEC Investigation
On April 2, 2008, the United States Securities and Exchange
Commission (SEC) requested that ProCentury
voluntarily provide information relating to its construction
defect reserves for the fiscal years 2003 through 2006.
ProCentury produced information and related documents in
response to this request and
follow-up
requests, as well as executed tolling agreements. On
August 10, 2009, the SEC notified in writing the Company,
Century and certain of Centurys current and former
officers that it had completed its investigation and that it did
not intend to recommend the filing of any enforcement action.
Available
Information
Our Internet address is www.meadowbrook.com. There we
make available, free of charge, our Annual Report on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
Statements of Beneficial Ownership (Forms 3, 4, and 5), and
any amendments to those reports, as soon as reasonably
practicable after we electronically file such material with, or
furnish to, the SEC. You may read and copy materials we file
with the SEC at the SECs Public Reference Room at
100 F Street, N.E., Washington D.C., 20549. You may
obtain information about the operation of the Public Reference
Room by calling the SEC at
1-800-SEC-0330.
In addition, the SEC maintains an Internet site that contains
reports, proxy statements, and other information that we file at
www.sec.gov. Our SEC reports can also be accessed through
the investor relations section of our website. The information
found on our website is not part of this or any other report we
file with, or furnished to the SEC. The Charters of the
Nominating and Governance Committee, the Compensation Committee,
the Audit Committee, the Finance Committee, and the Investment
Committee of our Board of Directors are also available on our
website, or available in print to any shareholder who requests
this information. In addition, our Corporate Governance
documents, Code of Conduct, and our Business Conduct Policy are
available on our website, or in print to any shareholder who
requests this information.
20
MEADOWBROOK
INSURANCE GROUP, INC.
If our
estimates of reserves for losses and loss adjustment expenses
are not adequate, we will have to increase our reserves, which
would result in reductions in net income, retained earnings,
statutory surplus, liquidity, and may limit our ability to pay
future dividends and service debt.
We establish reserves for losses and expenses related to the
adjustment of losses for the insurance policies we write. 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. We determine the amount of these reserves based on
our best estimate and judgment of the losses and costs we will
incur on existing insurance policies. While we believe our
reserves are adequate, we base these reserves on assumptions
about past and future events. The following factors could have a
substantial impact on our future loss experience:
|
|
|
|
|
the amounts of claims settlements and awards;
|
|
|
|
claims development patterns;
|
|
|
|
legislative and judicial activity;
|
|
|
|
changes in inflation and economic conditions; and
|
|
|
|
the accuracy and timely reporting of claim information.
|
Actual losses and the costs we incur related to the adjustment
of losses under insurance policies could exceed, perhaps
substantially, the amount of reserves we establish. When we
increase reserves, our pre-tax income for the period will
decrease by a corresponding amount. An increase in reserves may
also require us to write off a portion of our deferred
acquisition costs asset, which would cause a further reduction
of pre-tax income in that period.
If our
financial strength ratings are reduced, we may be adversely
impacted.
Insurance companies are subject to financial strength ratings
produced by external rating agencies. Higher ratings generally
indicate greater financial stability and a stronger ability to
pay claims. Ratings are assigned by rating agencies to insurers
based upon factors they believe are important to policyholders.
Ratings are not recommendations to buy, hold, or sell our
securities.
Our ability to write business is most influenced by our rating
from A.M. Best. A.M. Best ratings are designed to
assess an insurers financial strength and ability to meet
continuing obligations to policyholders. Currently, our
financial strength rating from A.M. Best is
A− (Excellent) for our Insurance Company
Subsidiaries. There can be no assurance that A.M. Best will
not change this rating in the future. A rating downgrade from
A.M. Best could materially adversely affect the business we
write and our results of operations.
If
market conditions cause our reinsurance to be more costly or
unavailable, we may be required to bear increased risks or
reduce the level of our underwriting commitments.
As part of our overall risk and capacity management strategy, we
purchase reinsurance for significant amounts of risk
underwritten by our Insurance Company Subsidiaries, especially
for the
excess-of-loss
and severity risks. Market conditions beyond our control
determine the availability and cost of the reinsurance we
purchase, which may affect the level of our business and
profitability. Our reinsurance facilities are generally subject
to annual renewal. We may be unable to maintain our current
reinsurance facilities or to obtain other reinsurance in
adequate amounts and at favorable rates. Increases in the cost
of reinsurance would adversely affect our profitability. In
addition, if we are unable to renew our expiring facilities or
to obtain new reinsurance on favorable terms, either our net
exposure to risk would increase or, if we are unwilling to bear
an increase in net risk exposures, we would have to reduce the
amount of risk we underwrite.
21
MEADOWBROOK
INSURANCE GROUP, INC.
The
current economic downturn and continuing volatility in the
financial market could materially and adversely affect our
business.
In 2008 and 2009, the capital and credit markets experienced
unprecedented volatility. While economic conditions have
recently improved, this trend may not continue and therefore,
there can be no assurance that we will not experience an adverse
effect, which may have a material impact on our overall
financial condition and results of operations.
We are
subject to credit risk with respect to the obligations of our
reinsurers and risk-sharing partners. The inability of our
reinsurers or risk-sharing partners to meet their obligations
could adversely affect our profitability.
We purchase reinsurance by transferring part of the risk we have
assumed (known as ceding) to a reinsurance company in exchange
for part of the premium we receive in connection with the risk
under pro rata and
excess-of-loss
contracts. These reinsurance arrangements diversify our business
and reduce our exposure to large losses or from hazards of an
unusual nature. Although reinsurance makes the reinsurer liable
to us to the extent the risk is transferred, the ceding of
insurance does not discharge us of our primary liability to our
policyholder. If all or any of the reinsuring companies fail to
pay or pay on a timely basis, we would be liable for such
defaulted amounts. Therefore, we are subject to credit risk with
respect to the obligations of our reinsurers. If our reinsurers
fail to pay us or fail to pay on a timely basis, our financial
results and financial condition could be adversely affected. In
order to minimize our exposure to significant losses from
reinsurer insolvencies, we evaluate the financial condition of
our reinsurers and monitor the economic characteristics of the
reinsurers on an ongoing basis and, if appropriate, we may
require trust agreements to collateralize the reinsurers
financial obligation to us.
In addition, with our risk-sharing programs, we are subject to
credit risk with respect to the payment of claims by our
clients captive,
rent-a-captive,
large deductible programs and indemnification agreements, as
well as on the portion of risk either ceded to captives or
retained by our clients. The capitalization and creditworthiness
of prospective risk-sharing partners is one of the factors we
consider upon entering into and renewing risk-sharing programs.
Generally, we collateralize balances due from our risk-sharing
partners through funds withheld trusts or stand-by letters of
credit issued by highly rated banks. No assurance can be given
regarding the future ability of any of our risk-sharing partners
to meet their obligations. The inability of our risk-sharing
partners to meet their obligations could adversely affect our
profitability.
Severe
weather conditions and other catastrophes may result in an
increase in the number and amount of claims
incurred.
The majority of our property business is exposed to the risk of
severe weather conditions and other catastrophes. Catastrophes
can be caused by various events, including natural events, such
as hurricanes, winter weather, tornadoes, windstorms,
earthquakes, hailstorms, severe thunderstorms and fires, and
other events, such as explosions, terrorist attacks and riots.
The incidence and severity of catastrophes and severe weather
conditions are inherently unpredictable. Severe weather
conditions and catastrophes can cause losses in the lines of
business acquired with the Merger. Generally these losses result
in an increase in the number of claims incurred as well as the
amount of compensation sought by claimants. In 2008, we recorded
$5.4 million of net after tax losses related to catastrophe
losses. In 2009, we did not have any catastrophic related
losses. Currently, we purchase catastrophe reinsurance to cover
for a potential catastrophe. However, it is possible that a
catastrophic event or multiple catastrophic events could cause
our loss and loss adjustment expense reserves to increase and
our liquidity and financial condition to decline. Refer to
Note 6 Reinsurance for a detailed
description of our reinsurance treaties and structure.
22
MEADOWBROOK
INSURANCE GROUP, INC.
We
face competitive pressures in our business that could cause our
revenues to decline and adversely affect our
profitability.
We compete with a large number of other companies in our
selected lines of business. We compete, and will continue to
compete, with major United States, foreign and other regional
insurers, as well as mutual companies, specialty insurance
companies, underwriting agencies and diversified financial
services companies. Many of our competitors have greater
financial and marketing resources than we do. Our profitability
could be adversely affected if we lose business or any of our
agents to competitors offering similar or better products at or
below our prices.
A number of new, proposed or potential legislative or industry
developments could further increase competition in our industry.
These developments include:
|
|
|
|
|
the formation of new insurers and an influx of new capital in
the marketplace as existing companies attempt to expand their
business as a result of better pricing
and/or terms;
|
|
|
|
programs in which state-sponsored entities provide property
insurance in catastrophe-prone areas, other alternative market
types of coverage; or other non-property insurance and
|
|
|
|
changing practices created by the Internet, which has increased
competition within the insurance business.
|
These developments could make the property and casualty
insurance marketplace more competitive by increasing the supply
of insurance capacity. In that event, the current market softens
further, and it may negatively influence our ability to maintain
or increase rates. Accordingly, these developments could have an
adverse effect on our business, financial condition and results
of operations.
Our
results may fluctuate as a result of many factors, including
cyclical changes in the insurance industry.
The results of companies in the property and casualty insurance
industry historically have been subject to significant
fluctuations and uncertainties. Our industrys
profitability can be affected by:
|
|
|
|
|
rising levels of actual costs that are not known by companies at
the time they price their products;
|
|
|
|
volatile and unpredictable developments, including man-made,
weather-related and other natural catastrophes or terrorist
attacks;
|
|
|
|
changes in loss reserves resulting from the general claims and
legal environments as different types of claims arise and
judicial interpretations relating to the scope of insurers
liability develop;
|
|
|
|
fluctuations in interest rates, inflationary pressures and other
changes in the investment environment, which affect returns on
invested assets and may impact the ultimate payout of
losses; and
|
|
|
|
an increase in medical costs beyond historic or expected annual
inflationary levels.
|
The demand for property and casualty insurance can also vary
significantly, rising as the overall level of economic activity
increases and falling as that activity decreases. The property
and casualty insurance industry historically is cyclical in
nature, with periods of reduced underwriting capacity and
favorable premium rates alternating with periods of excess
underwriting capacity and flat or falling premium rates. These
fluctuations in demand and supply could produce underwriting
results that would have a negative impact on our financial
condition and results of operations.
Our
geographic concentration ties our performance to the business,
economic, natural perils, man made perils, and regulatory
conditions within our concentrated regions.
One of our predominate lines of business is workers
compensation (30.4% of net earned premiums in 2009), which is
concentrated in California (35.7% of 2009 workers
compensation net earned premiums) and
23
MEADOWBROOK
INSURANCE GROUP, INC.
New England (13.9% of 2009 workers compensation net earned
premiums). Accordingly, unfavorable business, economic or
regulatory conditions in these states could negatively impact
our business. In addition, California and some of the New
England states are exposed to climate and environmental changes,
natural perils such as earthquakes, water supplies, and the
possibility of pandemics or terrorist acts. Accordingly, we
could suffer losses as a result of catastrophic events in these
states. In addition, general economic conditions affecting these
regions could have an adverse effect on the business we write
within these states. Because our business is concentrated in
this manner, we may be exposed to economic and regulatory risks
or risk from natural perils that are greater than the risks
associated with greater geographic diversification. Refer to
Note 6 Reinsurance for further
information regarding our reinsurance structure related to
workers compensation business.
Our
success depends on our ability to appropriately price the risks
we underwrite.
Our financial results depend on our ability to underwrite and
collect adequate premium rates for a wide variety of risks. Rate
adequacy is necessary to generate sufficient premiums to pay
losses, loss expenses and underwriting expenses and to earn a
profit. In order to price our products accurately, we must
collect and properly analyze a substantial amount of data,
develop, test and apply appropriate rating formulas, closely
monitor and timely recognize changes in trends and project both
severity and frequency of losses with reasonable accuracy. Our
ability to undertake these efforts successfully and price our
products accurately is subject to a number of risks and
uncertainties, some of which are outside our control. These
uncertainties include:
|
|
|
|
|
the availability of sufficient reliable data and our ability to
properly analyze available data;
|
|
|
|
the uncertainties that inherently characterize estimates and
assumptions;
|
|
|
|
the selection and application of appropriate rating and pricing
techniques;
|
|
|
|
any changes in legal standards, claim settlement practices,
medical care expenses and restoration costs;
|
|
|
|
changes in mandated rates or benefits set by the state
regulators; and
|
|
|
|
legislative actions.
|
Consequently, we could underprice risks, which would negatively
affect our profit margins, or we could overprice risks, which
could reduce our sales volume and competitiveness. In either
event, our profitability could be materially and adversely
affected.
The
failure of any of the loss limitation methods we employ could
have a material adverse effect on our results of operations and
financial condition.
We seek to limit our loss exposure by writing a number of our
insurance and reinsurance contracts on an
excess-of-loss
basis.
Excess-of-loss
insurance and reinsurance indemnifies the insured against losses
in excess of a specified amount. In addition, we limit program
size for each client and purchase third-party reinsurance for
our own account. In the case of our assumed proportional
reinsurance treaties, we seek per occurrence limitations or loss
and loss adjustment expense ratio caps to limit the impact of
losses ceded by the client. In proportional reinsurance, the
reinsurer shares a proportional part of the premiums and losses
of the reinsured. We also seek to limit our loss exposure by
geographic diversification. Various provisions of our policies,
such as limitations or exclusions from coverage or choice of
forum negotiated to limit our risks, may not be enforceable in
the manner we intend. As a result, one or more catastrophic or
other events could result in claims that substantially exceed
our expectations, which could have an adverse effect on our
results of operations or financial condition. Likewise, for
catastrophe events and for per risk events we buy a limited
amount of reinsurance coverage that we believe is adequate to
reimburse for our large losses with a very high degree of
probability, should the unlikely event occur that exceeds our
reinsurance coverage then the amounts in excess of our
reinsurance coverage could adversely impact our financial
condition or results of operations.
24
MEADOWBROOK
INSURANCE GROUP, INC.
Our
investment results and, therefore, our financial condition may
be impacted by changes in the business, financial condition or
operating results of the entities in which we invest, as well as
changes in government monetary policies, general economic
conditions and overall capital market conditions, all of which
impact interest rates.
Our results of operations depend, in part, on the performance of
our investments. Interest rates are highly sensitive to many
factors, including governmental monetary policies and domestic
and international economic and political conditions.
Fluctuations in interest rates affect our returns on and the
fair value of our fixed-maturity and equity securities. In
addition, market volatility can make it difficult to value
certain of our securities if trading becomes less frequent.
Interest rates in the United States are currently at historical
lows. Increases in interest rates may reduce the fair value of
our investments in available for sale fixed-maturity and equity
securities. In addition, defaults by third parties who fail to
pay or perform obligations could reduce our investment income
and could result in further investment losses in our portfolio.
Our fixed-maturity and equity investments are subject to:
|
|
|
|
|
credit risk, which is the risk that our investments will
decrease in value due to unfavorable changes in the financial
prospects or a downgrade in the credit rating of an entity in
which we have invested;
|
|
|
|
equity price risk, which is the risk that we will incur economic
loss due to a decline in common or preferred stock or bond
mutual fund share prices; and
|
|
|
|
interest rate risk, which is the risk that our investments may
decrease in value due to increases in interest rates.
|
Our fixed-maturity investment portfolio includes mortgage-backed
and other asset-backed securities. As with other fixed-maturity
investments, the fair value of these securities fluctuates
depending on market and other general economic conditions and
the interest rate environment. Changes in interest rates can
expose us to prepayment risks on these investments. When
interest rates fall, mortgage-backed securities are prepaid more
quickly than expected and the holder must reinvest the proceeds
at lower interest rates. Our mortgage-backed securities
currently consist of securities with features that reduce the
risk of prepayment, but there is no guarantee that we will not
invest in other mortgage-backed securities that lack this
protection. In periods of increasing interest rates,
mortgage-backed securities are prepaid more slowly, which may
require us to receive interest payments that are below the
prevailing interest rates for longer than expected.
Our investment portfolio also includes equity securities. These
investments are in preferred and common stocks of individual
companies, which are subject to economic loss from the decline
in preferred and common share prices. As a result, the fair
value of these investments will be determined by the specific
financial prospects of these individual companies, as well as
the equity markets in general.
As of the result of the risks described above, the value of our
investment portfolio could decrease, we could experience reduced
net investment income, and we could incur realized investment
losses, which could adversely affect our results of operations,
financial condition, cash flows, and liquidity.
We
could be forced to sell investments to meet our liquidity
requirements.
We believe we maintain adequate amounts of cash and short-term
investments to pay claims, and do not expect to have to sell
securities prematurely for such purposes. We may, however,
decide to sell securities as a result of changes in interest
rates, credit quality, the rate or repayment or other similar
factors. A significant increase in market interest rates could
result in a situation in which we are required to sell
securities at depressed prices to fund claims payments. Since
the securities within our investment portfolio are carried at
fair value, we expect these securities would be sold with no
material impact on our net equity, although it could result in
net realized losses. If these securities are sold, future net
investment income may be reduced if we are unable to reinvest in
securities with similar yields.
25
MEADOWBROOK
INSURANCE GROUP, INC.
If our
businesses do not perform well, we may be required to recognize
an impairment of our goodwill, which could have a material
adverse effect on our results of operations and financial
condition.
Goodwill represents the excess of the amounts we paid to acquire
subsidiaries and other businesses over the fair value of their
net assets at the date of acquisition. We evaluate existing
goodwill for impairment on an annual basis as of
October 1st, or more frequently if events or changes in
circumstances indicate that the asset might be impaired.
Goodwill impairment is performed at the reporting unit level. To
test goodwill for impairment, we are required to estimate the
fair value of each reporting unit. Since quoted market prices in
an active market are not available for our reporting units,
other valuation techniques are used. We have developed a model
to estimate the fair value of our reporting units utilizing a
discounted cash flow valuation technique (DCF
model). A DCF model is selected to be comparable to what
would be used by market participants to estimate fair value. The
impairment test incorporates estimates of future cash flows;
allocations of certain assets, liabilities and cash flows among
reporting units; future growth rates; terminal value amounts;
and the applicable weighted-average cost of capital used to
discount those estimated cash flows. These estimates are based
on our judgment. If it is determined that the goodwill has been
impaired, we would be required to write down the goodwill by the
amount of the impairment, with a corresponding charge to net
income. Such impairments could have a material adverse effect on
our results of operations or financial position.
Acquisitions
and integration of acquired businesses may result in operating
difficulties, which may prevent us from achieving the expected
benefits.
At times, we may investigate and pursue acquisition
opportunities if we believe such opportunities are consistent
with our long-term objectives and that the expected benefits
exceed the risks. Achieving such benefits is subject to a number
of uncertainties, including whether the combined businesses are
integrated in an efficient and effective manner, as well as
general competitive factors in the marketplace. We conduct due
diligence, however, the process of integrating an acquired
company or business can potentially be complex and costly.
Sometimes we can be confronted with unexpected issues that may
present significant risks, which could materially impact our
business, financial condition, results of operations, and cash
flows. In addition, we could potentially pay more for an
acquisition than its actual worth, which could materially impact
our financial condition, results of operations, and cash flows.
Because
we are heavily regulated by the states in which we operate, we
may be limited in the way we operate.
We are subject to extensive supervision and regulation in the
states in which we operate. The supervision and regulation
relate to numerous aspects of our business and financial
condition. The primary purpose of the supervision and regulation
is to maintain compliance with insurance regulations and to
protect policyholders and not our shareholders. The extent of
regulation varies, but generally is governed by state statutes.
These statutes delegate regulatory, supervisory and
administrative authority to state insurance departments. This
system of regulation covers, among other things:
|
|
|
|
|
standards of solvency, including risk-based capital measurements;
|
|
|
|
restrictions on the nature, quality and concentration of
investments;
|
|
|
|
restrictions on the types of terms that we can include in the
insurance policies we offer;
|
|
|
|
required methods of accounting;
|
|
|
|
required reserves for unearned premiums, losses and other
purposes;
|
|
|
|
permissible underwriting and claims settlement
practices; and
|
|
|
|
assessments for the provision of funds necessary for the
settlement of covered claims under certain insurance policies
provided by impaired, insolvent or failed insurance companies.
|
26
MEADOWBROOK
INSURANCE GROUP, INC.
The regulations of the state insurance departments may affect
the cost or demand for our products and may impede us from
obtaining rate increases or taking other actions we might wish
to take to increase our profitability. Furthermore, we may be
unable to maintain all required licenses and approvals and our
business may not fully comply with the wide variety of
applicable laws and regulations or the relevant authoritys
interpretation of the laws and regulations. Also, regulatory
authorities have relatively broad discretion to grant, renew or
revoke licenses and approvals. If we do not have the requisite
licenses and approvals or do not comply with applicable
regulatory requirements, the insurance regulatory authorities
could stop or temporarily suspend us from conducting some or all
of our activities or monetarily penalize us.
Although the United States federal government does not directly
regulate the insurance business, changes in federal legislation,
regulation, and / or administrative policies in
several areas, including changes in financial services
regulation (e.g.; the repeal of the McCarran-Ferguson Act) and
federal taxation, can significantly harm the insurance industry.
Litigation
may have an adverse effect on our business
We are subject at times to various claims, lawsuits and
proceedings relating principally to alleged errors or omissions
in the placement of insurance, claims administration, consulting
services and other business transactions arising in the ordinary
course of business. Where appropriate, we vigorously defend such
claims, lawsuits and proceedings. Some of these claims, lawsuits
and proceedings seek damages, including consequential, exemplary
or punitive damages, in amounts that could, if awarded, be
significant. Most of the claims, lawsuits and proceedings
arising in the ordinary course of business are covered by the
policy at issue, errors and omissions insurance or other
appropriate insurance. In terms of deductibles associated with
such insurance, we have established provisions against these
items, which are believed to be adequate in light of current
information and legal advice. With the assistance of outside
counsel, we adjust such provisions according to new developments
or changes in the strategy in dealing with such matters. On the
basis of current information, we do not expect the outcome of
the claims, lawsuits and proceedings to which we are subject to,
either individually, or in the aggregate, will have a material
adverse effect on our financial condition. However, it is
possible that future results of operations or cash flows for any
particular quarter or annual period could be materially affected
by an unfavorable resolution of any such matters.
Our
reliance on producers subjects us to their credit
risk.
With respect to our agency billed premiums generated by our
Insurance Company Subsidiaries, producers collect premiums from
the policyholders and forward them to us. In certain
jurisdictions, when the insured pays premium for these policies
to producers for payment, the premium might be considered to
have been paid under applicable insurance laws and the insured
will no longer be liable to us for those amounts, whether or not
we have actually received the premium from the producer.
Consequently, we assume a degree of credit risk associated with
producers. Although producers failures to remit premiums
to us have not caused a material adverse impact on us to date,
there may be instances where producers collect premium but do
not remit it to us and we may be required under applicable law
to provide the coverage set forth in the policy despite the
actual lack of collection of the premium by us. Current economic
conditions arising since 2008 have increased the risk of agent
insolvency. Because the possibility of these events is dependent
in large part upon the financial condition and internal
operations of our producers, we may not be able to quantify any
potential exposure presented by the risk. If we are unable to
collect premium from our producers in the future, our financial
condition and results of operations could be materially and
adversely affected.
Provisions
of the Michigan Business Corporation Act, our articles of
incorporation and other corporate governing documents and the
insurance laws of Michigan and Missouri may discourage takeover
attempts.
The Michigan Business Corporation Act contains
anti-takeover provisions. Chapter 7A (the
Fair Price Act) of the Business Corporation Act
applies to us and may have an anti-takeover effect and may
delay, defer
27
MEADOWBROOK
INSURANCE GROUP, INC.
or prevent a tender offer or takeover attempt that a shareholder
might consider in their best interest, including those attempts
that might result in shareholders receiving a premium over
market price for their shares.
The Fair Price Act provides that a supermajority vote of ninety
percent of the shareholders and no less than two-thirds of the
votes of non interested shareholders must approve a
business combination. The Fair Price Act defines a
business combination to encompass any merger,
consolidation, share exchange, sale of assets, stock issue,
liquidation, or reclassification of securities involving an
interested shareholder or certain
affiliates. An interested shareholder is
generally any person who owns ten percent or more of the
outstanding voting shares of the company. An
affiliate is a person who directly or indirectly
controls, is controlled by, or is under common control with, a
specified person. The supermajority vote required by the Fair
Price Act does not apply to business combinations that satisfy
certain conditions. These conditions include, among others:
(i) the purchase price to be paid for the shares of the
company in the business combination must be at least equal to
the highest of either (a) the market value of the shares or
(b) the highest per share price paid by the interested
shareholder within the preceding two-year period or in the
transaction in which the shareholder became an interested
shareholder, whichever is higher; and (ii) once becoming an
interested shareholder, the person may not become the beneficial
owner of any additional shares of the company except as part of
the transaction that resulted in the interested shareholder
becoming an interested shareholder or by virtue of proportionate
stock splits or stock dividends.
Our articles of incorporation allow our Board of Directors to
issue one or more classes or series of preferred stock with
voting rights, preferences and other privileges as the Board of
Directors may determine. The possible issuance of preferred
shares could adversely affect the holders of our common stock
and could prevent, delay, or defer a change of control.
We are also subject to the laws of Michigan, Ohio, Texas,
Washington D.C., and Missouri, which govern insurance holding
companies. Under these laws, a person generally must obtain the
applicable Insurance Departments approval to acquire,
directly or indirectly, five to ten percent or more of the
outstanding voting securities of our Insurance Company
Subsidiaries. An Insurance Departments determination of
whether to approve an acquisition would be based on a variety of
factors, including an evaluation of the acquirers
financial stability, the competence of its management, and
whether competition in that state would be reduced. These laws
may prevent, delay or defer a change of control of us or our
Insurance Company Subsidiaries.
Most
states assess our Insurance Company Subsidiaries to provide
funds for failing insurance companies and those assessments
could be material.
Our Insurance Company Subsidiaries are subject to assessments in
most states where we are licensed for the provision of funds
necessary for the settlement of covered claims under certain
policies provided by impaired, insolvent or failed insurance
companies. Maximum contributions required by law in any one year
vary by state, and have historically been less than one percent
of annual premiums written. We cannot predict with certainty the
amount of future assessments. Significant assessments could have
a material adverse effect on our financial condition and results
of operations.
We may
require additional capital in the future, which may not be
available or may only be available on unfavorable
terms.
Our future capital requirements depend on many factors,
including our ability to write new business successfully and to
establish premium rates and reserves at levels sufficient to
cover losses. To the extent that our present capital is
insufficient to meet future operating requirements
and/or cover
losses, we may need to raise additional funds through
financings. If we had to raise additional capital, equity or
debt financing may not be available or may be on terms that are
not favorable to us. In the case of equity financings, dilution
to our shareholders could result, and in any case such
securities may have rights, preferences and privileges that are
senior to those of the shares currently outstanding. If we
cannot obtain adequate capital on favorable terms or at all, our
business, operating results and financial condition could be
adversely affected.
28
MEADOWBROOK
INSURANCE GROUP, INC.
Our
status as an insurance holding company with no direct operations
could adversely affect our ability to meet our debt obligations
and pay shareholder dividends.
We are a holding company that transacts the majority of our
business through our Insurance Company Subsidiaries. Our ability
to meet our obligations on our outstanding debt, and to pay our
expenses and shareholder dividends, may depend upon the surplus
and earnings of our Insurance Company Subsidiaries and their
ability to pay dividends to us. Payments of dividends to us by
our Insurance Company Subsidiaries are restricted by state
insurance laws, including laws establishing minimum solvency and
liquidity thresholds, and could be subject to revised
restrictions in the future. As a result, at times, we may not be
able to receive dividends from our Insurance Company
Subsidiaries and we may not receive dividends in amounts
necessary to meet our debt obligations or to pay shareholder
dividends on our capital stock. In addition, the payment of
shareholder dividends by us is within the discretion of our
Board of Directors and depends on numerous factors, including
our results of operations, financial condition, competition,
market conditions, capital requirements and other factors that
our Board of Directors considers relevant.
Our
performance is dependent on the continued services and
performance of our senior management and other key
personnel.
The success of our business is dependent on our ability to
retain and motivate our senior management and key management
personnel and their efforts. The loss of the services of any of
our executive officers or other key employees could have a
material adverse effect on our business, financial condition,
results of operations, and cash flows. We have existing
employment or severance agreements with Robert S. Cubbin,
Christopher J. Timm, Karen M. Spaun, Michael G. Costello, and
other senior executives. We maintain a key person
life insurance policy on Robert S. Cubbin, our President and
CEO. The loss of any of these officers or other key personnel
could cause our ability to implement our business strategies to
be delayed or hindered.
Our future success also will depend on our ability to attract,
train, motivate and retain other highly skilled technical,
managerial, marketing, and customer service personnel.
Competition for these employees is strong and we may not be able
to successfully attract, integrate or retain sufficiently
qualified personnel. In addition, our future success depends on
our ability to attract, retain and motivate our agents and other
producers. Our failure to attract and retain the necessary
personnel and producers could have a material adverse effect on
our business, financial condition, results of operations, and
cash flows.
Although
we have paid cash dividends in the past, we may not pay cash
dividends in the future.
The declaration and payment of dividends is subject to the
discretion of our Board of Directors and will depend on our
financial condition, results of operations, cash flows, cash
requirements, future prospects, regulatory and contractual
restrictions on the payment of dividends by our Insurance
Company Subsidiaries and other factors deemed relevant by our
Board of Directors. There is no requirement that we must, and we
cannot assure you that we will, declare and pay any dividends in
the future. Our Board of Directors may determine to retain such
capital for general corporate or other purposes.
We
rely on our information technology and telecommunications
systems to conduct our business.
Our business is dependent upon the uninterrupted functioning of
our information technology and telecommunication systems. We
rely upon our systems, as well as the systems of our vendors, to
underwrite and process our business, make claim payments,
provide customer service, provide policy administration
services, such as endorsements, cancellations and premium
collections, comply with insurance regulatory requirements and
perform actuarial and other analytical functions necessary for
pricing and product development. Our operations are dependent
upon our ability to timely and efficiently process our business
and protect our information and telecommunications systems from
physical loss, telecommunications failure or other similar
catastrophic events, as well as from security breaches. While we
have implemented business contingency plans and other reasonable
and appropriate internal controls to protect our systems from
29
MEADOWBROOK
INSURANCE GROUP, INC.
interruption, loss or security breaches, a sustained business
interruption or system failure could adversely impact our
ability to process our business, provide customer service, pay
claims in a timely manner or perform other necessary business
functions. Likewise, a security breach of our computer systems
could also interrupt or damage our operations or harm our
reputation in the event confidential customer information is
disclosed to third parties. In addition, the cost to remedy a
severe security breach could also be substantial. These
circumstances could have a material adverse effect upon our
financial condition, results of operations, cash flows, or
reputation.
Managing
technology initiatives and obtaining the efficiencies
anticipated with technology implementation may present
significant challenges.
While technological enhancements and initiatives can streamline
several business processes and ultimately reduce the costs of
operations, these initiatives can present short-term costs and
implementation risks. Projections of associated costs,
implementation timelines, and the benefits of those results may
be inaccurate and such inaccuracies could increase over time. In
addition, there are risks associated with not achieving the
anticipated efficiencies from technology implementation that
could impact our financial condition, results of operations, and
cash flows.
|
|
ITEM 1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
In 1998, we purchased land in Southfield, Michigan for a cost of
$3.2 million. In 2004, the construction of our corporate
headquarters was completed on half of this land and in December
2004 we relocated to the new office building. Our corporate
headquarters are approximately 72,000 square feet. The
total construction cost of the building approximated
$12.0 million, which was paid in full at the closing on
January 19, 2005.
In 2003, we entered into a Purchase and Sale Agreement, whereby
we agreed to sell the remaining portion of the land to an
unaffiliated third party for the purpose of constructing an
office building adjacent to our corporate headquarters. Under
the Purchase and Sale Agreement, the third party agreed to pay
$2.1 million for the land, $1.2 million for their
share of the costs related to the common areas of the building,
and other related costs of approximately $226,000. In May 2005,
we closed on the transaction.
The unaffiliated third party had until July 2007 to pay the
principal balance, however we negotiated an extension through
May 1, 2009. Subsequent to the expiration of the extension,
it has been determined the unaffiliated third party does not
intend to pay the remaining principal balance. Therefore, we
intend to foreclose on the property in 2010.
With the ProCentury merger, we assumed the lease of their
corporate headquarters, an approximately 44,000 square foot
office building located in Westerville, Ohio. The lease
agreement for this building has an initial term of ten years,
which expires in 2013.
We are also a party to various leases, including other leases
acquired from ProCentury, for other locations in which we have
offices. We do not consider any of these leases to be material.
|
|
ITEM 3.
|
LEGAL
PROCEEDINGS
|
We are subject at times to various claims, lawsuits and
proceedings relating principally to alleged errors or omissions
in the placement of insurance, claims administration, consulting
services and other business transactions arising in the ordinary
course of business. Where appropriate, we vigorously defend such
claims, lawsuits and proceedings. Some of these claims, lawsuits
and proceedings seek damages, including consequential, exemplary
or punitive damages, in amounts that could, if awarded, be
significant. Most of the claims, lawsuits and proceedings
arising in the ordinary course of business are covered by the
policy at issue, errors
30
MEADOWBROOK
INSURANCE GROUP, INC.
and omissions insurance or other appropriate insurance. In terms
of deductibles associated with such insurance, we have
established provisions against these items, which are believed
to be adequate in light of current information and legal advice.
In accordance with accounting guidance, if it is probable that
an asset has been impaired or a liability has been incurred as
of the date of the financial statements and the amount of loss
is estimable, an accrual for the costs to resolve these claims
is recorded in our consolidated financial statements. Period
expenses related to the defense of such claims are included in
other operating expenses in the accompanying consolidated
statements of income. With the assistance of outside counsel, we
adjust such provisions according to new developments or changes
in the strategy in dealing with such matters. On the basis of
current information, we do not expect the outcome of the claims,
lawsuits and proceedings to which we are subject to, either
individually, or in the aggregate, will have a material adverse
effect on our financial condition. However, it is possible that
future results of operations or cash flows for any particular
quarter or annual period could be materially affected by an
unfavorable resolution of any such matters.
31
MEADOWBROOK
INSURANCE GROUP, INC.
PART II
|
|
ITEM 5.
|
Market
Price of and Dividends on the Registrants Common Equity
and Related Stockholder Matters
|
|
|
|
|
|
Shareholder Information
Corporate Headquarters
26255 American Drive
Southfield, MI
48034-6112
Phone:
(248) 358-1100
Independent Registered
Public Accounting Firm
Ernst & Young LLP
Detroit, MI
Corporate Counsel
Howard & Howard Attorneys PLLC.
Royal Oak, MI
|
|
Transfer Agent & Registrar
BNY Mellon Shareowner Services
P.O. Box 358015
Pittsburgh, PA 15252-8015
Stock Listing
New York Stock Exchange
Symbol: MIG
|
|
Annual Meeting
The Annual Meeting of Shareholders
will be held at:
2:00 p.m.
May 18, 2010
Corporate Headquarters
26255 American Drive
Southfield, MI
|
Shareholder
Relations and
Form 10-K
A copy of our 2009 Annual Report and
Form 10-K,
as filed with the Securities and Exchange Commission, may be
obtained upon written request to our Financial Reporting
Department at our corporate headquarters, or contact:
Karen M. Spaun, Senior Vice President and Chief Financial
Officer
(248) 204-8178
karen.spaun@meadowbrook.com
Direct
Investment Plan
Our Shareholder Investment Plan (Plan) offers a
simple and systematic way to purchase our common stock without
paying brokerage fees or commissions. With the Plans many
flexible features, an account may be customized to reflect
individual financial and investment objectives. If you would
like additional information including a prospectus and an
application, please contact:
BNY Mellon Shareowner Services
1-800-
442-8134
Or visit their website at
www.bnymellon.com/shareowner/isd
Share
Price and Dividend Information
Our common stock is traded on the New York Stock Exchange under
the symbol MIG. The following table sets forth the
high and low closing sale prices of our common shares as
reported by the NYSE and our quarterly dividends declared for
each period shown:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
High
|
|
|
Low
|
|
|
Dividends
|
|
|
First Quarter
|
|
$
|
7.01
|
|
|
$
|
5.08
|
|
|
$
|
0.02
|
|
Second Quarter
|
|
|
7.64
|
|
|
|
5.70
|
|
|
|
0.02
|
|
Third Quarter
|
|
|
8.21
|
|
|
|
6.27
|
|
|
|
0.03
|
|
Fourth Quarter
|
|
|
7.75
|
|
|
|
6.53
|
|
|
|
0.03
|
|
32
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2008
|
|
High
|
|
Low
|
|
Dividends
|
|
First Quarter
|
|
$
|
9.95
|
|
|
$
|
7.16
|
|
|
$
|
0.02
|
|
Second Quarter
|
|
|
8.60
|
|
|
|
5.20
|
|
|
|
0.02
|
|
Third Quarter
|
|
|
8.25
|
|
|
|
5.20
|
|
|
|
0.02
|
|
Fourth Quarter
|
|
|
7.59
|
|
|
|
3.97
|
|
|
|
0.02
|
|
For additional information regarding dividend restrictions,
refer to the Liquidity and Capital Resources section of
Managements Discussion and Analysis.
When evaluating the declaration of a dividend, our Board of
Directors considers a variety of factors, including but not
limited to, our cash flow, liquidity needs, results of
operations strategic plans, industry conditions, our overall
financial condition and other relevant factors. As a holding
company, the ability to pay cash dividends is partially
dependent on dividends and other permitted payments from our
subsidiaries. In 2009 and 2008, the Insurance Company
Subsidiaries paid dividends to our holding company of
$39.5 million and $46.2 million, respectively.
Shareholders
of Record
As of March 10, 2010, there were approximately 264 shareholders
of record of our common stock. For purposes of this
determination, Cede & Co., the nominee for the
Depositary Trust Company is treated as one holder.
Purchase
of Equity Securities by the Issuer
In July 2008, our Board of Directors authorized management to
purchase up to 3.0 million shares of our common stock in
market transactions for a period not to exceed twenty-four
months. Recently, on February 12, 2010, our Board of
Directors authorized us to purchase up to 5.0 million
shares of our common stock in market transactions for a period
not to exceed twenty-four months. This share repurchase plan
replaced the existing share repurchase plan authorized in July
2008.
The following table presents information with respect to
repurchases of our common stock made during the quarterly period
ended December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Maximum Number
|
|
|
|
|
|
|
Average
|
|
|
Shares Purchased
|
|
|
of Shares That May
|
|
|
|
Total
|
|
|
Price
|
|
|
as Part of Publicly
|
|
|
Yet Be Repurchased
|
|
|
|
Number of
|
|
|
Paid per
|
|
|
Announced Plans or
|
|
|
Under the Plans or
|
|
Period
|
|
Shares
|
|
|
Share
|
|
|
Programs
|
|
|
Programs
|
|
|
October 1 October 31, 2009
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
1,900,000
|
|
November 1 November 30, 2009
|
|
|
533,008
|
|
|
$
|
6.92
|
|
|
|
|
|
|
|
1,366,992
|
|
December 1 December 31, 2009
|
|
|
1,094,894
|
|
|
$
|
7.16
|
|
|
|
|
|
|
|
272,098
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,627,902
|
|
|
$
|
7.08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33
MEADOWBROOK
INSURANCE GROUP, INC.
Performance
Graph
The following graph sets forth, for the five year period ended
December 31, 2009, the cumulative total stockholder return
for the Companys common stock, the Russell 2000 Index, and
a Peer Group index. The graph assumes the investment of $100 on
December 31, 2004 in Common Stock of the Company, the
Russell 2000 Index, and a Peer Group index. The stock price
performance represented on the following graph is not
necessarily indicative of future stock price performance.
The performance graph shall not be deemed soliciting
material or to be filed with the Securities
and Exchange Commission, nor shall such information be deemed to
be incorporated by reference into any future filing of the
Company under the Securities Exchange Act of 1933 or Securities
Exchange Act of 1934, each as amended, except to the extent the
Company specifically incorporates it by reference into such
filing.
Comparison of Five Year Cumulative Total Return
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period Ending
|
|
Index
|
|
|
12/31/04
|
|
|
12/31/05
|
|
|
12/31/06
|
|
|
12/31/07
|
|
|
12/31/08
|
|
|
12/31/09
|
|
Meadowbrook Insurance Group, Inc.
|
|
|
|
100.00
|
|
|
|
|
117.03
|
|
|
|
|
198.20
|
|
|
|
|
188.58
|
|
|
|
|
130.74
|
|
|
|
|
152.33
|
|
|
|
Russell 2000
|
|
|
|
100.00
|
|
|
|
|
104.55
|
|
|
|
|
123.76
|
|
|
|
|
121.82
|
|
|
|
|
80.66
|
|
|
|
|
102.58
|
|
|
|
SNL Insurance $1B-$2.5B
|
|
|
|
100.00
|
|
|
|
|
115.46
|
|
|
|
|
144.94
|
|
|
|
|
140.54
|
|
|
|
|
115.72
|
|
|
|
|
126.38
|
|
|
|
34
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
ITEM 6.
|
SELECTED
CONSOLIDATED FINANCIAL DATA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except per share and ratio data)
|
|
|
Income Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums
|
|
$
|
688,687
|
|
|
$
|
457,683
|
|
|
$
|
346,451
|
|
|
$
|
330,872
|
|
|
$
|
332,209
|
|
Net written premiums
|
|
|
580,018
|
|
|
|
375,194
|
|
|
|
280,211
|
|
|
|
262,668
|
|
|
|
258,134
|
|
Net earned premiums
|
|
|
539,602
|
|
|
|
369,721
|
|
|
|
268,197
|
|
|
|
254,920
|
|
|
|
249,959
|
|
Net commissions and fees
|
|
|
37,881
|
|
|
|
42,904
|
|
|
|
45,988
|
|
|
|
41,172
|
|
|
|
35,916
|
|
Net investment income
|
|
|
50,366
|
|
|
|
36,624
|
|
|
|
26,400
|
|
|
|
22,075
|
|
|
|
17,975
|
|
Net realized (losses) gains
|
|
|
(225
|
)
|
|
|
(11,422
|
)
|
|
|
150
|
|
|
|
69
|
|
|
|
167
|
|
Total revenue
|
|
|
627,624
|
|
|
|
437,827
|
|
|
|
340,735
|
|
|
|
318,236
|
|
|
|
304,017
|
|
Net losses and LAE
|
|
|
307,087
|
|
|
|
212,885
|
|
|
|
150,969
|
|
|
|
146,293
|
|
|
|
151,542
|
|
Policy acquisition and other underwriting expenses
|
|
|
110,715
|
|
|
|
69,294
|
|
|
|
53,717
|
|
|
|
50,479
|
|
|
|
44,439
|
|
Other administrative expenses
|
|
|
39,413
|
|
|
|
35,000
|
|
|
|
32,269
|
|
|
|
28,824
|
|
|
|
26,810
|
|
Salaries and employee benefits
|
|
|
80,923
|
|
|
|
62,862
|
|
|
|
56,433
|
|
|
|
54,569
|
|
|
|
51,331
|
|
Amortization expense
|
|
|
5,781
|
|
|
|
6,310
|
|
|
|
1,930
|
|
|
|
590
|
|
|
|
373
|
|
Interest expense
|
|
|
10,596
|
|
|
|
7,681
|
|
|
|
6,030
|
|
|
|
5,976
|
|
|
|
3,856
|
|
Income before income taxes and equity earnings
|
|
|
73,109
|
|
|
|
43,795
|
|
|
|
39,387
|
|
|
|
31,505
|
|
|
|
25,666
|
|
Equity earnings of affiliates, net of tax
|
|
|
874
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity earnings of unconsolidated subsidiaries, net of tax
|
|
|
(12
|
)
|
|
|
269
|
|
|
|
331
|
|
|
|
128
|
|
|
|
1
|
|
Net income
|
|
|
52,650
|
|
|
|
27,397
|
|
|
|
27,992
|
|
|
|
22,034
|
|
|
|
17,910
|
|
Earnings per share Diluted
|
|
$
|
0.92
|
|
|
$
|
0.61
|
|
|
$
|
0.85
|
|
|
$
|
0.75
|
|
|
$
|
0.60
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments and cash and cash equivalents
|
|
$
|
1,203,215
|
|
|
$
|
1,085,648
|
|
|
$
|
651,601
|
|
|
$
|
527,600
|
|
|
$
|
460,233
|
|
Total assets
|
|
|
1,989,816
|
|
|
|
1,813,916
|
|
|
|
1,113,966
|
|
|
|
969,000
|
|
|
|
901,344
|
|
Loss and LAE reserves
|
|
|
949,177
|
|
|
|
885,697
|
|
|
|
540,002
|
|
|
|
501,077
|
|
|
|
458,677
|
|
Debt
|
|
|
49,875
|
|
|
|
60,250
|
|
|
|
|
|
|
|
7,000
|
|
|
|
7,000
|
|
Debentures
|
|
|
80,930
|
|
|
|
80,930
|
|
|
|
55,930
|
|
|
|
55,930
|
|
|
|
55,930
|
|
Shareholders equity
|
|
|
502,881
|
|
|
|
438,170
|
|
|
|
301,894
|
|
|
|
201,693
|
|
|
|
177,365
|
|
Book value per share
|
|
$
|
9.06
|
|
|
$
|
7.64
|
|
|
$
|
8.16
|
|
|
$
|
6.93
|
|
|
$
|
6.19
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP ratios (insurance companies only):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and LAE ratio(1)
|
|
|
60.7
|
%
|
|
|
62.0
|
%
|
|
|
61.2
|
%
|
|
|
62.3
|
%
|
|
|
65.2
|
%
|
Expense ratio(1)
|
|
|
31.9
|
%
|
|
|
31.3
|
%
|
|
|
34.2
|
%
|
|
|
34.5
|
%
|
|
|
33.5
|
%
|
Combined ratio
|
|
|
92.6
|
%
|
|
|
93.3
|
%
|
|
|
95.4
|
%
|
|
|
96.8
|
%
|
|
|
98.7
|
%
|
Accident year combined ratio(2)
|
|
|
97.9
|
%
|
|
|
97.8
|
%
|
|
|
98.0
|
%
|
|
|
97.9
|
%
|
|
|
96.8
|
%
|
Total (favorable) adverse development on prior years
|
|
$
|
(28,670
|
)
|
|
$
|
(16,772
|
)
|
|
$
|
(7,091
|
)
|
|
$
|
(2,719
|
)
|
|
$
|
4,884
|
|
35
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
(1) |
|
Both the GAAP loss and loss adjustment expense ratio and the
GAAP expense ratio are calculated based upon unconsolidated
insurance company operations. The following table details these
ratios and includes the intercompany fees, which are eliminated
upon consolidation. |
|
(2) |
|
The accident year combined ratio is the sum of the expense ratio
and accident year loss ratio. The accident year loss ratio
measures loss and LAE occuring in a particular year, regardless
of when they are reported and does not take into consideration
changes in estimates in loss reserves from prior accident years. |
Unconsolidated
GAAP data Ratio Calculation Table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Net earned premiums
|
|
$
|
539,602
|
|
|
$
|
369,721
|
|
|
$
|
268,197
|
|
|
$
|
254,920
|
|
|
$
|
249,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net losses and LAE
|
|
$
|
307,087
|
|
|
$
|
212,885
|
|
|
$
|
150,969
|
|
|
$
|
146,293
|
|
|
$
|
151,542
|
|
Intercompany claim fees
|
|
|
20,339
|
|
|
|
16,296
|
|
|
|
13,058
|
|
|
|
12,553
|
|
|
|
11,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated net losses and LAE
|
|
$
|
327,426
|
|
|
$
|
229,181
|
|
|
$
|
164,027
|
|
|
$
|
158,846
|
|
|
$
|
163,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP net loss and LAE ratio
|
|
|
60.7
|
%
|
|
|
62.0
|
%
|
|
|
61.2
|
%
|
|
|
62.3
|
%
|
|
|
65.2
|
%
|
Consolidated policy acquisition and other underwriting expenses
|
|
$
|
110,715
|
|
|
$
|
69,349
|
|
|
$
|
53,717
|
|
|
$
|
50,479
|
|
|
$
|
44,439
|
|
Intercompany administrative and other underwriting fees
|
|
|
61,422
|
|
|
|
46,371
|
|
|
|
37,890
|
|
|
|
37,442
|
|
|
|
39,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated policy acquisition and other underwriting expenses
|
|
$
|
172,137
|
|
|
$
|
115,720
|
|
|
$
|
91,607
|
|
|
$
|
87,921
|
|
|
$
|
83,670
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously indicated, the Merger with ProCentury was
completed following the close of business on July, 31, 2008.
Therefore, the above table includes only five months of
financial results for ProCentury for the year ended
December 31, 2008 and twelve months of financial results
for the year ended December 31, 2009.
36
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS
|
|
ITEM 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Forward-Looking
Statements
This
Form 10-K
may provide information including certain statements which
constitute forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as
amended. These include statements regarding the intent, belief,
or current expectations of management, including, but not
limited to, those statements that use the words
believes, expects,
anticipates, estimates, or similar
expressions. You are cautioned that any such forward-looking
statements are not guarantees of future performance and involve
a number of risks and uncertainties, and results could differ
materially from those indicated by such forward-looking
statements. Among the important factors that could cause actual
results to differ materially from those indicated by such
forward-looking statements are: the frequency and severity of
claims; uncertainties inherent in reserve estimates;
catastrophic events; a change in the demand for, pricing of,
availability or collectibility of reinsurance; increased rate
pressure on premiums; ability to obtain rate increases in
current market conditions; investment rate of return; changes in
and adherence to insurance regulation; actions taken by
regulators, rating agencies or lenders; attainment of certain
processing efficiencies; changing rates of inflation; general
economic conditions and other risks identified in our reports
and registration statements filed with the Securities and
Exchange Commission. We are not under any obligation to (and
expressly disclaim any such obligation to) update or alter our
forward-looking statements whether as a result of new
information, future events or otherwise.
Business
Overview
We are a publicly traded specialty insurance underwriter and
insurance administration services company. We market and
underwrite specialty property and casualty insurance programs
and products on both an admitted and non-admitted basis through
a broad and diverse network of independent retail, wholesale
program administrators and general agents, who value service,
specialized knowledge, and focused expertise. We primarily focus
on niche or specialty products and program business and risk
management solutions for agents, professional and trade
associations, pools, trusts, and small to medium-sized insureds.
These solutions include specialty program underwriting; excess
and surplus lines insurance products; alternative risk transfer
solutions; agency operations; and insurance administration
services. Program business refers to an aggregation of
individually underwritten risks that have some unique
characteristic and are distributed through a select group of
general agencies, retail agencies and program administrators. We
define our business segments as specialty insurance operations
and agency operations.
Our insurance programs are diversified geographically, by class
and line of business, type of insured and distribution. Within
the workers compensation line of business, we have a
regional focus in California and New England. Within the
commercial auto and commercial multiple peril line of business,
we have a regional focus in the Southeast and California. Within
the general liability line of business we have a focus in Texas.
Our
fee-for-service
business is managed on a regional basis with an emphasis in the
Midwest, New England, and southeastern regions of the United
States. Our corporate strategy emphasizes a regional focus and
diverse sources of revenue between underwritten premiums,
service fee revenue, and commissions. This allows us to leverage
fixed costs over a larger revenue base and take advantage of new
opportunities.
On July 31, 2008, the merger of Meadowbrook Insurance
Group, Inc. and ProCentury Corporation (ProCentury)
was completed (Merger). Under the terms of the
merger agreement, ProCentury shareholders were entitled to
receive, for each ProCentury common share, either $20.00 in cash
or Meadowbrook common stock based on a 2.5000 exchange ratio,
subject to adjustment as described within the merger agreement.
In accordance with the merger agreement, the stock price used in
determining the final cash and share consideration portion of
the purchase price was based on the volume-weighted average
sales price of a share
37
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
of Meadowbrook common stock for the
30-day
trading period ending on the sixth trading day before the
completion of the Merger, or $5.7326. Based upon the proration,
the total purchase price was $227.2 million, of which
$99.1 million consisted of cash, $122.7 million in
newly issued common stock, and approximately $5.4 million
in transaction related costs. The total number of common shares
issued for purposes of the stock portion of the purchase price
was 21.1 million shares.
ProCentury is a specialty insurance company, which primarily
underwrites general liability, commercial property,
environmental, garage, commercial multi-peril, commercial auto,
surety, and marine insurance primarily in the excess and surplus
lines, or non-admitted, market through a select
group of general agents. The excess and surplus lines market
provides insurance coverage for customers with
hard-to-place
risks that standard or admitted insurers typically choose not to
insure.
Five months of earnings of ProCentury are included in our
financial statements as of and for the year ended
December 31, 2008. Twelve months of earnings are included
as of and for the year ended December 31, 2009.
Since the completion of the Merger, we have been executing on
numerous revenue enhancement opportunities and leveraging the
infrastructure as summarized below:
|
|
|
|
|
Revenue enhancement opportunities:
|
|
|
|
|
|
launching a new wholesale relationship in the Midwest;
|
|
|
|
offering a surplus lines market need for an existing
workers compensation partner in New England; and
|
|
|
|
utilization of existing program capabilities for Century general
agents.
|
|
|
|
|
|
Leveraging shared infrastructure and increased size;
|
|
|
|
|
|
developing Centers of Expertise for claims management:
|
|
|
|
increased size and diversity benefit costs of reinsurance;
|
|
|
|
enhanced marketing capabilities through joint business
development functions; and
|
|
|
|
geographic expansion of Century offerings through existing
admitted markets.
|
|
|
|
|
|
Executing on opportunities to leverage other niche capabilities:
|
|
|
|
|
|
combined capabilities allow us to receive and evaluate more
opportunities; and
|
|
|
|
independently, neither company would have been able to meet the
comprehensive risk management solutions that some opportunities
require.
|
Specialty
Insurance Operations
Our specialty insurance operations segment, which includes
insurance company specialty programs and
fee-for-service
specialty or managed programs, focuses on specialty or niche
insurance business. Our specialty insurance operations provide
services and coverages tailored to meet specific requirements of
defined client groups and their members. These services include
risk management consulting, claims administration and handling,
loss control and prevention, and reinsurance placement, along
with various types of property and casualty insurance coverage,
including workers compensation, commercial multiple peril,
general liability, commercial auto liability, excess and surplus
lines, environmental, garage, surety, legal, professional
liability, errors and omissions, inland marine, and other lines
of business, where we see a market need and a profit potential.
Insurance coverage is provided primarily to associations or
similar groups of members and to specified classes of business
of our agents. We recognize revenue related to the services and
coverages the
38
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
specialty insurance operations provides within seven categories:
net earned premiums, management fees, claims fees, loss control
fees, reinsurance placement, investment income, and net realized
gains (losses).
We included the results of operations related to ProCentury
within the specialty insurance operations. Therefore, specialty
insurance operations include five months of results for
ProCentury for the year ended December 31, 2008 and twelve
months of results for the year ended December 31, 2009.
In addition, our subsidiary, Star, purchased a 28.5% ownership
interest in an insurance holding limited liability company. This
ownership interest is significant, but is less than a majority
ownership and, therefore, is accounted for under the equity
method of accounting. Star, therefore, will recognize 28.5% of
the profits and losses as a result of this equity interest
ownership. For segment reporting purposes, the equity earnings
related to this investment is shown gross of tax. Equity
earnings of affiliates, relates to our proportionate share of
this investment, which we consider to be consistent with our
specialty insurance operations and, therefore, we have included
the respective equity earnings within the specialty insurance
operations segment.
With a
fee-for-service
or managed program, we earn revenue by providing certain
operational and administrative functions and other services to a
clients risk-bearing entity, but generally do not share in
the operating results of the program. The fees we receive from
these programs are generally either a fixed amount or based on a
percentage of premium serviced or claim count.
Based upon the particular risk management goals of our clients,
market conditions and our assessment of the opportunity for
operating profit, our specialty insurance operations offer
solutions on a
fully-insured
basis, a risk-sharing basis, or a managed basis, in response to
a specific market opportunity. In a managed program, we earn
service fee revenue by providing certain operational functions
and other services to a clients risk-bearing entity, but
generally do not share in the operating results. In a
risk-sharing program, we share the operating results with the
client through a reinsurance agreement with an insurance
company, captive, or
rent-a-captive.
In a profit-sharing structure, we pay an agent a commission that
is adjusted based on the operating results of the program. These
structures, other than the profit-sharing commission structure,
are licensed insurance or reinsurance companies and are
accounted for in accordance with accounting guidance as it
relates to reinsurance and insurance products. In risk-sharing
programs, we derive revenue from net earned premiums,
fee-for-service
revenue and commissions, and investment income. In addition, we
may benefit from the fees our risk management subsidiary earns
for services we perform on behalf of our Insurance Company
Subsidiaries. These fees are eliminated upon consolidation.
However, the fees associated with the captives portion of
the program are reimbursed through a ceding commission. For a
fully-insured program, we provide insurance products without a
risk-bearing mechanism and derive revenue from net earned
premiums and investment income. For further descriptions of our
insurance programs and products refer to the Business section.
In addition to premium revenue and investment income from our
net retained portion of the operating results, we may also be
compensated through the receipt of fees for policy issuance
services and acquisition costs, captive administration,
reinsurance placement, loss prevention services, and claims
administrative and handling services. In addition, we may
benefit from the fees our risk management subsidiary earns for
services we perform on behalf of our Insurance Company
Subsidiaries. These fees are eliminated upon consolidation.
However, the fees associated with the captives portion of
the program are reimbursed through a ceding commission. For
financial reporting purposes, ceding commissions are treated as
a reduction in underwriting expenses.
With fully insured programs, we provide our insurance products
without a risk-bearing mechanism and derive revenue from net
earned premiums and investment income. Fully insured programs
are generally developed in response to specific market
opportunities and may evolve into a risk-sharing arrangement.
39
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Agency
Operations
We earn commission revenue through the operation of our retail
property and casualty insurance agencies, located in Michigan,
California, and Florida. The agency operations produce
commercial, personal lines, life, and accident and health
insurance, for more than fifty unaffiliated insurance carriers.
The agency produces an immaterial amount of business for our
affiliated Insurance Company Subsidiaries.
In recent years, we have derived our revenue from the following
sources (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
539,602
|
|
|
$
|
369,721
|
|
|
$
|
268,197
|
|
Management fees
|
|
|
18,901
|
|
|
|
21,168
|
|
|
|
23,963
|
|
Claims fees
|
|
|
7,428
|
|
|
|
8,879
|
|
|
|
9,025
|
|
Loss control fees
|
|
|
1,975
|
|
|
|
2,069
|
|
|
|
2,151
|
|
Reinsurance placement
|
|
|
931
|
|
|
|
728
|
|
|
|
929
|
|
Investment income
|
|
|
49,910
|
|
|
|
35,888
|
|
|
|
25,487
|
|
Net realized (losses) gains
|
|
|
(225
|
)
|
|
|
(11,422
|
)
|
|
|
150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty insurance operations
|
|
|
618,522
|
|
|
|
427,031
|
|
|
|
329,902
|
|
Agency operations
|
|
|
9,561
|
|
|
|
11,064
|
|
|
|
11,316
|
|
Holding Company interest income earned
|
|
|
456
|
|
|
|
736
|
|
|
|
913
|
|
Intersegment revenue
|
|
|
(915
|
)
|
|
|
(1,004
|
)
|
|
|
(1,396
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenue
|
|
$
|
627,624
|
|
|
$
|
437,827
|
|
|
$
|
340,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Critical
Accounting Policies
General
In certain circumstances, we are required to make estimates and
assumptions that affect amounts reported in our consolidated
financial statements and related footnotes. We evaluate these
estimates and assumptions on an on-going basis based on a
variety of factors. There can be no assurance, however, the
actual results will not be materially different than our
estimates and assumptions, and that reported results of
operation will not be affected by accounting adjustments needed
to reflect changes in these estimates and assumptions. We
believe the following policies are the most sensitive to
estimates and judgments.
Losses
and Loss Adjustment Expenses
Significant periods of time can elapse between the occurrence of
a loss, the reporting of the loss to the insurer, and the
insurers payment of that loss. To recognize liabilities
for unpaid losses and loss adjustment expenses
(LAE), insurers establish reserves as balance sheet
liabilities representing estimates of amounts needed to pay
reported and unreported net losses and LAE.
We establish a liability for losses and LAE, which represents
case based estimates of reported unpaid losses and LAE and
actuarial estimates of incurred but not reported losses
(IBNR) and LAE. Such liabilities, by necessity, are
based upon estimates and, while we believe the amount of our
reserves is adequate, the ultimate liability may be greater or
less than the estimate. As of December 31, 2009 and 2008,
we have accrued $949.2 million and $885.7 million of
gross loss and LAE reserves, respectively.
40
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Components
of Losses and Loss Adjustment Expense
The following table sets forth our gross and net reserves for
losses and LAE based upon an underlying source of data, at
December 31, 2009 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Case
|
|
|
IBNR
|
|
|
Total
|
|
|
Direct
|
|
$
|
263,064
|
|
|
$
|
570,095
|
|
|
$
|
833,159
|
|
Assumed-Directly Managed(1)
|
|
|
39,474
|
|
|
|
46,909
|
|
|
|
86,383
|
|
Assumed-Residual Markets(2)
|
|
|
9,401
|
|
|
|
12,505
|
|
|
|
21,906
|
|
Assumed-Retroceded
|
|
|
958
|
|
|
|
387
|
|
|
|
1,345
|
|
Assumed-Other
|
|
|
4,528
|
|
|
|
1,856
|
|
|
|
6,384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
317,425
|
|
|
|
631,752
|
|
|
|
949,177
|
|
Less Ceded
|
|
|
84,534
|
|
|
|
182,267
|
|
|
|
266,801
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
$
|
232,891
|
|
|
$
|
449,485
|
|
|
$
|
682,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Directly managed represents
business managed and processed by our underwriting, claims, and
loss control departments, utilizing our internal systems and
related controls.
|
|
(2)
|
|
Residual markets represent
mandatory pooled workers compensation business allocated
to individual insurance company writers based on the
insurers market share in a given state.
|
The reserves referenced in the above table related to our direct
and assumed business, which we directly manage and are
established through transactions processed through our internal
systems and related controls. Accordingly, the case reserves are
established on a current basis, therefore there is no delay or
lag in reporting of losses from a ceding company, and IBNR is
determined utilizing various actuarial methods based upon
historical data. Ultimate reserve estimates related to assumed
business from residual markets are provided by individual states
on a two quarter lag between the date of the evaluation and the
receipt of the estimate from the National Council on
Compensation Insurance (NCCI), and include an
estimated reserve based upon actuarial methods for this lag.
Assumed business, that is subsequently 100% retroceded to
participating reinsurers, relates to business previously
discontinued and now is in run-off. Relative to assumed business
from other sources, we receive case and paid loss data within a
forty-five day reporting period and develop our estimates for
IBNR based on both current and historical data.
The completeness and accuracy of data received from cedants on
assumed business that we do not manage directly is verified
through monthly reconciliations to detailed statements,
inception to date rollforwards of claim data, actuarial
estimates of historical trends, field audits, and a series of
management oversight reports on a program basis.
41
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
The following table sets forth our net case and IBNR reserves
for losses and LAE by line of business at December 31, 2009
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Case
|
|
|
Net IBNR
|
|
|
Total
|
|
|
Workers Compensation
|
|
$
|
80,001
|
|
|
$
|
105,728
|
|
|
$
|
185,729
|
|
Residual Markets
|
|
|
9,401
|
|
|
|
12,506
|
|
|
|
21,907
|
|
Commercial Multiple Peril/General Liability
|
|
|
84,710
|
|
|
|
248,978
|
|
|
|
333,688
|
|
Commercial Automobile
|
|
|
42,618
|
|
|
|
62,850
|
|
|
|
105,468
|
|
Other
|
|
|
16,161
|
|
|
|
19,423
|
|
|
|
35,584
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
232,891
|
|
|
$
|
449,485
|
|
|
$
|
682,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claim
Reserving Process and Methodology
When a claim is reported to one of our Insurance Company
Subsidiaries, for the majority of claims, our claims personnel
within our risk management subsidiary will establish a case
reserve for the estimated amount of the ultimate payment. The
amount of the reserve is primarily based upon a
case-by-case
evaluation of the type of claim involved, the circumstances
surrounding each claim, and the policy provisions relating to
the type of losses. The estimate reflects the informed judgment
of such personnel based on general insurance reserving
practices, which focus on the ultimate probable cost of each
reported claim, as well as the experience and knowledge of the
claims person. Until the claim is resolved, these estimates are
revised as deemed necessary by the responsible claims personnel
based on subsequent developments, new information or periodic
reviews of the claims.
In addition to case reserves and in accordance with industry
practice, we maintain estimates of reserves for losses and LAE
incurred but not yet reported. We project an estimate of
ultimate losses and LAE at each reporting date. The difference
between the projected ultimate loss and LAE reserves and the
case loss reserves and LAE reserves, is carried as IBNR
reserves. By using both estimates of reported claims and IBNR
determined using generally accepted actuarial reserving
techniques, we estimate the ultimate liability for losses and
LAE, net of reinsurance recoverables.
In developing claim and claim adjustment expense reserve
estimates, we perform a complete and detailed reserve analyses
each quarter. To perform this analysis, the data is organized at
a reserve category level. A reserve category can be
a line of business such as commercial automobile liability, or
it may be a particular geographical area within a line of
business such as Nevada workers compensation. The reserves
within a reserve category level are characterized as either
short tail or long tail. About 96% of our reserves can be
characterized as coming from long tail lines of business. For
long tail business, several years may lapse between the time the
business is written and the time when all claims are settled.
Our long-tail exposures include workers compensation,
commercial automobile liability, general liability, professional
liability, products liability, excess, and umbrella. Short-tail
exposures include property, commercial automobile physical
damage, a portion of ocean marine, and inland marine. The
analyses generally review losses both gross and net of
reinsurance.
The standard actuarial methods that we use to project ultimate
losses for both long-tail and short-tail exposures include, but
are not limited to, the following:
|
|
|
|
|
Paid Development Method
|
Incurred Development Method
Paid Bornhuetter-Ferguson Method
Reported Bornhuetter-Ferguson Method
Initial Expected Loss Method
Paid Roll-forward Method
42
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Incurred Roll-forward Method
Construction Defect Method
All of these methods are consistently applied to every reserve
category where they are applicable and they create indications
for each accident year. We use judgment selecting the best
estimate from within these estimates or adjusted estimates. As
such, no one method or group of methods is strictly used for any
line of business or reserve category within a line of business.
The individual selections by year are our best judgments based
on the strengths and weaknesses of the method, indications, the
inherent variability in the data and the specific modifications
to selections for data characteristics.
A brief description of the methods and some discussion of their
inherent strengths, weaknesses and uses are as follows:
Paid Development Method. This method
uses historical, cumulative paid losses by accident year and
develops those actual losses to estimated ultimate losses based
upon the assumption that each accident year will develop to
estimated ultimate cost in a manner that is analogous to prior
years, adjusted as deemed appropriate for the expected effects
of known changes in the claim payment environment, and to the
extent necessary supplemented by analyses of the development of
broader industry data.
Selection of the paid loss pattern requires analysis of several
factors including the impact of inflation on claims costs, the
rate at which claims professionals make claim payments and close
claims, the impact of judicial decisions, the impact of
underwriting changes, the impact of large claim payments and
other factors. Claim cost inflation itself requires evaluation
of changes in the cost of repairing or replacing property,
changes in the cost of medical care, changes in the cost of wage
replacement, judicial decisions, legislative changes and other
factors. Because this method assumes that losses are paid at a
consistent rate, changes in any of these factors can impact the
results. Since the method does not rely on case reserves, it is
not directly influenced by changes in the adequacy of case
reserves.
Incurred Development Method. This
method uses historical, cumulative reported loss dollars by
accident year and develops those actual losses to estimated
ultimate losses based upon the assumption that each accident
year will develop to estimated ultimate cost in a manner that is
analogous to prior years, adjusted as deemed appropriate for the
expected effects of known changes in the claim payment and case
reserving environment, and to the extent necessary supplemented
by analyses of the development of broader industry data.
Since the method uses more data (case reserves in addition to
paid losses) than the paid development method, the incurred
development patterns may be less variable than paid patterns.
However, selection of the incurred loss pattern requires
analysis of all of the factors listed in the description of the
paid development method. In addition, the inclusion of case
reserves can lead to distortions if changes in case reserving
practices have taken place and the use of case incurred losses
may not eliminate the issues associated with estimating the
incurred loss pattern subsequent to the most mature point
available.
Paid Bornhuetter-Ferguson Method. This
is a method that assigns partial weight to initial expected
losses for each accident year and partial weight to observed
paid losses. The weights assigned to the initial expected losses
decrease as the accident year matures.
The method assumes that only future losses will develop at the
expected loss ratio level. The percent of paid loss to ultimate
loss implied from the paid development method is used to
determine what percentage of ultimate loss is yet to be paid.
The use of the pattern from the paid development method requires
consideration of all factors listed in the description of the
paid development method. The estimate of losses yet to be paid
is added to current paid losses to estimate the ultimate loss
for each year. This method will react very slowly if actual
ultimate loss ratios are different from expectations due to
changes not accounted for by the expected loss ratio calculation.
43
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Reported Bornhuetter-Ferguson
Method. This is a method that assigns partial
weight to the initial expected losses and partial weight to
observed reported loss dollars (paid losses plus case reserves).
The weights assigned to the initial expected losses decrease as
the accident year matures.
The use of case incurred losses instead of paid losses can
result in development patterns that are less variable than paid
patterns. However, the inclusion of case reserves can lead to
distortions if changes in case reserving have taken place, and
the method requires analysis of all the factors that need to be
reviewed for the expected loss ratio and incurred development
methods.
Initial Expected Loss Method. This
method is used directly, and as an input to the
Bornhuetter-Ferguson methods. Initial expected losses for an
accident year are based on adjusting prior accident year
projections to the current accident year levels using underlying
loss trends, rate changes, benefit changes, reinsurance
structure and cost changes and other pertinent adjustments
specific to the line of business.
This method may be useful if loss development patterns are
inconsistent, losses emerge very slowly, or there is relatively
little loss history from which to estimate future losses. The
selection of the expected loss ratio requires analysis of loss
ratios from earlier accident years or pricing studies and
analysis of inflationary trends, frequency trends, rate changes,
underwriting changes, and other applicable factors.
Paid Roll-forward Method. This method
adjusts prior estimates of ultimate losses based on the actual
paid loss emergence in the quarter compared to the expected
emergence. It is useful in determining reserves that avoid
overreacting to ordinary fluctuations in the development
patterns.
Incurred Roll-forward Method. This
method adjusts prior estimates of ultimate losses based on the
actual case incurred loss emergence in the quarter compared to
the expected emergence. It may also be useful in determining
reserves that avoid overreacting to ordinary fluctuations in the
development patterns and generally reacts faster than the paid
roll-forward method.
Claims for short-tail lines of business settle more quickly than
long-tail lines of business, and in general, loss development
factors for short-tail lines are smaller than long-tail lines.
For long-tail lines, we tend to rely on initial expected loss
methods throughout the current accident year then move to
development factor based methods for older accident years.
Development methods on short-tail lines are generally reliable
in the third and fourth quarter of the initial accident year and
recorded loss ratios reflect a blend of the development and
forecast methods. Short-tail lines represent 4% of our total
reserves at December 31, 2009.
Construction Defect Method. The
provision for IBNR loss and ALAE for construction defect claims
is analyzed by projecting the number of IBNR claim counts and
applying a selected severity (i.e., a frequency severity type
approach). The provision for development on reported claims is
projected using a methodology similar to the incurred loss
development approach described above. However, the claims are
organized in a report year rather than accident year format. The
advantage of this is that it substantially reduces the length or
tail of the development.
The reserve categories where the above methods are not
applicable are few. The largest of these is our workers
compensation residual market reserve category, where we utilize
detailed reserve analyses performed by the industry statistical
agency NCCI in making our estimates. We adjust these estimates
for timing differences in the reporting of the data. The other
reserve categories that deviate from the above methods are
smaller; as a group constituting approximately one percent of
the total reserves.
Each of the methods listed above requires the selection and
application of parameters and assumptions. For all but the
initial expected loss method, the key assumptions are the
patterns with which our aggregate claims data will be paid or
will emerge over time (development patterns). These
patterns incorporate inherent assumptions of claims cost
inflation rates and trends in the frequency of claims, both
overall and by severity of claim. These are affected by
underlying loss trends, rate changes, benefit changes,
reinsurance
44
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
structure and cost changes and other pertinent adjustments which
are explicit key assumptions underlying the initial expected
loss method. Each of these key assumptions is discussed in the
following paragraphs.
To analyze the development patterns, we compile, to the extent
available, long-term and short-term historical data for our
insurance subsidiaries, organized in a manner which provides an
indication of the historical development patterns. To the extent
that the historical data may provide insufficient information
about future patterns whether due to environmental
changes such as legislation or due to the small volume or short
history of data for some segments of our business
benchmarks based on industry data, and forecasts made by
industry rating bureaus regarding the effect of legislative
benefit changes on such patterns, may be used to supplement,
adjust, or replace patterns based on our insurance
companies historical data.
Actuarial judgment is required in selecting the patterns to
apply to each segment of data being analyzed, and our views
regarding current and future claim patterns are among the
factors that enter into our establishment of the reserve for
losses and LAE at each balance sheet date. When short-term
averages or external rate bureau analyses indicate the claims
patterns are changing from historical company or industry
patterns, the new or forecasted information typically is
factored into the methodologies. When new claims emergence or
payment patterns have appeared in the actual data repeatedly
over multiple evaluations, those new patterns are given greater
weight in the selection process.
Because some claims are paid over many years, the selection of
claim emergence and payment patterns involves judgmentally
estimating the manner in which recently occurring claims will
develop for many years and at times, decades in the future. When
it is likely the actual development will occur in the distant
future, the potential for actual development to differ
substantially from historical patterns or current projections is
increased.
This process assumes that past experience, adjusted for the
effects of current developments and anticipated trends, is an
appropriate basis for predicting future events. In particular,
the development factor based methods all have as a key
assumption that the development of losses in the future will
follow a pattern similar to those measured by past experience
and as adjusted either explicitly or by actuarial judgment.
There is no precise method for subsequently evaluating the
impact of any specific factor on the adequacy of reserves,
because the eventual deficiency or redundancy is affected by
multiple and varied factors. With respect to the ultimate
estimates for losses and LAE, the key assumptions remained
consistent for the years ended December 31, 2009 and 2008.
Variability
of Claim Reserve Estimates
By its nature, the estimate of ultimate losses and LAE is
subject to variability due to differences between our
assumptions and actual events in the future. Although many
factors influence the actual cost of claims and our
corresponding reserve estimates, we do not measure and estimate
values for all of these variables individually. This is due to
the fact that many of the factors known to impact the cost of
claims cannot be measured directly, such as the impact on claim
costs due to economic inflation, coverage interpretations and
jury determinations. In most instances, we rely on our
historical experience or industry information to estimate the
values for the variables that are explicitly used in our reserve
analyses. We assume that the historical effect of these
unmeasured factors, which is embedded in our experience or
industry experience, is representative of the future effects of
these factors. Where we have reason to expect a change in the
effect of one of these factors, we perform analyses to perform
the necessary adjustments.
One implicit assumption underlying development patterns is that
the claims inflation trends will continue into the future
similar to their past patterns. To estimate the sensitivity of
the estimated ultimate loss and settlement expense payments to
an unexpected change in inflationary trends, our actuarial
department derives expected payment patterns separately for each
major line of business. These patterns were applied to the
December 31, 2009 loss and settlement expense reserves to
generate estimated annual incremental loss and
45
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
settlement expense payments for each subsequent calendar year.
Then, for the purpose of sensitivity testing, an explicit annual
inflationary variance of one percent was added to the
inflationary trend that is implicitly embedded in the estimated
payment pattern, and revised incremental loss and settlement
expense payments were calculated. General inflation trends have
been fairly stable over the past several years but there have
been fluctuations of one to two percent over the past ten years
and therefore we used a one percent annual inflation variance
factor. The effect differed by line of business but overall was
a three percent change in reserve adequacy or approximately
$13.4 million effect on after tax net income. A variance of
this type would typically be recognized in loss and settlement
expense reserves and, accordingly, would not have a material
effect on liquidity because the claims have not been paid.
An explicit assumption used in the analysis is the set of
initial expected loss ratios (IELRs) used in the
current accident year reserve projections and in some of the
prior accident year ultimate loss indications. To estimate the
sensitivity of the estimated ultimate loss to a change in IELRs,
the actuarial department recasted the loss reserve indications
using a set of IELRs all one percent higher than the final
IELRs. The overall impact of a one percent change in IELRs would
be a corresponding one percent change in reserve adequacy or a
$4.6 million effect on after tax net income. Often the loss
ratios by line of business will vary from the IELR in different
directions causing them to partially offset each other. A
variance of this type would typically be recognized in loss and
settlement expense reserves and, accordingly, would not have a
material effect on liquidity because the claims have not been
paid.
The other factors having influence upon the loss and LAE reserve
levels are too numerous and interdependent to efficiently model
and test for sensitivity. Likewise, the development factors by
reserve category and age are too numerous to model and test for
sensitivity. Instead, ranges are estimated by reserve category
considering past history, fluctuations in the development
patterns, emerging issues, trends and other factors. The ranges
are compiled and the total range is estimated considering the
sensitivity to all of the underlying factors together. The
resulting range is our best estimate of the expected ongoing
variability in the loss reserves.
Historic development as shown within the Analysis of
Loss and Loss Adjustment Expense Development table has
been six percent or less in the last five years but was ten to
seventeen percent in the years prior to the underwriting and
reserving shift in 2002. At that time, we concentrated our
efforts on eliminating underwriting relationships where we had
substantial liabilities above an aggregate exposure retained by
risk sharing associations and captives. For a large share of our
business, we also accelerated the pace at which we brought the
claim administration to our employees and away from outside
third party administrators. This change enabled us to more
rapidly recognize trends and underlying loss patterns, and
establish more accurate reserves in a timely manner.
Our range of loss and LAE reserves table shows that presently we
estimate them as going from favorable development of 9.1% to
unfavorable of 6.1%. The range was evaluated based on the
ultimate loss estimates from the actuarial methods described
above.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax Impact on Earnings from a Variance in Future Loss
Payments and Case Reserves as of December 31, 2009
|
|
(in thousands)
|
|
Line of Business
|
|
Minimum Reserve Range
|
|
|
Maximum Reserve Range
|
|
|
Workers Compensation (including Residual Markets)
|
|
$
|
(12,888
|
)
|
|
|
(6.2
|
)%
|
|
$
|
7,965
|
|
|
|
3.8
|
%
|
Commercial Multiple Peril/General Liability
|
|
|
(39,955
|
)
|
|
|
(12.0
|
)%
|
|
|
26,691
|
|
|
|
8.0
|
%
|
Commercial Automobile
|
|
|
(6,758
|
)
|
|
|
(6.4
|
)%
|
|
|
5,226
|
|
|
|
5.0
|
%
|
Other
|
|
|
(2,543
|
)
|
|
|
(7.1
|
)%
|
|
|
1,912
|
|
|
|
5.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(62,143
|
)
|
|
|
(9.1
|
)%
|
|
$
|
41,795
|
|
|
|
6.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
The sensitivity around our workers compensation reserves
primarily reflects the size and the maturity of the underlying
book of business. Our workers compensation reserves
represent 30% of our total reserves at December 31, 2009.
The sensitivity around our commercial multiple
peril / general liability reserves primarily reflects
the longer duration of reserves relating to our liability excess
program, which started in 2003, and construction defect
exposure, which together represent approximately 29% of the
$333.7 million reserves in this line of business as of
December 31, 2009. These lines of business are subject to
greater uncertainty than the remainder of our book of business.
The sensitivity around our commercial automobile reserves
primarily reflects the speed of reporting of the underlying
losses, as well as the maturity of the case law surrounding
automobile liability.
The sensitivity around the other lines of business primarily
reflects the size of the underlying book of business. Our other
reserves represent 5% of total reserves at December 31,
2009. A large portion of these reserves represent professional
liability programs which tend to be claims-made and reinsured at
lower limits, therefore reducing the volatility that is inherent
in a smaller book of business. Another large portion represents
property claims, which have a shorter reporting and payout
pattern than liability and workers compensation claims.
All of our reserves are sensitive to changes in the underlying
claim payment and case reserving practices, as well as the other
sources of variations mentioned above.
Reinsurance
Recoverables
Reinsurance recoverables represent (1) amounts currently
due from reinsurers on paid losses and LAE, (2) amounts
recoverable from reinsurers on case basis estimates of reported
losses and LAE, and (3) amounts recoverable from reinsurers
on actuarial estimates of IBNR losses and LAE. Such
recoverables, by necessity, are based upon estimates.
Reinsurance does not legally discharge us from our legal
liability to our insureds, but it does make the assuming
reinsurer liable to us to the extent of the reinsurance ceded.
Instead of being netted against the appropriate liabilities,
ceded unearned premiums and reinsurance recoverables on paid and
unpaid losses and LAE are reported separately as assets in our
consolidated balance sheets. Reinsurance recoverable balances
are also subject to credit risk associated with the particular
reinsurer. In our selection of reinsurers, we continually
evaluate their financial stability. While we believe our
reinsurance recoverables are collectible, the ultimate
recoverable may be greater or less than the amount accrued. At
December 31, 2009 and 2008, reinsurance recoverables on
paid and unpaid losses were $274.5 million and
$268.7 million, respectively.
In our risk-sharing programs, we are subject to credit risk with
respect to the payment of claims by our clients captive,
rent-a-captive,
large deductible programs, indemnification agreements, or on the
portion of risk either ceded to the captives, or retained by the
clients. The capitalization and credit worthiness of prospective
risk-sharing partners is one of the factors we consider upon
entering into and renewing risk-sharing programs. We
collateralize balances due from our risk-sharing partners
through funds withheld trusts or stand-by letters of credit
issued by highly rated banks. We have historically maintained an
allowance for the potential uncollectibility of certain
reinsurance balances due from some risk-sharing partners, some
of which may be in dispute. At the end of each quarter, an
analysis of these exposures is conducted to determine the
potential exposure to uncollectibility. At December 31,
2009, we believe this allowance is adequate. To date, we have
not, in the aggregate, experienced material difficulties in
collecting balances from our risk-sharing partners. No assurance
can be given, however, regarding the future ability of our
risk-sharing partners to meet their obligations.
47
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Investments
Our investment securities are classified as available for sale.
Investments classified as available for sale are available to be
sold in the future in response to our liquidity needs, changes
in market interest rates, tax strategies and asset-liability
management strategies, among other reasons. Available for sale
securities that are not determined to be
other-than-temporary
impaired (OTTI) are reported at fair value, with
unrealized gains and losses reported in the accumulated other
comprehensive income component of shareholders equity, net
of deferred taxes and, accordingly have no effect on net income.
Realized gains or losses on sale of investments are determined
on the basis of specific costs of the investments. Dividend
income is recognized when declared and interest income is
recognized when earned. Discount or premium on debt securities
purchased at other than par value is amortized using the
effective yield method.
Available for sale securities are reviewed for declines in fair
value that are determined to be
other-than-temporary.
For a debt security, if we intend to sell a security and it is
more likely than not we will be required to sell a debt security
before recovery of our amortized cost basis and the fair value
of the debt security is below amortized cost, we conclude that
an OTTI impairment has occurred and the amortized cost is
written down to current fair value, with a corresponding charge
to realized loss in the Consolidated Statements of Income. If we
do not intend to sell a debt security and it is not more likely
than not we will be required to sell a debt security before
recovery of our amortized cost basis but the present value of
the cash flows expected to be collected is less than the
amortized cost of the debt security (referred to as the credit
loss), we conclude that an OTTI has occurred and the amortized
cost is written down to the estimated recovery value with a
corresponding charge to realized loss in the Consolidated
Statements of Income, as this is also deemed the credit portion
of the OTTI. The remainder of the decline to fair value is
recorded in Other Comprehensive Income as an unrealized
non-credit OTTI in the Consolidated Statements of Comprehensive
Income.
When assessing our intent to sell a debt security and if it is
more likely than not we will be required to sell a debt security
before recovery of our cost basis, facts and circumstances such
as, but not limited to, decisions to reposition our security
portfolio, sale of securities to meet cash flow needs and sales
of securities to capitalize on favorable pricing, are evaluated.
In order to determine the amount of the credit loss for a debt
security, we calculate the recovery value by performing a
discounted cash flow analysis based on the current cash flows
and future cash flows expected to be recovered. The discount
rate is the effective interest rate implicit in the underlying
debt security upon issuance. The effective interest rate is the
original yield or the coupon if the debt security was previously
impaired. If an OTTI exists and there is not sufficient cash
flows or other information to determine a recovery value of the
security, we conclude that the entire OTTI is credit-related and
the amortized cost for the security is written down to current
fair value with a corresponding charge to realized loss in the
Consolidated Statements of Income.
To determine the recovery period of a debt security, we consider
the facts and circumstances surrounding the underlying issuer
including, but not limited to the following:
|
|
|
|
|
Historical and implied volatility of the security;
|
|
|
|
Length of time and extent to which the fair value has been less
than amortized cost;
|
|
|
|
Conditions specifically related to the security such as default
rates, loss severities, loan to value ratios, current levels of
subordination, third party guarantees, and vintage;
|
|
|
|
Specific conditions in an industry or geographic area;
|
|
|
|
Any changes to the rating of the security by a rating agency;
|
48
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
|
|
Failure, if any, of the issuer of the security to make scheduled
payments; and
|
|
|
|
Recoveries or additional declines in fair value subsequent to
the balance sheet date.
|
In periods subsequent to the recognition of an OTTI, the
security is accounted for as if it had been purchased on the
measurement date of the OTTI. Therefore, for a fixed maturity
security, the discount or reduced premium is reflected in net
investment income over the contractual term of the investment in
a manner that produces a constant effective yield.
For an equity security, if we do not have the ability and intent
to hold the security for a sufficient period of time to allow
for a recovery in value, we conclude that an OTTI has occurred,
and the cost of the equity security is written down to the
current fair value, with a corresponding charge to realized loss
within the Consolidated Statements of Income. When assessing our
ability and intent to hold the equity security to recovery, we
consider, among other things, the severity and duration of the
decline in fair value of the equity security, as well as the
cause of decline, a fundamental analysis of the liquidity,
business prospects and overall financial condition of the issuer.
Revenue
Recognition
We account for our reinsurance and insurance products in
accordance with Accounting Standards Codification
(ASC) 944 Financial
Services Insurance.
Premiums written, which include direct, assumed, and ceded
premiums are recognized as earned on a pro rata basis over the
life of the policy term. Unearned premiums represent the portion
of premiums written that are applicable to the unexpired terms
of policies in force. Provisions for unearned premiums on
reinsurance assumed from others are made on the basis of ceding
reports when received and actuarial estimates.
Assumed premium estimates are specifically related to the
mandatory assumed pool business from the NCCI, or residual
market business. The pools cede workers compensation
business to participating companies based upon the individual
companys market share by state. The activity is reported
from the NCCI to participating companies on a two quarter lag.
To accommodate this lag, we estimate premium and loss activity
based on historical and market based results. Historically, we
have not experienced any material difficulties or disputes in
collecting balances from NCCI; and therefore, no provision for
doubtful accounts is recorded related to the assumed premium
estimate.
Fee income, which includes risk management consulting, loss
control, and claims services, is recognized during the period
the services are provided. Depending on the terms of the
contract, claims processing fees are recognized as revenue over
the estimated life of the claims, or the estimated life of the
contract. For those contracts that provide services beyond the
expiration or termination of the contract, fees are deferred in
an amount equal to managements estimate of our obligation
to continue to provide services in the future.
Commission income, which includes reinsurance placement, is
recorded on the later of the effective date or the billing date
of the policies on which they were earned. Commission income is
reported net of any
sub-producer
commission expense. Any commission adjustments that occur
subsequent to the earnings process are recognized upon
notification from the insurance companies. Profit sharing
commissions from insurance companies are recognized when
determinable, which is when such commissions are received.
We review, on an ongoing basis, the collectibility of our
receivables and establish an allowance for estimated
uncollectible accounts. As of December 31, 2009 and 2008,
the allowance for uncollectibles on receivables was
$3.4 million and $2.9 million, respectively.
49
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Equity
Earnings of Affiliates
Equity earnings represent investments in affiliates in which we
do not exercise control and have a 20% or more voting interest.
Such investments in affiliates are accounted for using the
equity method of accounting. We have an equity interest in one
affiliate, and the equity earnings of this interest were
recorded in net income. Equity earnings, net of tax, for 2009
were $874,000. We had no equity earnings related to this
affiliate for 2008 and 2007. We did not receive any dividends
from this affiliate in 2009.
Additionally, we are recording the equity earnings in this
affiliate based on a month lag due to timing differences in
respect to the availability of information, as permissible under
FASB ASC
323-10-35-6,
Investments Equity Method and Joint
Ventures Subsequent Measurement.
Legal
Contingencies
We are subject at times to various claims, lawsuits and
proceedings relating principally to alleged errors or omissions
in the placement of insurance, claims administration, consulting
services and other business transactions arising in the ordinary
course of business. Where appropriate, we vigorously defend such
claims, lawsuits and proceedings. Some of these claims, lawsuits
and proceedings seek damages, including consequential, exemplary
or punitive damages, in amounts that could, if awarded, be
significant. Most of the claims, lawsuits and proceedings
arising in the ordinary course of business are covered by the
policy at issue, errors and omissions insurance or other
appropriate insurance. In terms of deductibles associated with
such insurance, we have established provisions against these
items, which are believed to be adequate in light of current
information and legal advice. In accordance with accounting
guidance, if it is probable that an asset has been impaired or a
liability has been incurred as of the date of the financial
statements and the amount of loss is estimable; an accrual is
provided for the costs to resolve these claims in our
consolidated accompanying financial statements. Period expenses
related to the defense of such claims are included in other
operating expenses in the accompanying consolidated statements
of income. We, with the assistance of outside counsel, adjust
such provisions according to new developments or changes in the
strategy in dealing with such matters. On the basis of current
information, we do not expect the outcome of the claims,
lawsuits and proceedings to which we are subject to, either
individually, or in the aggregate, will have a material adverse
effect on our financial condition. However, it is possible that
future results of operations or cash flows for any particular
quarter or annual period could be materially affected by an
unfavorable resolution of any such matters.
Goodwill
We evaluate existing goodwill for impairment on an annual basis
as of October 1st, or more frequently if events or changes
in circumstances indicate that the asset might be impaired.
Goodwill impairment is performed at the reporting unit level. To
test goodwill for impairment, we are required to estimate the
fair value of each reporting unit. Since quoted market prices in
an active market are not available for our reporting units,
other valuation techniques are used. We have developed a model
to estimate the fair value of our reporting units utilizing a
discounted cash flow valuation technique (DCF
model). A DCF model is selected to be comparable to what
would be used by market participants to estimate fair value. The
impairment test incorporates estimates of future cash flows;
allocations of certain assets, liabilities and cash flows among
reporting units; future growth rates; terminal value amounts;
and the applicable weighted-average cost of capital used to
discount those estimated cash flows. These estimates are based
on managements judgment. The estimates and projections
used in the estimate of fair value are consistent with our
forecast and long-range plans.
In accordance with accounting guidance, we concluded our
reporting units to be agency operations and specialty insurance
operations. The nature of the business and economic
characteristics of all agency operations and all specialty
insurance operations are similar based upon, but not limited to,
the following; (1) management alignment within each
reporting unit, (2) our Insurance Company Subsidiaries
operate under a
50
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
reinsurance pooling arrangement, and (3) our ability to
leverage our expertise and fixed costs within each reporting
unit.
Deferred
Policy Acquisition Costs
Commissions and other costs of acquiring insurance business that
vary with and are primarily related to the production of new and
renewal business are deferred and amortized over the terms of
the policies or reinsurance treaties to which they relate.
Investment earnings are anticipated in determining the
recoverability of such deferred amounts. We reduce these costs
for premium deficiencies. There were no premium deficiencies for
the years ended December 31, 2009, 2008 and 2007.
Federal
Income Taxes
We provide for federal income taxes based on amounts we believe
we ultimately will owe. Inherent in the provision for federal
income taxes are estimates regarding the deductibility of
certain items and the realization of certain tax credits. In the
event the ultimate deductibility of certain items or the
realization of certain tax credits differs from estimates, we
may be required to significantly change the provision for
federal income taxes recorded in the consolidated financial
statements. Any such change could significantly affect the
amounts reported in the consolidated statements of income.
We utilize the asset and liability method of accounting for
income tax. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Valuation
allowances are established when necessary to reduce the deferred
tax assets to the amounts more likely than not to be realized.
Results
of Operations
Executive
Overview
Our results for the full year 2009 include the positive impact
from continued selective growth, coupled with our adherence to
strict corporate underwriting guidelines, as well as a focus on
current accident year price adequacy, and the benefits derived
from leveraging our fixed costs. Our generally accepted
accounting principles (GAAP) combined ratio improved
0.7 percentage points to 92.6% for the year ended
December 31, 2009, from 93.3% in 2008. Net operating
income, excluding amortization, increased 31.4% to
$59.3 million, compared to $45.1 million in 2008.
Our 2009 year to date results included a pre-tax loss of
$3.5 million related to impairment charges on our
investment portfolio. This is down from a pre-tax loss of
$11.7 million in 2008, which were also related to
impairment charges. In September 2008, at the height of the
economys financial crisis, we experienced losses primarily
in preferred stock investments in Fannie Mae, Freddie Mac,
Lehman Brothers, and GMAC. Our exposure to unrealized losses and
other than temporarily impaired securities decreased during
2009, as the financial markets began to stabilize and improve.
The 2009 impairments primarily consisted of asset-backed
securities with rising default rates, declining prepayment
speeds, and increasing loss severity of collateral value. In
addition, this impairment charge also included a few corporate
securities where the issuer experienced deteriorating business
conditions and results, which put pressure on its valuation and,
to a lesser extent, further deterioration in preferred stock
securities.
Offsetting the impairment charges in 2009, were pre-tax realized
gains of $3.6 million that we recognized in the fourth
quarter of 2009 from the sale of certain securities which were
sold for tax planning purposes.
51
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Our investment portfolio as of December 31, 2009, includes
pre-tax net unrealized gains of $44.5 million, or a $0.80
book value per share, compared to pre-tax net unrealized gains
of $3.8 million in 2008, or a $0.07 book value per share.
After-tax net unrealized gains were $28.9 million, or a
$0.52 book value per share, compared to after-tax net unrealized
gains of $2.5 million, or a $0.04 book value per share in
2008. Our conservative investment philosophy, which focuses on a
high quality, short duration investments with both
diversifications in specific securities, as well as investment
sectors, has minimized our asset risk in relation to our GAAP
equity.
Gross written premium increased $231.0 million, or 50.5%,
to $688.7 million, compared to $457.7 million in 2008.
Included in this increase was $139.7 million in gross
written premiums related to our Century Surety Company
(Century) operations. In addition, this increase
includes $92.2 million in gross written premiums related to
our new relationship with a program agent who specializes in
non-contractors workers compensation in the Midwest,
California, and other western states, as well as new programs
which include a general agent that focuses on the food services
industry and a general agent who focuses on heterogeneous
workers compensation in the Southeast region of the United
States. The increase is also a result of growth in new business
from programs implemented in 2008 and 2009. We anticipate
further growth during 2010 as the annualized premiums of these
programs continue to be realized. In addition, we continue to
experience selective growth within existing programs consistent
with our corporate underwriting guidelines and our controls over
price adequacy. While the level of rate decreases has slowed, we
have seen a continued competitive market. Along with the
recession, there has been downward pressure on revenue growth,
but a decrease in frequency of losses has helped to support
underwriting profitability.
With 2009 as our first full year of operations after the merger
with ProCentury, we continue to see opportunities emerge as we
use our admitted market capabilities to expand our footprint
with Centurys wholesale agents in areas including marine,
garage, and workers compensation, and as we roll out
surplus lines products through an existing agent in markets not
previously serviced by ProCentury, and as we continue to
leverage costs by creating economies of scale for purchasing
reinsurance and managing the back office operations.
By utilizing the capabilities of our combined company, we have
also begun underwriting environmental related risks.
Centurys environmental expertise has now been combined
with the existing workers compensation and automobile
liability platform to provide an integrated program for
environmental risks. The standard surety operation for Century
is now being marketed as Star Surety to take advantage of the
higher treasury listing and broader licensing and filing
capabilities of Star. The combined platform has expanded agent
relationships and rounded out agency relationship needs, which
should grow both our programs and products.
In July 2009, our subsidiary, Star, purchased a 28.5% ownership
interest in an insurance holding limited liability company for
$14.8 million in cash. This ownership interest is
significant, but is less than a majority ownership and,
therefore, is accounted for under the equity method of
accounting. Star, therefore, will recognize 28.5% of the profits
and losses as a result of this equity interest ownership.
On June 24, 2009, we announced the affirmation of
A.M. Best Companys financial strength rating of
A− (Excellent) for our Insurance Company
Subsidiaries.
2009
compared to 2008:
Net income for the year ended December 31, 2009, increased
92.2%, or $25.3 million to $52.7 million, or $0.92 per
dilutive share, compared to net income of $27.4 million, or
$0.61 per dilutive share, for the comparable period of 2008. Net
operating income, a non-GAAP measure, increased
$14.7 million, or 37.9%, to $53.5 million, or $0.93
per dilutive share, compared to net operating income of
$38.8 million, or $0.86 per dilutive share for the
comparable period in 2008, with lower weighted average shares
outstanding. Total diluted weighted average shares outstanding
for the year ended December 31, 2009 were 57,413,391,
52
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
compared to 44,995,712 for the comparable period in 2008. This
increase in the weighted average shares is primarily the result
of the equity issued in connection with the ProCentury merger.
Net income for the year ended December 31, 2009, included
net after-tax realized losses of $865,000, or $0.01 per diluted
share, which consisted of other than temporary impairments
primarily related to certain asset-backed securities, corporate
bonds, and preferred stocks, which were primarily offset by the
previously mentioned realized gains recognized in the fourth
quarter of 2009 for tax planning purposes. The net after-tax
realized losses of $865,000, or $0.01 per diluted share,
compares to after-tax realized losses of $11.4 million, or
$0.25 per diluted share in 2008. Net investment income increased
37.5% to $50.4 million, primarily related to the increase
in invested assets as a result of the ProCentury merger.
Overall, we continue to see favorable prior accident year
reserve development, as well as selective growth consistent with
our corporate underwriting guidelines and our controls over
price adequacy. Net income for the year ended December 31,
2008, included after tax catastrophe losses of $5.4 million
related to Hurricanes Gustav and Ike. The favorable improvement
within net income was slightly offset by lower net commission
and fee revenue.
Revenues for the year ended December 31, 2009, increased
$189.8 million, or 43.3%, to $627.6 million, from
$437.8 million for the comparable period in 2008. This
increase reflects a $169.9 million increase in net earned
premiums, of which $114.2 million related to our Century
operations. Excluding the net earned premiums related to our
Century operations, the increase of $55.7 million was
primarily the result of overall growth within our existing
programs and new business we implemented in 2008 and 2009. Our
overall net commission and fees were down 11.7%, or
$5.0 million, as further explained below. In addition, the
revenues reflect a $13.7 million increase in investment
income, which primarily reflects the increase in invested assets
as a result of the ProCentury merger, as well as continued
positive cash flow from operations.
For the year ended December 31, 2009, we recorded pre-tax
and after-tax equity earnings of $1.3 million, or $0.02 per
share and $874,000, or $0.015 per share respectively. The equity
earnings relate to our share of earnings relating to our 28.5%
ownership interest in an insurance holding limited liability
company, as described above.
2008
compared to 2007:
Net income for the year ended December 31, 2008, was
$27.4 million, or $0.61 per dilutive share, compared to net
income of $28.0 million, or $0.85 per dilutive share, for
the comparable period of 2007. Net operating income, a non-GAAP
measure, increased $10.9 million, or 39.2%, to
$38.8 million, or $0.86 per dilutive share, compared to net
operating income of $27.9 million, or $0.84 per dilutive
share for the comparable period in 2007, with lower weighted
average shares outstanding. Total weighted average shares
outstanding for the year ended December 31, 2008 were
44,995,712, compared to 33,101,965 for the comparable period in
2007. This increase in the weighted average shares was primarily
the result of the equity issued in connection with the
ProCentury merger, as well as a full year impact of the shares
issued in July 2007 related to our capital raise.
Net income for the year ended December 31, 2008, was
negatively impacted by after-tax realized losses of
$11.4 million, or $0.25 per diluted share, primarily as a
result of the other than temporary impairments in certain
preferred stock investments, which primarily related to Freddie
Mac, Fannie Mae, and Lehman Brothers investments, but also
included several corporate bonds and asset-backed and
mortgage-backed securities. In addition, net income for the year
included the after-tax impact of catastrophe losses related to
Hurricanes Gustav and Ike of $5.4 million, or $0.12 per
diluted share. In addition, net income included amortization
expense of $6.3 million, compared to $1.9 million in
2007. We experienced improvements in our expense ratio as we
continued to benefit from the elimination of the fronting fees
associated with our prior use of an unaffiliated insurance
carriers A rated policy forms. Our expense
ratio also benefited by our ability to further leverage fixed
costs in the management company. In addition, net investment
income increased 38.7% to $36.6 million. Somewhat
offsetting the positive variables was a substantial increase in
amortization expense
53
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
related to the acquisition of the USSU business in 2007. In
addition, amortization expense increased due to the other
intangibles acquired in the ProCentury merger.
Revenues increased $97.1 million, or 28.5%, to
$437.8 million for the year ended December 31, 2008,
from $340.7 million for the comparable period in 2007. This
increase reflected a $101.5 million increase in net earned
premiums, of which $80.6 million related to ProCentury.
Excluding the net earned premiums related to ProCentury, the
increase was primarily the result of overall growth within our
existing programs and new business we began underwriting in 2007
and 2008. Our overall net commissions and fees were down 6.7%,
or $3.1 million. This decrease was primarily the result of
a decrease in fees related to our New England-based programs,
caused by a decrease in premium volume due to reduced rates in
the self-insured markets on which the fees are based, due to
mandatory rate reductions and an increase in competition. In
addition, this decrease reflected slightly lower agency
commission revenue, which resulted from more competitive pricing
in certain jurisdictions. In 2008, we converted a portion of the
policies produced by USSU to our Insurance Company Subsidiaries.
The intercompany management fees associated with that portion of
the underwritten policies of the USSU business that we brought
in house were $2.2 million for the year ended
December 31, 2008. These fees are now eliminated upon
consolidation, thereby lowering net commissions and fees, but
not impacting overall consolidated results.
In addition, the revenues reflected a $10.2 million
increase in investment income, which primarily reflected the
increase in invested assets acquired in the ProCentury merger.
The remaining increase in investment income was partially the
result of overall positive cash flow and the net proceeds
received from our equity offering in July 2007. Slightly
offsetting the increases was the $11.4 million in realized
losses, primarily related to the other than temporary
impairments recorded in the last half of 2008, as previously
indicated.
Specialty
Insurance Operations
The following table sets forth the revenues and results from
operations for our specialty insurance operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
539,602
|
|
|
$
|
369,721
|
|
|
$
|
268,197
|
|
Management fees
|
|
|
18,901
|
|
|
|
21,168
|
|
|
|
23,963
|
|
Claims fees
|
|
|
7,428
|
|
|
|
8,879
|
|
|
|
9,025
|
|
Loss control fees
|
|
|
1,975
|
|
|
|
2,069
|
|
|
|
2,151
|
|
Reinsurance placement
|
|
|
931
|
|
|
|
728
|
|
|
|
929
|
|
Investment income
|
|
|
49,910
|
|
|
|
35,888
|
|
|
|
25,487
|
|
Net realized (losses) gains
|
|
|
(225
|
)
|
|
|
(11,422
|
)
|
|
|
150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
618,522
|
|
|
$
|
427,031
|
|
|
$
|
329,902
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty insurance operations
|
|
$
|
97,346
|
|
|
$
|
60,125
|
|
|
$
|
47,898
|
|
2009
compared to 2008:
Revenues from specialty insurance operations increased
$191.5 million, or 44.8%, to $618.5 million for the
year ended December 31, 2009 from $427.0 million for
the comparable period in 2008.
54
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Net earned premiums increased $169.9 million, or 45.9%, to
$539.6 million for the year ended December 31, 2009,
from $369.7 million in the comparable period in 2008. This
increase was the result of $114.2 million in net earned
premiums related to our Century operations. The remaining
increase of $55.7 million was primarily the result of
growth within our existing programs and the new business we
implemented in 2008 and 2009.
Management fees decreased $2.3 million, or 10.7%, to
$18.9 million for the year ended December 31, 2009,
from $21.2 million for the comparable period in 2008. This
decrease primarily relates to two programs we previously managed
where the client is now performing their own policy
administration services. This decrease is also due to an overall
decrease in fees within our specialty program manager
subsidiary, primarily as a result of competitive pricing
pressures. In addition, this decrease was the result of a
decrease in fees in our New England-based self-insured programs,
caused by a decrease in premium volume from continued
competition and poor economic conditions.
Claim fees decreased $1.5 million, or 16.3%, to
$7.4 million for the year ended December 31, 2009,
from $8.9 million for the comparable period in 2008. This
decrease primarily relates to a program we previously managed
where the client is now performing their own claim
administrative services. In addition, this decrease is related
to the loss of a specific workers compensation program and
is also related to lower premium volumes related to self-insured
programs, which is the basis for the fee revenue.
Net investment income increased $14.0 million, or 39.1%, to
$49.9 million for the year ended December 31, 2009,
from $35.9 million for the comparable period in 2008. This
increase is primarily the result of $12.7 million in net
investment income related to ProCentury. Overall, invested
assets increased due to the inclusion of ProCenturys
invested assets from the Merger of approximately
$425.1 million at July 31, 2008, coupled with the
investing of positive cash flows from operations. Total cash
flows from operations as of December 31, 2009 were
$127.7 million, compared to $93.9 million in 2008. The
positive cash flows from operations were primarily due to
favorable underwriting results. The average investment yield for
December 31, 2009 was 4.40%, compared to 4.22% in 2008. The
current pre-tax book yield was 4.44%. The current after-tax book
yield was 3.36%, compared to 3.32% in 2008. The duration of the
investment portfolio is 4.4 years at December 31,
2009, compared to 4.5 years at December 31, 2008.
Specialty insurance operations generated pre-tax income of
$97.3 million for the year ended December 31, 2009,
compared to pre-tax income of $60.1 million for the
comparable period in 2008. This increase in pre-tax income
demonstrates a continued improvement in underwriting results
including favorable reserve development on prior accident years,
selective growth in premium, adherence to our strict
underwriting guidelines, and our overall leveraging of fixed
costs. This improvement was also attributable to an increase in
net investment income. In addition, this improvement was
attributable to an increase of $11.2 million related to
realized gains and losses. Pre-tax realized losses for the year
ended December 31, 2009 were $225,000, compared to a
pre-tax loss of $11.4 million for the comparable period in
2008. The realized losses recognized in the year related to
impairment charges related to specific securities as previously
mentioned, offset by realized gains from sales of certain
securities for tax planning purposes. The realized loss in 2008
related to the other than temporary impairments recognized in
the fourth quarter of 2008, which related to securities within
the investment portfolio acquired with the ProCentury merger.
The GAAP combined ratio was 92.6% for the year ended
December 31, 2009, compared to 93.3% for the same period in
2008.
Net loss and loss adjustment expenses (LAE)
increased $94.2 million, or 44.3%, to $307.1 million
for the year ended December 31, 2009, from
$212.9 million for the same period in 2008. Our loss and
LAE ratio decreased 1.3 percentage points to 60.7% for the
year ended December 31, 2009, from 62.0% for the same
period in 2008. This ratio is the unconsolidated net loss and
LAE in relation to net earned premiums. Our accident year loss
ratio, which is a non-GAAP measure, was 66.0% in 2009, compared
to 66.5% in 2008. An accident year loss ratio measures losses
and LAE occurring in a particular year, regardless of when they
are reported and does not take into consideration changes in
estimates in loss reserves from prior accident years.
55
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Our 2009 accident year loss ratio is a good means of comparison
to historical trends and current industry estimates. We continue
to see favorable development primarily resulting from within our
general liability line of business due to lower frequency and
severity and better than expected incurred and paid claims
results. To a lesser extent, we continue to experience favorable
development in workers compensation, auto liability, and
professional liability, slightly offset by unfavorable
development in our excess liability line of business. In
addition, we revised our estimated claims handling costs through
a comprehensive actual costs study, which increased favorable
development within our unallocated loss adjustment expense
reserve. Our results in 2008 included after-tax catastrophe
losses of $5.4 million related to Hurricanes Gustav and
Ike. Additional discussion of our reserve activity is described
below within the Other Items Reserves section.
Our expense ratio was 31.9% for the year ended December 31,
2009, compared to 31.3% for the same period in 2008. This ratio
is the unconsolidated policy acquisition and other underwriting
expenses in relation to net earned premiums. Our overall
leveraging of fixed costs has been somewhat offset by the higher
level of internal costs and reductions in ceding commission,
primarily related to a reduction in risk-sharing partner
participation and a reduction in the ceding commission rate
within one particular line of business on a specific program. In
addition, the overall proportion of risk sharing programs in
relation to our overall book of business has decreased as a
result of the ProCentury merger. In addition, higher average
direct commission rates associated with Centurys business
also contributed to the increase in the expense ratio, which
includes twelve months of these costs for 2009 and only five
months in 2008. The higher commissions were slightly offset by
lower insurance related assessments. As a surplus lines carrier,
Century is not subject to premium taxes on its non-admitted
business.
2008
compared to 2007:
Revenues from specialty insurance operations increased
$97.1 million, or 29.4%, to $427.0 million for the
year ended December 31, 2008, from $329.9 million for
the comparable period in 2007.
Net earned premiums increased $101.5 million, or 37.8%, to
$369.7 million for the year ended December 31, 2008,
from $268.2 million in the comparable period in 2007. This
increase was primarily the result of $79.3 million in net
earned premiums related to ProCentury. Excluding the net earned
premiums related to ProCentury, net earned premiums increased
$22.2 million, or 8.3%. This increase was primarily the
result of overall growth within our existing programs and the
new business we began writing in 2007 and 2008, as well as
additional selective growth consistent with our corporate
underwriting guidelines.
Management fees decreased $2.8 million, or 11.7%, to
$21.2 million for the year ended December 31, 2008,
from $24.0 million in the comparable period in 2007. This
decrease was primarily the result of a decrease in fees related
to our New England-based programs, primarily caused by a
decrease in premium volume due to reduced rates in the
self-insured markets on which the fees are based, due to
mandatory rate reductions and an increase in competition.
Claim fees remained relatively flat for 2008 compared to 2007.
Net investment income increased $10.4 million, or 40.8%, to
$35.9 million in 2008, from $25.5 million in 2007.
This increase was primarily the result of $8.7 million in
net investment income related to ProCentury. Overall, invested
assets increased due to the inclusion of ProCenturys
invested assets, which were $434.3 million at
December 31, 2008, coupled with the investing from positive
cash flows from operations. The positive cash flows from
operations were due to favorable underwriting results, increased
fee revenue, and the lengthening of the duration of our
reserves. The increase in the duration of our reserves reflected
the impact of growth in our excess liability business, which was
implemented at the end of 2003. This type of business has a
longer duration than the average reserves on our other programs
and was a larger proportion of reserves. In addition, the
increase in average invested assets reflects cash flows from our
equity offering in July 2007. The average investment yield for
December 31, 2008 was 4.22%, compared to 4.6% in 2007. The
current pre-tax book yield was 4.4%. The current after-tax book
yield for the year ended December 31, 2008
56
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
was 3.3%, compared to 3.4% in 2007. The duration of the
investment portfolio was 4.5 years at December 31,
2008, compared to 4.3 years at December 31, 2007.
Specialty insurance operations generated pre-tax income of
$60.1 million for the year ended December 31, 2008,
compared to pre-tax income of $47.9 million for the
comparable period in 2007. This increase in pre-tax income
primarily demonstrated a continued improvement in underwriting
results including favorable reserve development on prior
accident years, selective growth in premium, adherence to our
strict underwriting guidelines, and our overall leveraging of
fixed costs. In addition, this improvement was attributable to
an increase in net investment income. Partially offsetting these
improvements were the previously mentioned other than temporary
impairments recognized in the investment portfolio in the last
half of the year, which primarily related to securities within
the investment portfolio acquired with the Merger. In addition,
these improvements were also partially offset by the impact of
the losses incurred with the two hurricanes, as mentioned above.
The GAAP combined ratio was 93.3% for the year ended
December 31, 2008, compared to 95.4% for the same period in
2007.
Net loss and loss adjustment expenses (LAE)
increased $61.9 million, or 41.0%, to $212.9 million
for the year ended December 31, 2008, from
$151.0 million for the same period in 2007. Our loss and
LAE ratio increased 0.8 percentage points to 62.0% in 2008,
from 61.2% for the same period in 2007. This ratio is the
unconsolidated net loss and LAE in relation to net earned
premiums. Net loss and LAE includes $49.2 million of net
loss and LAE expense related to ProCentury. In addition, the
loss and LAE ratio of 62.0% includes 2.3 percentage points
related to the previously mentioned catastrophe losses. The loss
and LAE ratio includes favorable development of
$16.8 million, or 4.5 percentage points, compared to
favorable development of $7.1 million, or
2.6 percentage points in 2007. The increase in our
favorable development in comparison to 2007 was primarily the
result of an increase in favorable development within our auto
liability and general liability lines of business due to lower
frequency and severity and better than expected claims results.
This was somewhat offset by an increase in adverse development
for an excess program.
Our expense ratio decreased 2.9 percentage points to 31.3%
for the year ended December 31, 2008, from 34.2% for the
same period in 2007. This ratio is the unconsolidated policy
acquisition and other underwriting expenses in relation to net
earned premiums. The decrease in our expense ratio reflects the
anticipated decrease in commission due to the elimination of the
fronting fees paid in 2007 to an unaffiliated insurance carrier
to use their A rated policy forms, which was
approximately 0.6 percentage points incurred in 2007,
compared to no costs in 2008. Despite a higher level of internal
fixed costs at ProCentury, we achieved a 0.5 percentage
point improvement on the expense ratio from leveraging the fixed
costs of the combined company. In addition, lower insurance
related assessments and a lower level of other underwriting
expenses, such as loss control and commissions relating to mix
of business also contributed to this improvement.
Agency
Operations
The following table sets forth the revenues and results from
operations from our agency operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
2009
|
|
2008
|
|
2007
|
|
Net commission
|
|
$
|
9,561
|
|
|
$
|
11,064
|
|
|
$
|
11,316
|
|
Pre-tax (loss) income(1)
|
|
$
|
(1,010
|
)
|
|
$
|
1,142
|
|
|
$
|
2,087
|
|
|
|
|
(1)
|
|
Our agency operations include an
allocation of corporate overhead, which includes expenses
associated with accounting, information services, legal, and
other corporate services. The corporate overhead allocation
excludes those expenses specific to the holding company. For the
years ended December 31, 2009, 2008, and 2007, the
allocation of corporate overhead to the agency operations
segment was $3.4 million, $2.8 million, and
$2.8 million, respectively.
|
57
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
2009
compared to 2008:
Revenue from agency operations, which consists primarily of
agency commission revenue, was $9.6 million for the year
ended December 31, 2009, compared to $11.1 million for
the comparable period in 2008. This decrease primarily reflects
regional competition, poor economic conditions, and a softer
insurance market within our mid to larger Michigan accounts and
isolated competitive pricing pressure in the California
automobile market. In addition, this decrease is partially
attributable to a $300,000 adjustment to reduce an agency
commission accrual.
Agency operations generated a pre-tax loss, after the allocation
of corporate overhead, of ($1.0) million for the year ended
December 31, 2009, compared to pre-tax income of
$1.1 million for the comparable period in 2008. The
decrease in the pre-tax income is primarily attributable to the
decrease in agency commission revenue mentioned above.
2008
compared to 2007:
Revenue from agency operations, which consists primarily of
agency commission revenue, decreased $252,000, or 2.2%, to
$11.1 million for the year ended December 31, 2008,
from $11.3 million for the comparable period in 2007. This
decrease primarily reflected regional competition and a softer
insurance market within our mid to larger Michigan accounts and
isolated competitive pricing pressure in the California
automobile market.
Agency operations generated pre-tax income, after the allocation
of corporate overhead, of $1.1 million for the year ended
December 31, 2008, compared to $2.1 million for the
comparable period in 2007. The decrease in the pre-tax income
was primarily attributable to the decrease in agency commission
revenue mentioned above.
Other
Items
Reserves
At December 31, 2009, our best estimate for the ultimate
liability for loss and LAE reserves, net of reinsurance
recoverables, was $682.4 million. We established a
reasonable range of reserves of approximately
$620.2 million to $724.2 million. This range was
established primarily by considering the various indications
derived from standard actuarial techniques and other appropriate
reserve considerations. The following table sets forth this
range by line of business (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum Reserve
|
|
|
Maximum Reserve
|
|
|
|
|
Line of Business
|
|
Range
|
|
|
Range
|
|
|
Selected Reserves
|
|
|
Workers Compensation(1)
|
|
$
|
194,753
|
|
|
$
|
215,606
|
|
|
$
|
207,636
|
|
Commercial Multiple Peril/General Liability
|
|
|
293,767
|
|
|
|
360,413
|
|
|
|
333,687
|
|
Commercial Automobile
|
|
|
98,676
|
|
|
|
110,660
|
|
|
|
105,469
|
|
Other
|
|
|
33,037
|
|
|
|
37,492
|
|
|
|
35,584
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Reserves
|
|
$
|
620,233
|
|
|
$
|
724,171
|
|
|
$
|
682,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes residual markets
|
Reserves are reviewed by our internal actuaries for adequacy on
a quarterly basis. When reviewing reserves, we analyze
historical data and estimate the impact of numerous factors such
as (1) per claim information; (2) industry and our
historical loss experience; (3) legislative enactments,
judicial decisions, legal
58
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
developments in the imposition of damages, and changes in
political attitudes; and (4) trends in general economic
conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of
current developments and anticipated trends, is an appropriate
basis for predicting future events. There is no precise method
for subsequently evaluating the impact of any specific factor on
the adequacy of reserves, because the eventual deficiency or
redundancy is affected by multiple factors.
The key assumptions used in our selection of ultimate reserves
included the underlying actuarial methodologies, a review of
current pricing and underwriting initiatives, an evaluation of
reinsurance costs and retention levels, and a detailed claims
analysis with an emphasis on how aggressive claims handling may
be impacting the paid and incurred loss data trends embedded in
the traditional actuarial methods. With respect to the ultimate
estimates for losses and LAE, the key assumptions remained
consistent for the years ended December 31, 2009 and 2008.
For the year ended December 31, 2009, we reported a
decrease in net ultimate loss estimates for accident years 2008
and prior of $28.7 million, or 4.6% of $625.3 million
of net loss and LAE reserves at December 31, 2008. The
decrease in net ultimate loss estimates reflected revisions in
the estimated reserves as a result of actual claims activity in
calendar year 2009 that differed from the projected activity.
There were no significant changes in the key assumptions
utilized in the analysis and calculations of our reserves during
2009 and 2008. The major components of this change in ultimate
loss estimates are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves at
|
|
|
Incurred Losses
|
|
|
Paid Losses
|
|
|
Reserves at
|
|
|
|
December 31,
|
|
|
Current
|
|
|
Prior
|
|
|
Total
|
|
|
Current
|
|
|
Prior
|
|
|
Total
|
|
|
December 31,
|
|
Line of Business
|
|
2008
|
|
|
Year
|
|
|
Years
|
|
|
Incurred
|
|
|
Year
|
|
|
Years
|
|
|
Paid
|
|
|
2009
|
|
|
Workers Compensation
|
|
$
|
147,813
|
|
|
$
|
104,259
|
|
|
$
|
(7,787
|
)
|
|
$
|
96,472
|
|
|
$
|
17,495
|
|
|
$
|
41,061
|
|
|
$
|
58,556
|
|
|
$
|
185,729
|
|
Residual Markets
|
|
|
23,984
|
|
|
|
6,588
|
|
|
|
(3,585
|
)
|
|
|
3,003
|
|
|
|
2,474
|
|
|
|
2,606
|
|
|
|
5,080
|
|
|
|
21,907
|
|
Commercial Multiple Peril/General Liability
|
|
|
317,188
|
|
|
|
101,992
|
|
|
|
(9,395
|
)
|
|
|
92,597
|
|
|
|
3,626
|
|
|
|
72,471
|
|
|
|
76,097
|
|
|
|
333,688
|
|
Commercial Automobile
|
|
|
92,788
|
|
|
|
66,080
|
|
|
|
(4,073
|
)
|
|
|
62,007
|
|
|
|
16,722
|
|
|
|
32,605
|
|
|
|
49,327
|
|
|
|
105,468
|
|
Other
|
|
|
43,558
|
|
|
|
56,838
|
|
|
|
(3,830
|
)
|
|
|
53,008
|
|
|
|
36,200
|
|
|
|
24,782
|
|
|
|
60,982
|
|
|
|
35,584
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Reserves
|
|
|
625,331
|
|
|
$
|
335,757
|
|
|
$
|
(28,670
|
)
|
|
$
|
307,087
|
|
|
$
|
76,517
|
|
|
$
|
173,525
|
|
|
$
|
250,042
|
|
|
|
682,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance Recoverable
|
|
|
260,366
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
266,801
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
885,697
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
949,177
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Re-estimated
|
|
|
Development
|
|
|
|
|
|
|
Reserves at
|
|
|
as a
|
|
|
|
Reserves at
|
|
|
December 31,
|
|
|
Percentage of
|
|
|
|
December 31,
|
|
|
2009
|
|
|
Prior Year
|
|
Line of Business
|
|
2008
|
|
|
on Prior Years
|
|
|
Reserves
|
|
|
Workers Compensation
|
|
$
|
147,813
|
|
|
$
|
140,026
|
|
|
|
(5.3
|
)%
|
Commercial Multiple Peril/General Liability
|
|
|
317,188
|
|
|
|
307,793
|
|
|
|
(3.0
|
)%
|
Commercial Automobile
|
|
|
92,788
|
|
|
|
88,715
|
|
|
|
(4.4
|
)%
|
Other
|
|
|
43,558
|
|
|
|
39,728
|
|
|
|
(8.8
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total
|
|
|
601,347
|
|
|
|
576,262
|
|
|
|
(4.2
|
)%
|
Residual Markets
|
|
|
23,984
|
|
|
|
20,399
|
|
|
|
(14.9
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Reserves
|
|
$
|
625,331
|
|
|
$
|
596,661
|
|
|
|
(4.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Workers
Compensation Excluding Residual Markets
The projected net ultimate loss estimate for the workers
compensation line of business excluding residual markets
decreased $7.8 million, or 5.3% of net workers
compensation reserves. This net overall decrease reflects
decreases of $2.6 million, $1.2 million, and
$3.3 million in accident years 2007, 2006, and 2005,
respectively. The decreases reflect better than expected
experience for many of our workers compensation programs,
including a Nevada, Florida, New England, and countrywide
workers compensation association program. Actual losses
reported were less than expected given the prior actuarial
assumptions. These decreases were offset by an increase of
$507,000 in the net ultimate loss estimate for accident year
2003. This increase in the net ultimate loss estimate for this
accident year was due to greater than expected claim emergence
in a Florida workers compensation program. The change in
ultimate loss estimates for all other accident years was
insignificant.
Commercial
Multiple Peril and General Liability
The commercial multiple peril line and general liability line of
business had a decrease in net ultimate loss estimates of
$9.4 million, or 3.0% of net commercial multiple peril and
general liability reserves. The net decrease reflects decreases
of $5.0 million, $6.8 million, $701,000 and
$1.5 million in the ultimate loss estimates for accident
years 2008, 2007, 2006 and 1994, respectively. The decreases
were due to better than expected claim emergence in general
liability business. These decreases were offset by increases in
the net ultimate loss estimates of $716,000, $1.8 million
and $1.4 million for accident years 2005, 2004 and 2003,
respectively. These increases were due to greater than expected
claim emergence in an excess liability program. The change in
ultimate loss estimates for all other accident years was
insignificant.
Commercial
Automobile
The projected net ultimate loss estimate for the commercial
automobile line of business decreased $4.1 million, or 4.4%
of net commercial automobile reserves. This net overall decrease
reflects decreases of $611,000, $2.9 million and $662,000
for accident years 2008, 2007 and 2005, respectively. The
decreases for these accident years were due to better than
expected claim emergence in two California-based programs and an
excess liability program. These decreases were offset by
increases of $635,000 and $629,000 in accident years 2006 and
2004, respectively. These increases were due to greater than
expected claim emergence in an excess liability program and a
garage program. The change in ultimate loss estimates for all
other accident years was insignificant.
Other
The projected net ultimate loss estimate for the other lines of
business decreased $3.8 million, or 8.8% of net reserves.
This net decrease reflects decreases of $860,000,
$1.3 million and $675,000 in the net ultimate loss estimate
for accident years 2008, 2007 and 2005, respectively. These
decreases were primarily due to better than expected case
reserve development during the calendar year in a professional
liability program. The change in ultimate loss estimates for all
other accident years was insignificant.
Residual
Markets
The workers compensation residual market line of business
had a decrease in net ultimate loss estimate of
$3.6 million, or 14.9% of net reserves. This decrease
reflects decreases of $2.4 million and $598,000 in accident
years 2008 and 2007, respectively. We record loss reserves as
reported by the National Council on Compensation Insurance
(NCCI), plus a provision for the reserves incurred
but not yet analyzed and reported to us due to a two quarter lag
in reporting. These changes reflect a difference between our
estimate of the lag incurred but not reported and the amounts
reported by the NCCI in the year. The change in ultimate loss
estimates for all other accident years was insignificant.
60
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Salaries
and Employee Benefits
Salaries and employee benefits increased $18.0 million, or
28.7%, to $80.9 million in 2009, from $62.9 million in
2008. This increase was primarily the result of the salary
expense related to our Century operations. This increase was
also the result of an increase in variable compensation, in
comparison to 2008, due to performance criteria established by
our Compensation Committee of the Board of Directors. The
increase in variable compensation was primarily attributable to
the inclusion of additional participants into the variable
compensation plans due to the ProCentury merger, as well as
overall improved financial results.
Salaries and employee benefits increased $6.4 million, or
11.4%, to $62.9 million in 2008, from $56.4 million in
2007. Included in the $62.9 million were salaries and
employee benefits related to ProCentury of $9.1 million.
Excluding the salaries and employee benefits related to
ProCentury, overall salaries and employee benefits would have
decreased $2.6 million. This decrease primarily reflected a
decrease in variable compensation. The decrease in variable
compensation, in comparison to 2007, reflected the increase in
our targeted measure for earning variable compensation. In
addition, this decrease was the result of a decrease in profit
sharing commissions. The decrease in profit sharing commissions
was the result of our purchase of an excess liability book of
business. As a result of us owning the book of business, we no
longer pay the profit sharing commissions.
Additional discussion of our variable compensation plan is
described below under Variable Compensation.
Other
Administrative Expenses
Other administrative expenses increased $4.4 million, or
12.6%, to $39.4 million in 2009, from $35.0 million in
2008. This increase was primarily the result of an overall
increase in administrative expenses related to our Century
operations, as well as an increase in expenses related to
technology initiatives. In addition, this increase was
attributable to an increase in holding company expenses,
primarily related to certain legal expenses and an increase in
director fees. Also, contributing to this increase was an
overall increase in bad debt expense specific to our Insurance
Company Subsidiaries, compared to the same period in 2008.
Partially offsetting this increase was a reduction in the
management fee previously associated with our acquisition of
USSU. In January 2008, we exercised our option to purchase the
remainder of the economics related to the acquisition of the
USSU business, by terminating the management agreement with the
former owners, thereby eliminating the management fee associated
with the Management Agreement.
Other administrative expenses increased $2.7 million, or
8.4%, to $35.0 million, from $32.3 million in 2007.
This increase was primarily the result of slight increases in
various general operating expenses, primarily due to the Merger
with ProCentury. Partially offsetting this increase was a
reduction in the management fee previously associated with our
acquisition of USSU, as described above.
Salaries and employee benefits and other administrative expenses
include both corporate overhead and the holding company expenses
included in the non-allocated expenses of our segment
information.
Amortization
Expense
Amortization expense for 2009, 2008, and 2007 was
$5.8 million, $6.3 million, and $1.9 million,
respectively. Amortization expense per dilutive share for 2009,
2008, and 2007 was $0.10, $0.14, and $0.06, respectively.
Amortization expense primarily relates to the other intangibles
related to our acquisition of the USSU business, a public entity
excess book of business, and the agent relationships and trade
names associated with the Merger.
61
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Interest
Expense
Interest expense for 2009, 2008, and 2007 was
$10.6 million, $7.7 million, and $6.0 million,
respectively. Interest expense is primarily attributable to our
debentures, which are described within the Liquidity and
Capital Resources section of Managements Discussion
and Analysis, as well as our line of credit and term loan. The
overall increase in 2009 compared to 2008, as well as 2008
compared to 2007, primarily relates to interest expense related
to the term loan we used to finance a portion of the purchase
price for the Merger. In addition, the increase in interest
expense was partially related to the interest attributable to
the trust preferred debt instruments as a result of the
ProCentury merger. The average interest rate for the year ended
December 31, 2009 was 7.07%, compared to 7.13% for the
comparable period in 2008. This slight decrease reflects the
impact of a lower cost of debt associated with the term loan,
which had an average interest rate of 5.95% in 2009. The 2008
interest primarily related to the debentures. The average
interest rate for the year ended December 31, 2008 was
7.13%, compared to 8.67% in 2007. This decrease reflects the
impact of a lower cost of debt associated with the term loan,
which had an average interest rate of 5.95% in 2008. The average
interest rate in 2007 was 8.67%, which primarily related to the
debentures.
Interest expense for 2007 includes interest related to a
temporary increase in our line of credit, which was associated
with borrowings to fund the cash portion of the USSU business
acquisition. Upon receipt of the net proceeds from our capital
raise in July 2007, we reduced this outstanding balance to zero.
Federal
Income Taxes
Federal income tax expense for 2009, 2008 and 2007, was
$20.9 million, $16.1 million, and $10.8 million,
or 28.8%, 37.3% and 28.1% of income before taxes, respectively.
The decrease in the effective tax rate from 2008 to 2009,
primarily relates to a decrease in our fee-based and
underwriting income as a percentage of pre-tax income. This
decrease was slightly offset by an increase in the valuation
allowance related to impairment charges. The effective tax rate
on operating income was 27.8% and 28.2% in 2009 and 2008,
respectively. Net operating income is net income less realized
gains (losses) net of taxes associated with such gains (losses).
While net operating income is a non-GAAP measure, management
believes it is beneficial in reviewing the financial statements.
The effective tax rate related to net investment income remained
relatively flat at 24.3% in comparison to 2008.
The increase in the effective tax rate from 2007 to 2008
reflects the impact of establishing a valuation allowance for
the previously mentioned other than temporary impairments.
Excluding, the impact of these impairments and the related tax
valuation, the effective tax rate would have been 30.2%. This
increase reflects the impact of a higher contribution of
underwriting income to pre-tax income and a lower contribution
of net investment income in 2008, compared to 2007. Investment
income represented 83.6% of pre-tax income for 2008, compared to
67.0% in 2007. This change in proportion reflects the improved
underwriting results in 2008, compared to 2007.
Other
Than Temporary Impairments
At December 31, 2009 and 2008, we had 127 and 365
securities that were in an unrealized loss position,
respectively. Of the securities held at December 31, 2009,
forty-one had an aggregate $30.0 million and
$2.3 million fair value and unrealized loss, respectively,
and have been in an unrealized loss position for more than
twelve months. At December 31, 2008, twenty three
securities had an aggregate $24.5 million and
$3.7 million fair value and unrealized loss, respectively,
and have been in an unrealized loss position for more than
twelve months.
After our review of our investment portfolio in relation to our
OTTI policy, the Company recorded an OTTI loss of
$5.2 million for the year ended December 31, 2009, of
which a non-credit related OTTI loss of
62
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
$1.7 million was recognized in other comprehensive income,
resulting in a credit related OTTI loss of $3.5 million.
For the year ended December 31, 2008, we recorded an OTTI
loss of $11.7 million.
For additional information regarding our investment and OTTI
policies refer to the Investment section within
Critical Accounting Policies of Managements
Discussion and Analysis. Refer to Note 3
Investments, for additional information specific to OTTI
and their fair value and amount of unrealized losses segregated
by the time period the investment has been in an unrealized loss
position.
Liquidity
and Capital Resources
Our principal sources of funds are insurance premiums,
investment income, proceeds from the maturity and sale of
invested assets from our Insurance Company Subsidiaries, and
risk management fees and agency commissions from our
non-regulated subsidiaries. Funds are primarily used for the
payment of claims, commissions, salaries and employee benefits,
other operating expenses, shareholder dividends, share
repurchases, and debt service.
A significant portion of our consolidated assets represents
assets of our Insurance Company Subsidiaries that may not be
transferable to the holding company in the form of dividends,
loans or advances. The restriction on the transferability to the
holding company from our Insurance Company Subsidiaries is
limited by regulatory guidelines. These guidelines generally
specify that dividends can be paid only from unassigned surplus
and only to the extent that all dividends in the current twelve
months do not exceed the greater of 10% of total statutory
surplus as of the end of the prior fiscal year or 100% of the
statutory net income for the prior year, less any dividends paid
in the prior twelve months. Using these criteria, the available
ordinary dividend available to be paid from the Insurance
Company Subsidiaries during 2009 is $39.5 million without
prior regulatory approval. In addition to ordinary dividends,
the Insurance Company Subsidiaries have the capacity to pay
$51.1 million of extraordinary dividends in 2009 subject to
prior regulatory approval. The Insurance Company
Subsidiaries ability to pay future dividends without
advance regulatory approval is dependent upon maintaining a
positive level of unassigned surplus, which in turn, is
dependent upon the Insurance Company Subsidiaries generating net
income. Total ordinary dividends paid from our Insurance Company
Subsidiaries to our holding company were $39.5 million and
$46.2 million in 2009 and 2008, respectively. We remain
well within our targets as they relate to our premium leverage
ratios, even taking into consideration the dividends paid by our
Insurance Company Subsidiaries. Our targets for gross and net
written premium to statutory surplus are 2.75 to 1.0 and 2.25 to
1.0, respectively. As of December 31, 2009, on a statutory
consolidated basis, the gross and net premium leverage ratios
were 2.0 to 1.0 and 1.6 to 1.0, respectively. The ordinary
dividends paid in 2009 and 2008 we funded from current financial
earnings.
We also generate operating cash flow from non-regulated
subsidiaries in the form of commission revenue, outside
management fees, and intercompany management fees. These sources
of income are used to meet debt service, shareholders
dividends, and other operating expenses of the holding company
and non-regulated subsidiaries. Earnings before interest, taxes,
depreciation, and amortization from non-regulated subsidiaries
were approximately $6.8 million for the year ended
December 31, 2009.
We have a line of credit totaling $35.0 million, which
there was no outstanding balance at December 31, 2009. The
undrawn portion of the revolving credit facility is available to
finance working capital and for general corporate purposes,
including but not limited to, surplus contributions to our
Insurance Company Subsidiaries to support premium growth or
strategic acquisitions.
Cash flow provided by operations was $127.7 million,
$93.9 million, and $88.6 million in 2009, 2008, and
2007, respectively. The increase in cash flow from operations
reflects growth in underwriting profits and growth in net
investment income, primarily as a result of the Merger. Our
strong operating cash flows are also the result of our ability
to match the duration of our invested assets and reserve
duration as it relates to our
63
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
incurred losses. We maintain a strong balance sheet with
geographic spread of risks, high quality reinsurance, and a high
quality investment portfolio.
Other
Items
Debentures
The following table summarizes the principal amounts and
variables associated with our debentures (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rate at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
Year of
|
|
|
|
Year
|
|
|
|
|
|
|
|
2009
|
|
Principal
|
|
Issuance
|
|
Description
|
|
Callable
|
|
|
Year Due
|
|
|
Interest Rate Terms
|
|
(1)
|
|
Amount
|
|
|
2003
|
|
Junior subordinated debentures
|
|
|
2008
|
|
|
|
2033
|
|
|
Three-month LIBOR, plus 4.05%
|
|
|
4.30
|
%
|
|
$
|
10,310
|
|
2004
|
|
Senior debentures
|
|
|
2009
|
|
|
|
2034
|
|
|
Three-month LIBOR, plus 4.00%
|
|
|
4.27
|
%
|
|
|
13,000
|
|
2004
|
|
Senior debentures
|
|
|
2009
|
|
|
|
2034
|
|
|
Three-month LIBOR, plus 4.20%
|
|
|
4.46
|
%
|
|
|
12,000
|
|
2005
|
|
Junior subordinated debentures
|
|
|
2010
|
|
|
|
2035
|
|
|
Three-month LIBOR, plus 3.58%
|
|
|
3.83
|
%
|
|
|
20,620
|
|
|
|
Junior subordinated debentures(2)
|
|
|
2007
|
|
|
|
2032
|
|
|
Three-month LIBOR, plus 4.00%
|
|
|
4.26
|
%
|
|
|
15,000
|
|
|
|
Junior subordinated debentures(2)
|
|
|
2008
|
|
|
|
2033
|
|
|
Three-month LIBOR, plus 4.10%
|
|
|
4.37
|
%
|
|
|
10,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
80,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The underlying three-month LIBOR
rate varies as a result of the interest rate reset dates used in
determining the three-month LIBOR rate, which varies for each
long-term debt item each quarter.
|
|
(2)
|
|
Represents the junior subordinated
debentures acquired in conjunction with the Merger.
|
Excluding the junior subordinated debentures acquired in
conjunction with the Merger, we received a total of
$53.3 million in net proceeds from the issuances of the
above long-term debt, of which $26.2 million was
contributed to the surplus of our Insurance Company Subsidiaries
and the remaining balance was used for general corporate
purposes. Associated with the issuance of the above long-term
debt we incurred approximately $1.7 million in issuance
costs for commissions paid to the placement agents in the
transactions.
The issuance costs associated with these debentures have been
capitalized and are included in other assets on the balance
sheet. As of June 30, 2007, these issuance costs were being
amortized over a seven year period as a component of interest
expense. The seven year amortization period represented
managements best estimate of the estimated useful life of
the bonds related to both the senior debentures and junior
subordinated debentures. Beginning July 1, 2007, we
reevaluated our best estimate and determined a five year
amortization period to be a more accurate representation of the
estimated useful life. Therefore, this change in amortization
period from seven years to five years has been applied
prospectively beginning July 1, 2007.
The junior subordinated debentures issued in 2003 and 2005, were
issued in conjunction with the issuance of $10.0 million
and $20.0 million in mandatory redeemable trust preferred
securities to a trust formed by an institutional investor from
our unconsolidated subsidiary trusts, respectively.
In relation to the junior subordinated debentures acquired in
conjunction with the Merger, we also acquired the remaining
unamortized portion of the capitalized issuance costs associated
with these debentures. The remaining unamortized portion of the
issuance costs we acquired was $625,000. These are included in
other assets on the balance sheet. The remaining balance is
being amortized over a five year period beginning August 1,
2008, as a component of interest expense.
64
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Interest
Rate Swaps
We have entered into interest rate swap transactions to mitigate
our interest rate risk on our existing debt obligations. These
interest rate swap transactions have been designated as cash
flow hedges and are deemed highly effective hedges. These
interest rate swap transactions are recorded at fair value on
the balance sheet and the effective portion of the changes in
fair value are accounted for within other comprehensive income.
The interest differential to be paid or received is accrued and
recognized as an adjustment to interest expense.
The following table summarizes the rates and amounts associated
with our interest rate swaps (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount at
|
|
|
|
|
Expiration
|
|
|
|
|
Counterparty
|
|
|
|
|
December 31,
|
|
Effective Date
|
|
|
Date
|
|
|
Debt Instrument
|
|
Interest Rate Terms
|
|
Fixed Rate
|
|
|
2009
|
|
|
|
10/6/2005
|
|
|
|
9/16/2010
|
|
|
Junior subordinated debentures
|
|
Three-month LIBOR, plus 3.58%
|
|
|
8.340
|
%
|
|
$
|
20,000
|
|
|
4/23/2008
|
|
|
|
5/24/2011
|
|
|
Senior debentures
|
|
Three-month LIBOR, plus 4.20%
|
|
|
7.720
|
%
|
|
|
7,000
|
|
|
4/23/2008
|
|
|
|
6/30/2013
|
|
|
Junior subordinated debentures
|
|
Three-month LIBOR, plus 4.05%
|
|
|
8.020
|
%
|
|
|
10,000
|
|
|
4/29/2008
|
|
|
|
4/29/2013
|
|
|
Senior debentures
|
|
Three-month LIBOR, plus 4.00%
|
|
|
7.940
|
%
|
|
|
13,000
|
|
|
7/31/2008
|
|
|
|
7/31/2013
|
|
|
Term loan(1)
|
|
Three-month LIBOR
|
|
|
3.950
|
%
|
|
|
49,875
|
|
|
8/15/2008
|
|
|
|
8/15/2013
|
|
|
Junior subordinated debentures(2)
|
|
Three-month LIBOR
|
|
|
3.780
|
%
|
|
|
10,000
|
|
|
9/4/2008
|
|
|
|
9/4/2013
|
|
|
Junior subordinated debentures(2)
|
|
Three-month LIBOR
|
|
|
3.790
|
%
|
|
|
15,000
|
|
|
|
|
(1)
|
|
Relates to our term loan, which has
an effective date of July 31, 2008 and an expiration date
of July 31, 2013. We are required to make fixed rate
interest payments on the current balance of the term loan,
amortizing in accordance with the term loan amortization
schedule. We fixed only the variable interest portion of the
loan. As of December 31, 2009, the actual interest payments
associated with the term loan also include an additional rate of
2.00% in accordance with the credit agreement.
|
|
(2)
|
|
Relates to the debentures acquired
from the ProCentury merger. We fixed only the variable interest
portion of the debt. The actual interest payments associated
with the debentures also include an additional rate of 4.10% and
4.00% on the $10.0 million and $15.0 million
debentures, respectively.
|
On May 24, 2009, the interest rate swap for the
$5.0 million portion of our $12.0 million senior
debenture expired. As of December 31, 2009, we did not
enter into another interest rate swap transaction for this
portion of our debt. Therefore, the associated interest expense
is no longer at a fixed amount and will fluctuate in accordance
with the debt terms, as described above.
In relation to the above interest rate swaps, the net interest
expense incurred for the year ended December 31, 2009 and
2008, was approximately $4.1 million and $763,000,
respectively. The net interest income received for the year
ended December 31, 2007, was approximately $172,000.
As of December 31, 2009 and December 31, 2008, the
total fair value of the interest rate swaps was approximately
($5.9 million) and ($8.9 million), respectively.
Accumulated other comprehensive income at December 31, 2009
and 2008, included accumulated loss on the cash flow hedge, net
of taxes, of approximately $3.9 million and
$5.8 million, respectively.
65
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Credit
Facilities
On July 31, 2008, we executed $100 million in senior
credit facilities (the Credit Facilities). The
Credit Facilities included a $65.0 million term loan
facility, which was fully funded upon the closing of our Merger
with ProCentury and a $35.0 million revolving credit
facility, which was partially funded upon closing of the Merger.
As of December 31, 2009, the outstanding balance on our
term loan facility was $49.9 million. We did not have an
outstanding balance on our revolving credit facility as of
December 31, 2009. The undrawn portion of the revolving
credit facility is available to finance working capital and for
general corporate purposes, including but not limited to,
surplus contributions to our Insurance Company Subsidiaries to
support premium growth or strategic acquisitions. At
December 31, 2008, we had an outstanding balance of
$60.3 million on our term loan and did not have an
outstanding balance on our revolving credit facility.
The principal amount outstanding under the Credit Facilities
provides for interest at LIBOR, plus the applicable margin, or
at our option, the base rate. The base rate is defined as the
higher of the lending banks prime rate or the Federal
Funds rate, plus 0.50%, plus the applicable margin. The
applicable margin is determined by the consolidated indebtedness
to consolidated total capital ratio. In addition, the Credit
Facilities provide for an unused facility fee ranging between
twenty basis points and forty basis points, based on our
consolidated leverage ratio as defined by the Credit Facilities.
At December 31, 2009, the interest rate on our term loan
was 5.95%, which consisted of a fixed rate of 3.95%, plus an
applicable margin of 2.00%.
The debt financial covenants applicable to the Credit Facilities
consist of: (1) minimum consolidated net worth starting at
eighty percent of pro forma consolidated net worth after giving
effect to the acquisition of ProCentury, with quarterly
increases thereafter, (2) minimum Risk Based Capital Ratio
for Star of 1.75 to 1.00, (3) maximum permitted
consolidated leverage ratio of 0.35 to 1.00, (4) minimum
consolidated debt service coverage ratio of 1.25 to 1.00, and
(5) minimum A.M. Best Company rating of
B++. As of December 31, 2009, we were in
compliance with these debt covenants.
Investment
Portfolio
As of December 31, 2009 and 2008, the recorded values of
our investment portfolio, including cash and cash equivalents,
were $1.2 billion and $1.1 billion, respectively.
In general, we believe our overall investment portfolio is
conservatively invested. The duration of the investment
portfolio at December 31, 2009 is 4.4 years, compared
to 4.5 years at December 31, 2008. Our pre-tax book
yield is 4.4%. The current after-tax yield is 3.4%, compared to
3.3% in 2008. Approximately 98.2% of our fixed income investment
portfolio is investment grade.
Shareholders
Equity
At December 31, 2009, shareholders equity was
$502.9 million, or a book value of $9.06 per common share,
compared to $438.2 million, or a book value of $7.64 per
common share, at December 31, 2008.
In July 2008, our Board of Directors authorized us to purchase
up to 3.0 million shares of our common stock in market
transactions for a period not to exceed twenty-four months. For
the year ended December 31, 2009, we purchased and retired
1.9 million shares of common stock for a total cost of
approximately $13.9 million. For the year ended
December 31, 2008, we purchased and retired
800,000 shares of common stock for a total cost of
approximately $4.9 million.
At our regularly scheduled board meeting on February 12,
2010, our Board of Directors authorized us to purchase up to
5.0 million shares of our common stock in market
transactions for a period not to exceed twenty-four months. This
share repurchase plan replaced the existing share repurchase
plan authorized in July 2008.
66
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
On February 13, 2009, our Board of Directors and the
Compensation Committee of the Board of Directors approved the
distribution of our LTIP award for the
2007-2008
plan years, which included both a cash and stock award. The
stock portion of the LTIP award was $1.6 million, which
resulted in the issuance of 161,686 shares of our common
stock. Of the 161,686 shares issued, 55,968 shares
were retired for payment of the participants associated
withholding taxes related to the compensation recognized by the
participant. Refer to Note 13 Variable
Compensation for further detail. The retirement of the
shares for the associated withholding taxes reduced our paid in
capital by approximately $329,000.
For the years ended December 31, 2009 and 2008, cash
dividends paid to common shareholders totaled $5.2 million
and $3.8 million, respectively. On February 12, 2010,
our Board of Directors declared a quarterly dividend of $0.03
per common share. The dividend is payable on April 5, 2010,
to shareholders of record as of March 19, 2010.
When evaluating the declaration of a dividend, our Board of
Directors considers a variety of factors, including but not
limited to, cash flow, liquidity needs, results of operations,
industry conditions, and our overall financial condition. As a
holding company, the ability to pay cash dividends is partially
dependent on dividends and other permitted payments from our
Insurance Company Subsidiaries.
ProCentury
Merger
Following the close of business on July 31, 2008, our
Merger with ProCentury was completed. In accordance with the
Merger Agreement, the stock price used in determining the final
cash and share consideration portion of the purchase price was
based on the volume-weighted average sales price of a share of
Meadowbrook common stock for the
30-day
trading period ending on the sixth trading day before the
completion of the Merger, or $5.7326. Based upon the final
proration, the total purchase price was $227.2 million, of
which $99.1 million consisted of cash, $122.7 million
in newly issued common stock, and approximately
$5.4 million in transaction related costs. The total number
of new common shares issued for purposes of the stock portion of
the purchase price was 21.1 million shares.
The Merger was accounted for under the purchase method of
accounting, which resulted in goodwill of $59.5 million
equaling the excess of the purchase price over the fair value of
identifiable assets, as of December 31, 2008. Goodwill is
not amortized, but is subject to at least annual impairment
testing. Identifiable intangibles, which are subject to
amortization, of $21.0 million and $5.0 million were
recorded related to agent relationships and trade names,
respectively.
Our allocation period for purchase accounting adjustments closed
in the third quarter of 2009. As a result of the purchase
accounting adjustments made in 2009, the final goodwill related
to the Merger was $59.3 million as of December 31,
2009.
Equity
Earnings of Affiliates
In July 2009, our subsidiary, Star, purchased a 28.5% ownership
interest in an insurance holding limited liability company. Our
ownership interest is significant, but is less than a majority
ownership and, therefore, is accounted for under the equity
method of accounting. Therefore, Star, recognized 28.5% of the
profits and losses as a result of this equity interest
ownership. For segment reporting purposes, the equity earnings
related to this investment is shown gross of tax. Equity
earnings of affiliates, relates to our proportionate share of
this investment, which we consider to be consistent with our
specialty insurance operations and, therefore, we have included
the respective equity earnings within the specialty insurance
operations segment.
67
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Adjusted
Expense Ratio
Included in our GAAP expense ratio is the impact of the margin
associated with our fee-based operations. If the profit margin
from our
fee-for-service
business is recognized as an offset to our underwriting expense,
a more realistic picture of our operating efficiency emerges.
The following table illustrates our adjusted expense ratio,
which reflects the GAAP expense ratio of our insurance company
subsidiaries, net of the pre-tax profit, excluding investment
income, of our
fee-for-service
and agency subsidiaries (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Net earned premiums
|
|
$
|
539,602
|
|
|
$
|
369,721
|
|
|
$
|
268,197
|
|
Less: Consolidated net loss and LAE
|
|
|
307,087
|
|
|
|
212,885
|
|
|
|
150,969
|
|
Intercompany claim fees
|
|
|
20,339
|
|
|
|
16,296
|
|
|
|
13,058
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated net loss and LAE
|
|
|
327,426
|
|
|
|
229,181
|
|
|
|
164,027
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated policy acquisition and other underwriting expenses
|
|
|
110,715
|
|
|
|
69,349
|
|
|
|
53,717
|
|
Intercompany administrative and other underwriting fees
|
|
|
61,422
|
|
|
|
46,371
|
|
|
|
37,890
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated policy acquisition and other underwriting expenses
|
|
|
172,137
|
|
|
|
115,720
|
|
|
|
91,607
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting income
|
|
$
|
40,039
|
|
|
$
|
24,820
|
|
|
$
|
12,563
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP combined ratio as reported
|
|
|
92.6
|
%
|
|
|
93.3
|
%
|
|
|
95.4
|
%
|
Specialty insurance operations pre-tax income
|
|
$
|
97,346
|
|
|
$
|
60,125
|
|
|
$
|
47,898
|
|
Less: Underwriting income
|
|
|
40,039
|
|
|
|
24,820
|
|
|
|
12,563
|
|
Net investment income and realized (losses) gains
|
|
|
50,141
|
|
|
|
25,202
|
|
|
|
26,550
|
|
Equity earnings of affiliates
|
|
|
1,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee-based operations pre-tax income
|
|
|
5,822
|
|
|
|
10,103
|
|
|
|
8,785
|
|
Agency operations pre-tax income
|
|
|
(1,010
|
)
|
|
|
1,142
|
|
|
|
2,087
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
fee-for-service
pre-tax income
|
|
$
|
4,812
|
|
|
$
|
11,245
|
|
|
$
|
10,872
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP expense ratio as reported
|
|
|
31.9
|
%
|
|
|
31.3
|
%
|
|
|
34.2
|
%
|
Adjustment to include pre-tax income from total
fee-for-service
income(1)
|
|
|
0.9
|
%
|
|
|
3.0
|
%
|
|
|
4.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP expense ratio as adjusted
|
|
|
31.0
|
%
|
|
|
28.3
|
%
|
|
|
30.1
|
%
|
GAAP loss and LAE ratio as reported
|
|
|
60.7
|
%
|
|
|
62.0
|
%
|
|
|
61.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP combined ratio as adjusted
|
|
|
91.7
|
%
|
|
|
90.3
|
%
|
|
|
91.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation of consolidated pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty insurance operations pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee-based operations pre-tax income
|
|
$
|
5,822
|
|
|
$
|
10,103
|
|
|
$
|
8,785
|
|
Underwriting income
|
|
|
40,039
|
|
|
|
24,820
|
|
|
|
12,563
|
|
Net investment income and realized (losses) gains
|
|
|
50,141
|
|
|
|
25,202
|
|
|
|
26,550
|
|
Equity earnings of affiliates
|
|
|
1,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total specialty insurance operations pre-tax income
|
|
|
97,346
|
|
|
|
60,125
|
|
|
|
47,898
|
|
Agency operations pre-tax income
|
|
|
(1,010
|
)
|
|
|
1,142
|
|
|
|
2,087
|
|
Less: Holding company expenses
|
|
|
5,506
|
|
|
|
3,481
|
|
|
|
2,638
|
|
Interest expense
|
|
|
10,596
|
|
|
|
7,681
|
|
|
|
6,030
|
|
Amortization expense
|
|
|
5,781
|
|
|
|
6,310
|
|
|
|
1,930
|
|
Equity earnings of affiliates
|
|
|
1,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated pre-tax income
|
|
$
|
73,109
|
|
|
$
|
43,795
|
|
|
$
|
39,387
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Adjustment to include pre-tax income from total
fee-for-service
income is calculated by dividing total
fee-for-service
income by net earned premiums. |
68
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Regulatory
A significant portion of our consolidated assets represents
assets of our Insurance Company Subsidiaries that may not be
transferable to the holding company in the form of dividends,
loans or advances. The restriction on the transferability to the
holding company from our Insurance Company Subsidiaries is
limited by regulatory guidelines. These guidelines generally
specify that dividends can be paid only from unassigned surplus
and only to the extent that all dividends in the current twelve
months do not exceed the greater of 10% of total statutory
surplus as of the end of the prior fiscal year or 100% of the
statutory net income for the prior year, less any dividends paid
in the prior twelve months. Using these criteria, the available
ordinary dividend available to be paid from the Insurance
Company Subsidiaries during 2009 is $39.5 million without
prior regulatory approval. In addition to ordinary dividends,
the Insurance Company Subsidiaries have the capacity to pay
$51.1 million of extraordinary dividends in 2009 subject to
prior regulatory approval. The Insurance Company
Subsidiaries ability to pay future dividends without
advance regulatory approval is dependent upon maintaining a
positive level of unassigned surplus, which in turn, is
dependent upon the Insurance Company Subsidiaries generating net
income. Total ordinary dividends paid from our Insurance Company
Subsidiaries to our holding company were $39.5 million and
$46.2 million in 2009 and 2008, respectively.
Our Insurance Company Subsidiaries are required to maintain
certain deposits with regulatory authorities, which totaled
$98.5 million and $100.9 million at December 31,
2009 and 2008, respectively.
69
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Contractual
Obligations and Commitments
The following table is a summary of our contractual obligations
and commitments as of December 31, 2009 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less Than
|
|
|
One to
|
|
|
Three to
|
|
|
More Than
|
|
|
|
Total
|
|
|
One Year
|
|
|
Three Years
|
|
|
Five Years
|
|
|
Five Years
|
|
|
Non-regulated companies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Term Loan
|
|
$
|
49,875
|
|
|
$
|
12,125
|
|
|
$
|
29,500
|
|
|
$
|
8,250
|
|
|
$
|
|
|
Lines of Credit(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debentures(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior debentures due 2034; issued $13.0 million
|
|
|
13,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,000
|
|
Senior debentures due 2034; issued $12.0 million
|
|
|
12,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,000
|
|
Junior subordinated debentures due 2035; issued
$20.6 million
|
|
|
20,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,620
|
|
Junior subordinated debentures due 2033; issued
$10.3 million
|
|
|
10,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,310
|
|
Junior subordinated debentures due 2032; issued
$15.0 million(3)
|
|
|
15,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15,000
|
|
Junior subordinated debentures due 2033; issued
$10.0 million(3)
|
|
|
10,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt
|
|
|
130,805
|
|
|
|
12,125
|
|
|
|
29,500
|
|
|
|
8,250
|
|
|
|
80,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest on Term Loan(4)
|
|
|
6,027
|
|
|
|
2,746
|
|
|
|
3,076
|
|
|
|
205
|
|
|
|
|
|
Interest on Debentures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior debentures due 2034; issued $13.0 million
|
|
|
7,224
|
|
|
|
1,032
|
|
|
|
2,064
|
|
|
|
2,064
|
|
|
|
2,064
|
|
Senior debentures due 2034; issued $12.0 million
|
|
|
5,344
|
|
|
|
763
|
|
|
|
1,527
|
|
|
|
1,527
|
|
|
|
1,527
|
|
Junior subordinated debentures due 2035; issued
$20.6 million
|
|
|
11,841
|
|
|
|
1,692
|
|
|
|
3,383
|
|
|
|
3,383
|
|
|
|
3,383
|
|
Junior subordinated debentures due 2033; issued
$10.3 million
|
|
|
5,708
|
|
|
|
815
|
|
|
|
1,631
|
|
|
|
1,631
|
|
|
|
1,631
|
|
Junior subordinated debentures due 2032; issued
$15.0 million(3)
|
|
|
8,180
|
|
|
|
1,169
|
|
|
|
2,337
|
|
|
|
2,337
|
|
|
|
2,337
|
|
Junior subordinated debentures due 2033; issued
$10.3 million(3)
|
|
|
5,516
|
|
|
|
788
|
|
|
|
1,576
|
|
|
|
1,576
|
|
|
|
1,576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest Payable
|
|
|
49,840
|
|
|
|
9,005
|
|
|
|
15,594
|
|
|
|
12,723
|
|
|
|
12,518
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease obligations(5)
|
|
|
13,198
|
|
|
|
4,134
|
|
|
|
6,467
|
|
|
|
2,597
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulated companies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses(6)
|
|
|
949,177
|
|
|
|
261,004
|
|
|
|
330,500
|
|
|
|
132,802
|
|
|
|
224,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,143,020
|
|
|
$
|
286,268
|
|
|
$
|
382,061
|
|
|
$
|
156,372
|
|
|
$
|
318,319
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Relates to our revolving line of credit, which currently does
not have an outstanding balance. |
|
(2) |
|
Five year call feature associated with debentures, estimated
seven year repayment. For a description of our debentures and
related interest rate terms, as well as actual rates in
accordance with our interest rate swap transactions, refer to
Note 8 Debt and Note 9
Derivative Instruments. |
70
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
(3) |
|
Relates to the junior subordinated debentures acquired in
conjunction with the ProCentury merger. |
|
(4) |
|
For a description of our term loan and its interest rate terms,
as well as actual rates in accordance with our interest rate
swap transaction, refer to Note 8 Debt
and Note 9 Derivative Instruments. |
|
(5) |
|
Consists of rental obligations under real estate leases related
to branch offices. In addition, includes amounts related to
equipment leases. |
|
(6) |
|
The loss and loss adjustment expense payments do not have
contractual maturity dates and the exact timing of payments
cannot be predicted with certainty. However, based upon
historical payment patterns, we have included an estimate of our
gross losses and loss adjustment expenses. In addition, we have
anticipated cash receipts on reinsurance recoverables on unpaid
losses and loss adjustment expenses of $266.8 million, of
which we estimate that these payments to be paid for losses and
loss adjustment expenses for the periods less than one year, one
to three years, three to five years, and more than five years to
be $49.9 million, $74.5 million, $36.2 million,
and $106.2 million, respectively, resulting in net losses
and loss adjustment expenses of $211.1 million,
$256.0 million, $96.6 million, and
$118.7 million, respectively. |
We maintain an investment portfolio with varying maturities that
we believe will provide adequate cash for the payment of claims.
Variable
Compensation
We have established two variable compensation plans as an
incentive for performance of our management team. They consist
of an Annual Bonus Plan (Bonus Plan) and a Long-Term
Incentive Plan (LTIP). The Bonus Plan is a
discretionary cash bonus plan premised upon a targeted growth in
net after-tax earnings on a year over year basis. Each year, the
Compensation Committee and our Board of Directors establish a
new target based upon prior year performance and the forecasted
performance levels anticipated for the following year. The
amount of the bonus pool is established by aggregating the
individual targets for each participant, which is a percentage
of salary. At the end of the year, the Compensation Committee
and the Board of Directors review our performance in relation to
performance targets and then establish the total bonus pool to
be utilized to pay cash bonuses to the management team based
upon overall corporate and individual participant goals.
The LTIP is intended to provide an incentive to management to
improve our performance over a three year period, thereby
increasing shareholder value. The LTIP is not discretionary and
is based upon a target for an average three year return on
beginning equity. If the targets are met and all other terms and
conditions are satisfied, the LTIP awards are paid. The LTIP is
paid 50% in cash and 50% in stock. A participants
percentage is established by the Compensation Committee and the
Board of Directors in advance of any new three year LTIP award.
The stock component of the LTIP is paid based upon the closing
stock price at the beginning of the three year LTIP performance
period, in accordance with the terms and conditions of the LTIP.
With the ProCentury merger our Compensation Committee and Board
of Directors determined that our opportunity for successfully
integrating the ProCentury merger would be heightened and
shareholder value increased, if all participants were in the
same equity-based plan beginning in 2009. As a result, our
Compensation Committee approved the termination of our current
2007-2009
LTIP effective December 31, 2008 and established a new plan
for
2009-2011
based on new performance targets. Based on this amendment, the
current LTIP participants would receive their award based on a
two-year performance period, rather than a three-year period.
Therefore, the total award would be approximately two-thirds of
the original three-year award. There were no accounting
adjustments as a result of the amendment as there were no
changes to the underlying plan, only an adjustment to the
performance period.
71
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Both the Bonus Plan and the LTIP are administered by the
Compensation Committee of the Board of Directors and all awards
are reviewed and approved by the Board of Directors at both
inception and at distribution.
Regulatory
and Rating Issues
The National Association of Insurance Commissioners
(NAIC) has adopted a risk-based capital
(RBC) formula to be applied to all property and
casualty insurance companies. The formula measures required
capital and surplus based on an insurance companys
products and investment portfolio and is used as a tool to
evaluate the capital of regulated companies. The RBC formula is
used by state insurance regulators to monitor trends in
statutory capital and surplus for the purpose of initiating
regulatory action. In general, an insurance company must submit
a calculation of its RBC formula to the insurance department of
its state of domicile as of the end of the previous calendar
year. These laws require increasing degrees of regulatory
oversight and intervention as an insurance companys RBC
declines. The level of regulatory oversight ranges from
requiring the insurance company to inform and obtain approval
from the domiciliary insurance commissioner of a comprehensive
financial plan for increasing its RBC to mandatory regulatory
intervention requiring an insurance company to be placed under
regulatory control in a rehabilitation or liquidation proceeding.
At December 31, 2009, each of our Insurance Company
Subsidiaries was in excess of any minimum threshold at which
corrective action would be required.
Insurance operations are subject to various leverage tests
(e.g., premium to statutory surplus ratios), which are evaluated
by regulators and rating agencies. Our targets for gross and net
written premium to statutory surplus are 2.75 to 1.0 and 2.25 to
1.0, respectively. As of December 31, 2009, on a statutory
consolidated basis, gross and net premium leverage ratios were
2.0 to 1.0 and 1.6 to 1.0, respectively.
The NAICs Insurance Regulatory Information System
(IRIS) was developed by a committee of state
insurance regulators and is primarily intended to assist state
insurance departments in executing their statutory mandates to
oversee the financial condition of insurance companies operating
in their respective states. IRIS identifies thirteen industry
ratios and specifies usual values for each ratio.
Departure from the usual values on four or more
ratios generally leads to inquiries or possible further review
from individual state insurance commissioners.
In 2009, our Insurance Company Subsidiaries generated three
ratios that varied from the usual value range. The
variations and reasons are set forth below:
|
|
|
|
|
Ratio
|
|
Usual Range
|
|
Value
|
|
Company: Star
|
|
|
|
|
Adjusted Liabilities to Liquid Assets
|
|
Under 100%
|
|
116%(1)
|
Company: Williamsburg
|
|
|
|
|
Gross Agents Balances to Policyholders Surplus
|
|
Under 40%
|
|
40%(2)
|
Company: ProCentury Insurance Company
|
|
|
|
|
Change in Net Premiums Written
|
|
Over -33% or Under 33%
|
|
184%(3)
|
|
|
|
(1) |
|
Adjusted Liabilities to Liquid Assets on Star is outside the
usual range primarily as a result of our Intercompany
Reinsurance Pooling Agreement. The Adjusted Liabilities includes
the gross amount of reinsurance payables related to the pool and
does not allow an offset to those payables for any reinsurance
recoverables related to the pool. In addition, the reinsurance
recoverables are not included in the Liquid Assets portion of
the formula. This causes the ratio results to appear much higher
due to the timing of the settlement of the pool balances. Pool
balances between the entities are settled in the month following
the completion of the pooling. |
72
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
(2) |
|
The Gross Agents Balances to Policyholders Surplus
on Williamsburg was impacted by our Intercompany Reinsurance
Pooling Agreement. Williamsburgs assumed premium
receivable increased as a result of the pooling agreement.
Excluding the intercompany pooling, this ratio would have been
within the usual range for 2009. These balances settled on
January 21, 2010, resulting in an updated ratio of 93%. |
|
(3) |
|
The Change in Net Premiums Written outside the usual range
resulted primarily from the Intercompany Reinsurance Pooling
Agreement whereby ProCentury Insurance Company is assuming its
share of a much larger pool base in 2009. ProCentury Insurance
Company also wrote additional direct business in the ocean
marine, inland marine and commercial auto liability lines of
business in 2009, compared with 2008. |
Reinsurance
Considerations
We seek to manage the risk exposure of our Insurance Company
Subsidiaries, including those insurance company subsidiaries we
acquired in the ProCentury merger, and our clients through the
purchase of
excess-of-loss
and quota share reinsurance. Our reinsurance requirements are
analyzed on a specific program basis to determine the
appropriate retention levels and reinsurance coverage limits. We
secure this reinsurance based on the availability, cost, and
benefits of various reinsurance alternatives.
Reinsurance does not legally discharge an insurer from its
primary liability for the full amount of risks assumed under
insurance policies it issues, but it does make the assuming
reinsurer liable to the insurer to the extent of the reinsurance
ceded. Therefore, we are subject to credit risk with respect to
the obligations of our reinsurers.
In regard to our
excess-of-loss
reinsurance, we manage our credit risk on reinsurance
recoverables by reviewing the financial stability,
A.M. Best rating, capitalization, and credit worthiness of
prospective or existing reinsurers. We generally do not seek
collateral where the reinsurer is rated A− or
better by A. M. Best, has $500 million or more in surplus,
and is admitted in the state of Michigan. The following table
sets forth information relating to our five largest unaffiliated
excess-of-loss
reinsurers based upon ceded premium as of December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance Premium Ceded
|
|
Reinsurance Recoverable
|
|
A.M. Best
|
Reinsurer
|
|
December 31, 2009
|
|
December 31, 2009
|
|
Rating
|
|
|
(In thousands)
|
|
(In thousands)
|
|
|
|
Motors Insurance Corporation(1)
|
|
$
|
9,032
|
|
|
$
|
19,203
|
|
|
|
B++
|
|
Swiss Reinsurance America Corporation
|
|
|
8,372
|
|
|
|
17,045
|
|
|
|
A
|
|
Munich Reinsurance America
|
|
|
7,654
|
|
|
|
18,502
|
|
|
|
A+
|
|
Lloyds Syndicate Number 2003
|
|
|
4,145
|
|
|
|
9,619
|
|
|
|
A
|
|
Aspen Insurance UK Ltd.
|
|
|
4,107
|
|
|
|
17,097
|
|
|
|
A
|
|
|
|
|
(1) |
|
Effective January 1, 2010, a novation was completed which
transferred all the ceded premium and reinsurance recoverables
between us and Motors Insurance Corporation to Maiden
Reinsurance Company (Maiden Re). All reinsurance transactions
and related collateral and trust accounts are now with Maiden
Re, which has an A.M. Best rating of A−. |
In regard to our risk-sharing partners (client captive or
rent-a-captive
quota-share non-admitted reinsurers), we manage credit risk on
reinsurance recoverables by reviewing the financial stability,
capitalization, and credit worthiness of prospective or existing
reinsures or partners. We customarily collateralize reinsurance
balances due from non-admitted reinsurers through funds withheld
trusts or stand-by letters of credit issued by highly rated
banks.
To date, we have not, in the aggregate, experienced material
difficulties in collecting reinsurance recoverables.
73
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Off-Balance
Sheet Arrangements
As of December 31, 2009, we have no off-balance sheet
arrangements as defined in Item 303(a) (4) of
Regulation S-K.
Convertible
Note
In December 2005, we entered into a $6.0 million
convertible note receivable with an unaffiliated insurance
agency. The effective interest rate of the convertible note is
equal to the three-month LIBOR, plus 5.2% and is due
December 20, 2010. This agency has been a producer for us
for over ten years. As security for the loan, the borrower
granted us a security interest in its accounts, cash, general
intangibles, and other intangible property. Also, the
shareholder then pledged 100% of the common shares of three
insurance agencies, the common shares owned by the shareholder
in another agency, and has executed a personal guaranty. This
note is convertible upon our option based upon a pre-determined
formula. The conversion feature of this note is considered an
embedded derivative, and therefore is accounted for separately
from the note. At December 31, 2009, the estimated fair
value of the derivative is not material to the financial
statements.
Accounting
Standards Codification
In June 2009, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 168 The FASB
Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles a replacement of FASB
Statement No. 162, which established FASB
Accounting Standards Codification (the Codification
or ASC). The Codification became the single source
of authoritative accounting principles in preparation of
financial statements in conformity with GAAP. Prospectively,
only one level of authoritative GAAP will exist, excluding the
guidance issued by the SEC. All other literature will be
non-authoritative. The Codification did not change current GAAP,
but is intended to simplify user access to all authoritative
GAAP by providing all the authoritative guidance, by particular
topic, using a consistent structure. The Codification was
effective on a prospective basis for periods ending after
September 15, 2009. As the Codification did not change
existing GAAP, the adoption of the Codification did not have an
impact on our financial condition or results of operations.
However, the adoption of the Codification did change our
references to GAAP accounting standards.
Recent
Accounting Standards
In April 2009, the FASB issued ASC
320-10-65,
Debt and Equity Securities Transition and
Open Effective Date Information (previously FSP
No. FAS 115-2
and
FAS 124-2,
Recognition and Presentation of
Other-Than-Temporary-Impairments).
ASC
320-10-65
requires entities to separate an
other-than-temporary
impairment of a debt security into two components when there are
credit related losses associated with the impaired debt security
for which management believes the Company does not have the
intent to sell the security, and it is more likely than not that
it will not be required to sell the security before recovery of
its amortized cost basis. If management concludes a security is
other-than-temporarily
impaired, ASC
320-10-65
requires that the difference between the fair value and the
amortized cost of the security be presented as an
other-than-temporary-impairment
charge within earnings, with an offset for any noncredit-related
loss component of the
other-than-temporary-impairment
charge to be recognized in other comprehensive income. In
addition, ASC
320-10-65
requires that companies record, as of the beginning of the
interim period of adoption, a cumulative effect adjustment to
reclassify the noncredit component of a previously recognized
OTTI loss from retained earnings to other comprehensive income
if the company does not intend to sell the security before
anticipated recovery of its amortized cost basis. ASC
320-10-65
became effective for interim and annual periods ending after
June 15, 2009. We adopted ASC
320-10-65 in
the second quarter of 2009. The adoption of ASC
320-10-65
did not have a material impact on our financial position or
results of operations.
74
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
The cumulative effect adjustment upon adoption at the beginning
of the second quarter between retained earnings and other
comprehensive income was $1.5 million.
In April 2009, the FASB issued ASC
820-10-65-4,
Fair Value Measurements and Disclosures
Transition and Open Effective Date Information
(previously FSP
No. FAS 157-4,
Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions that are Not Orderly).
ASC
820-10-65-4
provides additional guidance for estimating fair value in
accordance with ASC 820 Fair Value Measurements and
Disclosures when the volume and level of activity for
an asset or liability have significantly decreased in relation
to normal market activity. 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. ASC
820-10-65-4
became effective for interim and annual periods ending after
June 15, 2009. We adopted ASC
820-10-65-4
in the second quarter of 2009. The adoption of ASC
820-10-65-4
did not have a material impact on our financial position or
results of operations.
In April 2009, the FASB issued ASC
825-10-65-1,
Financial Instruments Transition and Open
Effective Date Information (previously FSP
FAS 107-1
and APB
28-1,
Interim Disclosures about Fair Value of Financial
Instruments). ASC
825-10-65-1
requires disclosures about fair value of financial instruments
for interim reporting periods of publicly traded companies as
well as in annual financial statements. ASC
825-10-65-1
became effective for periods ending after June 15, 2009. We
adopted ASC
825-10-65-1
in the second quarter of 2009 and began providing the additional
required disclosure information.
In April 2009, the FASB issued ASC
805-20
Business Combinations Identifiable Assets
and Liabilities, and Any Noncontrolling Interest
(previously FSP FAS 141(R)-1, Accounting for
Assets Acquired and Liabilities Assumed in a Business
Combination that Arise from Contingencies. ASC
805-20
requires that assets and liabilities assumed in a business
combination that arise from contingencies be recognized at fair
value only if fair value can be reasonably estimated. ASC
805-20 is
effective for business combinations for which the acquisition
date is on or after December 15, 2008. The adoption of ASC
805-20 did
not have an impact on our financial condition or results of
operation, as it applies prospectively to business combinations
effective December 15, 2008, or after and, therefore, did
not impact our previous transactions involving purchase
accounting. We will apply the provisions as applicable.
In May 2009, the FASB issued ASC 855 Subsequent
Events (previously SFAS No. 165
Subsequent Events). ASC 855 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.
ASC 855 became effective for periods ending after June 15,
2009. We adopted ASC 855 during the quarter ended June 30,
2009. The adoption of ASC 855 did not have an impact on our
consolidated financial condition or results of operations.
In June 2009, the FASB issued ASC 810
Consolidation (previously
SFAS No. 167 Amendments to FASB
Interpretation No. 46(R). ASC 810 contains
consolidation guidance applicable to variable interest entities.
The guidance further requires enhanced disclosures, including
disclosure of significant judgments and assumptions as to
whether a variable interest entity must be consolidated, and how
involvement with the variable interest entity affects a
companys financial statements. The guidance is effective
for annual periods beginning after November 15, 2009. Upon
adoption of this guidance, we will need to reconsider our
consolidation conclusions for all entities with which we are
involved. We have evaluated the impact on our adoption of ASC
810 and have concluded that the adoption would not have a
material impact on our financial condition and results of
operations.
75
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Related
Party Transactions
At December 31, 2009 and 2008, we held an $825,000 and
$852,000 note receivable from one of our executive officers,
including $164,000 and $191,000 of accrued interest,
respectively. This note arose from a transaction in late 1998 in
which we loaned the officer funds to exercise 64,718 common
stock options to cover the exercise price and the taxes incurred
as a result of the exercise. The note bears interest equal to
the rate charged pursuant to our revolving credit agreement and
is due on demand any time after January 1, 2002. As of
December 31, 2009, the rate was 2.25%. The loan is
partially collateralized by 64,718 shares of our common
stock under a stock pledge agreement. For the years ended
December 31, 2009 and 2008, $43,800 and $43,800,
respectively, have been paid against the loan. As of
December 31, 2009, the cumulative amount that has been paid
against this loan was $250,400. Refer to
Note 20 Related Party Transaction for
further information.
76
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
Item 7A.
|
Qualitative
and Quantitative Disclosures About Market Risk
|
Market risk is the risk of loss arising from adverse changes in
market rates and prices, such as interest rates as well as other
relevant market rate or price changes. The volatility and
liquidity in the markets in which the underlying assets are
traded directly influence market risk. The following is a
discussion of our primary risk exposures and how those exposures
are currently managed as of December 31, 2009. Our market
risk sensitive instruments are primarily related to fixed income
securities, which are available for sale and not held for
trading purposes.
Interest rate risk is managed within the context of an asset and
liability management strategy where the target duration for the
fixed income portfolio is based on the estimate of the liability
duration and takes into consideration our surplus. The
investment policy guidelines provide for a fixed income
portfolio duration of between three and a half and five and a
half years. At December 31, 2009, our fixed income
portfolio had a modified duration of 4.44 years, compared
to 4.47 years at December 31, 2008.
At December 31, 2009, the fair value of our investment
portfolio, excluding cash and cash equivalents, was
$1.1 billion. Our market risk to the investment portfolio
is primarily interest rate risk associated with debt securities.
Our exposure to equity price risk is related to our investments
in relatively small positions of preferred stocks and mutual
funds with an emphasis on dividend income. These investments
comprise 2.5% of our investment portfolio.
Our investment philosophy is one of maximizing after-tax
earnings and has historically included significant investments
in tax-exempt bonds. We continue to increase our holdings of
tax-exempt securities based on our desire to maximize after-tax
investment income. For our investment portfolio, there were no
significant changes in our primary market risk exposures or in
how those exposures are managed compared to the year ended
December 31, 2008. We do not anticipate significant changes
in our primary market risk exposures or in how those exposures
are managed in future reporting periods based upon what is known
or expected to be in effect.
A sensitivity analysis is defined as the measurement of
potential loss in future earnings, fair values, or cash flows of
market sensitive instruments resulting from one or more selected
hypothetical changes in interest rates and other market rates or
prices over a selected period. In our sensitivity analysis
model, a hypothetical change in market rates is selected that is
expected to reflect reasonable possible near-term changes in
those rates. Near term means a period of up to one
year from the date of the consolidated financial statements. In
our sensitivity model, we use fair values to measure our
potential loss of debt securities assuming an upward parallel
shift in interest rates to measure the hypothetical change in
fair values. The table below presents our models estimate
of changes in fair values given a change in interest rates.
Dollar values are in thousands.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rates Down 100bps
|
|
Rates Unchanged
|
|
Rates Up 100bps
|
|
Fair Value
|
|
$
|
1,142,670
|
|
|
$
|
1,088,554
|
|
|
$
|
1,032,815
|
|
Yield to Maturity or Call
|
|
|
2.59
|
%
|
|
|
3.62
|
%
|
|
|
4.63
|
%
|
Effective Duration
|
|
|
4.67
|
|
|
|
5.09
|
|
|
|
5.30
|
|
The other financial instruments, which include cash and cash
equivalents, equity securities, premium receivables, reinsurance
recoverables, line of credit and other assets and liabilities,
when included in the sensitivity model, do not produce a
material change in fair values.
Our debentures are subject to variable interest rates. Thus, our
interest expense on these debentures is directly correlated to
market interest rates. At December 31, 2009 and 2008, we
had debentures of $80.9 million. At this level, a
100 basis point (1%) change in market rates would change
annual interest expense by $809,000.
Our term loan is subject to variable interest rates. Thus, our
interest expense on our term loan is directly correlated to
market interest rates. At December 31, 2009, we had an
outstanding balance on our term loan of $49.9 million. At
this level, a 100 basis point (1%) change in market rates
would change annual interest
77
MEADOWBROOK
INSURANCE GROUP, INC.
expense by $499,000. At December 31, 2008, we had an
outstanding balance on our term loan of $60.25 million. At
this level, a 100 basis point (1%) change in market rates
would change annual interest expense by $602,500.
We have entered into interest rate swap transactions to mitigate
our interest rate risk on our existing debt obligations. These
interest rate swap transactions have been designated as cash
flow hedges and are deemed highly effective hedges. These
interest rate swap transactions are recorded at fair value on
the balance sheet and the effective portion of the changes in
fair value are accounted for within other comprehensive income.
The interest differential to be paid or received is accrued and
recognized as an adjustment to interest expense. Refer to
Note 9 Derivative Instruments for
further detail relating to our interest rate swap transactions.
In addition, our revolving line of credit under which we can
borrow up to $35.0 million is subject to variable interest
rates. Thus, our interest expense on the revolving line of
credit is directly correlated to market interest rates. At
December 31, 2009 and 2008, we did not have an outstanding
balance on our revolving line of credit.
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
Refer to list of Financial Statement Schedules and
Note 21 Quarterly Financial Data (Unaudited)
of the Notes to the Consolidated Financial Statements.
|
|
Item 9.
|
Changes
in and Disagreements With Accountants on Accounting and
Financial Disclosure
|
None.
|
|
Item 9A.
|
Controls
and Procedures
|
Evaluation
of Disclosure Controls and Procedures
Our disclosure controls and procedures (as defined in
Rule 13a-15(e)
under the Securities Exchange Act of 1934, the Exchange
Act), which we refer to as disclosure controls, are
controls and procedures that are designed with the objective of
ensuring that information required to be disclosed in our
reports filed under the Exchange Act, such as this annual
report, is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange
Commissions rules and forms. Disclosure controls are also
designed with the objective of ensuring that such information is
accumulated and communicated to our management, including our
Chief Executive Officer and our Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosure. There are inherent limitations to the effectiveness
of any control system. A control system, no matter how well
conceived and operated, can provide only reasonable assurance
that its objectives are met. No evaluation of controls can
provide absolute assurance that all control issues and instances
of fraud, if any, within our Company have been detected.
As of December 31, 2009, an evaluation was carried out
under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and
operation of disclosure controls and procedures. Based upon that
evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that the design and operation of these
disclosure controls and procedures were effective to ensure that
material information relating to us is made known to management,
including our Chief Executive Officer and Chief Financial
Officer, particularly during the period when our periodic
reports are being prepared.
Managements
Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining
adequate internal control over financial reporting (as defined
in
Rules 13a-15(f)
and
15d-15(f)
under the Exchange Act). Our internal control system was
designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
accounting principles generally
78
MEADOWBROOK
INSURANCE GROUP, INC.
accepted in the United States of America. Because of its
inherent limitations, internal controls over financial reporting
may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to
the risk that controls may be inadequate because of changes in
conditions, or the degree of compliance with the policies or
procedures may deteriorate.
Under the supervision and with the participation of our
management, including our principal executive officer and
principal financial officer, we conducted an evaluation of the
effectiveness of our internal controls over financial reporting
as of December 31, 2009. In making this assessment,
management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control Integrated Framework.
Based on our assessment, we concluded that, as of
December 31, 2009, our internal controls over financial
reporting were effective based on those criteria.
The attestation report of Ernst & Young LLP, our
independent registered public accounting firm, regarding
internal control over financial reporting is set forth in
Item 8 of this Annual Report on
Form 10-K
under the caption Report of Independent Registered Public
Accounting Firm and incorporated herein by reference.
Changes
in Internal Control over Financial Reporting
There have been no changes in our internal control over
financial reporting during the most recent quarter ended
December 31, 2009, which have materially affected, or are
reasonably likely to materially affect, our internal controls
over financial reporting.
|
|
Item 9B.
|
Other
Information
|
None.
PART III
Certain information required by Part III is omitted from
this Report in that the Registrant will file a definitive Proxy
Statement pursuant to Regulation 14A (the Proxy
Statement) not later than 120 days after the end of
the fiscal year covered by this report and certain information
included therein is incorporated herein by reference. Only those
sections of the Proxy Statement that specifically address the
items set forth herein are incorporated by reference.
|
|
Item 10.
|
Directors,
Executive Officers, and Corporate Governance
|
The information required by this item is included under the
captions Information about the Nominees, the Incumbent
Directors and Other Executive Officers, Corporate
Governance, Code of Conduct, Report of
the Audit Committee, and Section 16(a)
Beneficial Ownership Reporting Compliance of our Proxy
Statement relating to our Annual Meeting of Shareholders to be
held on May 18, 2010, which is hereby incorporated by
reference. Our Code of Conduct can be found on our website
www.meadowbrook.com.
|
|
Item 11.
|
Executive
Compensation
|
The information required by this item is included under the
captions Compensation of Executive Officers,
Director Compensation, Report of the
Compensation Committee of the Board on Executive
Compensation,Employment Agreements,
Other Senior Executive Employment Agreements,
and Compensation Committee Interlocks and Insider
Participation of our Proxy Statement relating to our
Annual Meeting of Shareholders to be held on May 18, 2010,
which is hereby incorporated by reference.
79
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
The information required by this item is included under the
caption Security Ownership of Certain Beneficial Owners
and Management of our Proxy Statement relating to our
Annual Meeting of Shareholders to be held on May 18, 2010,
which is hereby incorporated by reference.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Compensation Plan Information
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Remaining Available for
|
|
|
|
Number of Securities to
|
|
|
Weighted-Average
|
|
|
Future Issuance Under
|
|
|
|
be Issued Upon Exercise
|
|
|
Exercise Price of
|
|
|
Equity Compensation
|
|
|
|
of Outstanding Options,
|
|
|
Outstanding Options,
|
|
|
Plans (Excluding
|
|
|
|
Warrants and Rights
|
|
|
Warrants and Rights
|
|
|
Securities in Column (a))
|
|
Plan Category
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
Equity compensation plans approved by security holders(1)
|
|
|
0
|
|
|
$
|
0.00
|
|
|
|
2,617,749
|
|
Equity compensation plans not approved by security holders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
0
|
|
|
$
|
0.00
|
|
|
|
2,617,749
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
The 2,617,749 number of shares remaining available for future
issuance relates to our 2002 Amended and Restated Stock Option
Plan of 617,749 shares and our 2009 Equity Compensation
plan of 2,000,000 shares. |
|
|
Item 13.
|
Certain
Relationships and Related Transactions and Director
Independence
|
The information required by this item is included under the
captions Certain Relationships and Related Party
Transactions and Independence
Determination of our Proxy Statement relating to our
Annual Meeting of Shareholders to be held on May 18, 2010,
which is hereby incorporated by reference.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
The information required by this item is included under the
caption The Second Proposal on Which You are Voting on
Ratification of Appointment of Independent Registered Public
Accounting Firm of our Proxy Statement relating to our
Annual Meeting of Shareholders to be held on May 18, 2010,
which is hereby incorporated by reference.
80
MEADOWBROOK
INSURANCE GROUP, INC.
PART IV
|
|
Item 15.
|
Exhibits,
Financial Statement Schedules
|
(A) The following documents are filed as part of this
Report:
|
|
|
|
|
|
|
|
|
|
|
|
|
Page
|
|
|
1.
|
|
|
List of Financial Statements:
|
|
|
|
|
|
|
|
|
|
|
|
82
|
|
|
|
|
|
|
|
|
83
|
|
|
|
|
|
|
|
|
84
|
|
|
|
|
|
|
|
|
85
|
|
|
|
|
|
|
|
|
86
|
|
|
|
|
|
|
|
|
87
|
|
|
|
|
|
|
|
|
88
|
|
|
|
|
|
|
|
|
89-127
|
|
|
2.
|
|
|
Financial Statement Schedules
|
|
|
|
|
|
|
|
|
|
|
|
128
|
|
|
|
|
|
|
|
|
129-132
|
|
|
|
|
|
|
|
|
133-135
|
|
|
|
|
|
|
|
|
136
|
|
|
|
|
|
|
|
|