e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the fiscal year ended December 31, 2007
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TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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Commission File
Number: 1-14094
Meadowbrook Insurance Group,
Inc.
(Exact name of Registrant as
specified in its charter)
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Michigan
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38-2626206
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(State of
Incorporation)
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(IRS Employer Identification
No.)
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26255 American Drive, Southfield, MI
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48034-6112
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(Address of principal executive
offices)
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(Zip Code)
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Registrants telephone number, including area code:
(248) 358-1100
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class
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Name of Exchange on Which Registered
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Common Stock, $.01 par value per share
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New York Stock Exchange
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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 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
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Non-accelerated
filer o
Smaller reporting company
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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, 2007 was
$334,600,690. As of March 3, 2008, there were
37,020,677 shares of the Companys common stock
($.01 par value) outstanding.
Documents
Incorporated by Reference
Certain portions of the Registrants Proxy Statement for
the 2008 Annual Shareholders Meeting scheduled for
May 9, 2008 are incorporated by reference into
Part III of this report.
MEADOWBROOK
INSURANCE GROUP, INC.
PART I
The
Company
Meadowbrook Insurance Group, Inc. (We,
Our, or Us) (NYSE: MIG) is a holding
company organized as a Michigan corporation in 1985. We were
formerly known as Star Holding Company and in November 1995,
upon acquisition of Meadowbrook, Inc. (Meadowbrook),
we changed our name. Meadowbrook was founded in 1955 as
Meadowbrook Insurance Agency and was subsequently incorporated
in Michigan in 1965.
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, Williamsburg National Insurance Company, and
Ameritrust Insurance Corporation (which collectively are
referred to as the Insurance Company Subsidiaries),
as well as, American Indemnity Insurance Company, Ltd. and
Preferred Insurance Company, Ltd (PICL). We also
serve as a holding company for Meadowbrook, Crest Financial
Corporation, and their subsidiaries. As of December 31,
2007, PICL was deregulated under Bermuda law and merged into
Meadowbrooks subsidiary, Meadowbrook Risk Management, Ltd.
On January 31, 2008, PICL was contemporaneously dissolved.
Pursuant to Financial Accounting Standards Board Interpretation
Number (FIN) 46(R), 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
FIN 46(R), we do not consolidate our subsidiary American
Indemnity Insurance Company, Ltd. (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.
Significant
Acquisitions
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On April 16, 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 excess workers compensation coverage for a
select group of insurance companies.
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In November 2005, we acquired Insurance & Benefit
Consultants (IBC) of Sarasota, Florida. IBC is a
retail agency specializing in group and individual health
insurance products and personal financial planning services.
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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., and approximately ninety-four
percent of the outstanding stock of PICL (collectively,
TPA). TPA is a program-oriented risk management
company that provides risk management services to self-insured
clients, manages alternative risk management programs, and
performs underwriting, policy issuance and loss control services
for an unaffiliated insurance company. In January 2002, we
purchased the remaining six percent minority interest of PICL.
As previously indicated, PICL was dissolved effective
January 31, 2008.
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In July 1998, we acquired Florida Preferred Administrators, Inc.
(Florida Preferred), a third party administrator and
Ameritrust Insurance Corporation (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.
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In July 1997, we acquired Crest Financial Corporation
(Crest), a California-based holding company, which
formerly owned Williamsburg National Insurance Company
(Williamsburg). Crest provides
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MEADOWBROOK
INSURANCE GROUP, INC.
risk management services primarily to Williamsburg. On
December 31, 1999, Williamsburg became a wholly owned
subsidiary of Star.
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In July 1990, we acquired Savers Property and Casualty Insurance
Company (Savers).
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Proposed
Merger with ProCentury Corporation
On February 20, 2008, we executed a definitive merger
agreement with ProCentury Corporation (ProCentury)
for a merger transaction valued at approximately
$272.6 million in cash and stock to be paid to ProCentury
shareholders. The combined entity will adopt and operate under
the Meadowbrook name and will continue to trade on the NYSE
under the ticker symbol MIG. Our Chief Executive
Officer, Robert S. Cubbin, will continue in his current role in
the post-merger combined entity and two ProCentury board members
are expected to join Meadowbrooks Board of Directors.
The merger is expected to expand and complement our specialty
lines capabilities with ProCenturys insurance
professionals and product expertise in the excess and surplus
lines market. We believe there are significant profitable
revenue growth opportunities, as well as cost savings
opportunities.
We expect to finance the cash portion of the purchase price
through a combination of cash and debt. Completion of the
transaction is subject to various closing conditions, including
the receipt of required regulatory and shareholder approval. We
expect to complete the merger in the third quarter of 2008.
Employees
At March 3, 2008, we employed approximately 643 associates
to service our clients and provide management services to our
Insurance Operations as defined below. We believe we have
good relationships with our employees.
Overview
We are a full-service risk management organization which focuses
on niche or specialty program business and risk management
solutions for agents, professional and trade associations,
pools, trusts, and small to medium-sized insureds. Our programs
are primarily on a regional basis with a single line of business
within a program. Within the workers compensation line of
business we have a regional focus in New England, Florida, and
Nevada. Within the commercial auto and commercial multiple peril
we have a regional focus in California. Our
fee-for-service
business is also on a regional basis with an emphasis in the
Midwest and southeastern regions, as well as the self-insured
market in Nevada. 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 without sacrificing pricing of our
insurance premiums. Currently, we manage over $800 million
in gross written premiums.
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. Our Michigan-based retail insurance
agency operations are consistently ranked as a leading business
insurance agency in Michigan and the United States.
For over thirty years, we have specialized in providing risk
management 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 potentially turn risk management into a profit center.
By having their capital at risk, our clients are motivated to
reduce exposure and share in the underwriting profits and
investment income derived from their risk management plan.
Based upon the particular risk management goals of our clients
and our assessment of the opportunity for operating profit, we
offer solutions on a managed basis, a risk-sharing basis, or a
fully-insured basis, in
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MEADOWBROOK
INSURANCE GROUP, INC.
response to a specific market opportunity. In a managed program,
we earn service fee revenue by providing management 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 a captive or
rent-a-captive.
The captive and
rent-a-captive
structures are licensed reinsurance companies and are accounted
for under the provisions of Statement of Financial Accounting
Standards (SFAS) No. 113, Accounting
and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts. 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. In a
fully-insured program, we provide insurance products without a
risk-bearing mechanism and derive revenue from net earned
premiums and investment income.
We have developed a broad range of capabilities and services in
the design, management, and servicing of our clients risk
management needs. These capabilities and services include:
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program and product design;
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underwriting, risk selection, and policy issuance;
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sales, marketing, and public relations to members of groups;
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administration of risk-bearing entities, such as mutual
insurance companies, captives,
rent-a-captives,
public entity pools, and risk retention and risk purchasing
groups;
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claims handling and administration;
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loss prevention and control;
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reinsurance placement;
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risk analysis and identification;
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actuarial and loss reserve analysis;
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information technology and processing;
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feasibility studies;
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litigation management;
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accounting and financial statement preparation;
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regulatory compliance; and
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audit support.
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We remain committed to our long-term return on equity goal of
14% to 16%. While the equity offering in 2007 created a
temporary dilutive impact on our return on equity, we expect to
deploy the remaining capital and reach our targeted return on
equity of 15% by the end of 2009 and beginning of 2010. Our
targeted return on equity focuses on growing net commissions and
fees and growing net investment leverage and income, while
maintaining underwriting profitability. During 2008, we expect
gross written premium to grow to between $385.0 million and
$395.0 million, based upon premium volume growth from new
programs implemented in 2007, as well as from the expansion of
existing programs.
Company
Segments
Agency
Operations
We earn commission revenue through the operation of our retail
property and casualty insurance agencies, located in Michigan,
California, and Florida. Our agency operations produce
commercial, personal lines, life,
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MEADOWBROOK
INSURANCE GROUP, INC.
and accident and health insurance, with more than fifty
unaffiliated insurance carriers. The agency produces an
immaterial amount of business for our affiliated Insurance
Company Subsidiaries.
In total, our agency operations generated commissions of
$11.3 million, $12.3 million, and $11.3 million,
for the years ended December 31, 2007, 2006, and 2005,
respectively.
Specialty
Risk Management Operations
Our specialty risk management operations segment, which includes
insurance company specialty programs and
fee-for-service
specialty programs, focuses on specialty or niche insurance
business. Specialty risk management 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, and inland marine.
Insurance coverage is provided primarily to associations or
similar groups of members and to specified classes of business
of our agent-partners. We recognize revenue related to the
services and coverages from our specialty risk management
operations within seven categories: net earned premiums,
management fees, claims fees, loss control fees, reinsurance
placement, investment income, and net realized gains (losses).
Net earned premiums include the following lines of business:
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Workers Compensation
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Commercial Multiple Peril
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General Liability
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Errors and Omissions
Automobile
Owners, Landlord and Tenant
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Employment Practices Liability
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Professional Liability
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Medical
Real Estate Appraisers
Pharmacists
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Inland Marine
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Product Liability
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Excess Reinsurance
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Commercial Property
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Description
of Specialty Risk Management Programs
Fee-for-Service
Specialty Programs:
With a managed program, we earn
fee-for-service
revenue by providing management and other services to a
clients risk-bearing entity, but generally do not share in
the operating results of the program. We believe our managed
programs provide a consistent source of revenue, as well as
opportunities for revenue growth without a proportionate
increase in capital. Revenue growth may occur through the sale
of existing products to
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MEADOWBROOK
INSURANCE GROUP, INC.
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 fee revenue from managed programs
include:
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program design and development;
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underwriting;
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reinsurance placement;
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policy administration;
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loss prevention and control;
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claims administration and handling;
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litigation management;
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information technology and processing;
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accounting functions; and
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general management and oversight of the program.
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The fees we receive from our managed programs are generally
either a fixed amount or based on a percentage of premium
serviced or claim count.
We provide insurance management services to public entity
associations and currently manage public entity pools and other
insurance entities, which provide insurance coverage for
approximately 1,700 participants, including city, county,
township, and village governments in three states, as well as
other diverse industry groups.
Insurance
Company Programs:
We provide three broad types of insurance company programs,
including fully insured, captives and client risk-sharing
programs. 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 share the operating results with the client or
client group through a reinsurance agreement with a 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. The captive and
rent-a-captive
structures are licensed 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. Therefore,
the transactions associated with the captive and
rent-a-captive
structures are accounted for under the provisions of
SFAS No. 113, Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration
Contracts.
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
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MEADOWBROOK
INSURANCE GROUP, INC.
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.
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 loss prevention,
risk control measures and adherence to stricter underwriting
guidelines.
The following schematic illustrates the basic elements in many
of our client risk-sharing programs.
CAPTIVE
RISK-SHARING STRUCTURE
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(1)
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We account for transactions with
these risk-sharing clients as reinsurance under the provisions
of SFAS No. 113 Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration
Clients.
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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
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MEADOWBROOK
INSURANCE GROUP, INC.
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.
In applying FIN 46(R)s provisions to the captive
risk-sharing structure, 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 either SFAS No. 57, Related Party
Disclosures, or paragraph 16 of FIN 46(R).
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.
In another version of client risk-sharing, the agent accepts an
up-front commission that is adjusted up or down based on
operating results of the program produced.
With a fully-insured program, we provide our insurance products
without a risk-sharing 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.
Description
of Major Specialty Risk Management 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
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INSURANCE GROUP, INC.
through a 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.
We currently provide administrative services for approximately
eleven captives
and/or
rent-a-captives
and hold an insignificant minority interest in two of these
captives. These services are provided by our subsidiaries in
Bermuda and Barbados.
Reinsurance Placement. Through our reinsurance
intermediary subsidiary, Meadowbrook Intermediaries, Inc., 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.
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.
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.
In 2000, we launched our Advantage System
(Advantage). Advantage is an internet-based business
processing system for quoting and binding workers
compensation insurance policies. In addition to reducing our
internal administrative processing costs, Advantage enhances
underwriting practices by automating risk selection criteria.
Insurance
Company Subsidiaries
Our Insurance Company Subsidiaries issue insurance policies.
Through our Insurance Company Subsidiaries, we engage in
specialty risk management programs where we assume underwriting
risks in exchange for premium. Our Insurance Company
Subsidiaries primarily focus on specialty programs designed
specifically for trade groups and associations, whose members
are homogeneous in nature. Members are typically
small-to-medium
sized businesses. 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
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INSURANCE GROUP, INC.
generally, our programs operate on a regional or state-specific
basis. We maintain underwriting authority through our regional
offices based upon underwriting guidelines set forth 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, which offers our
clients a captive or
rent-a-captive
option, complements our Insurance Company Subsidiaries.
Star, Williamsburg and Ameritrust are domiciled in Michigan.
Savers is domiciled in Missouri and American Indemnity is a
Bermuda-based insurance company.
We may at times place risks directly with third party insurance
carriers and participate in the risk as a reinsurance partner.
Such arrangements typically generate management fee revenue and
provide a means to manage premium leverage ratios.
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 2.8 to 1.0 and 2.25 to
1.0, respectively. As of December 31, 2007, on a statutory
consolidated basis, gross and net premium leverage ratios were
1.8 to 1.0 and 1.5 to 1.0, respectively.
Our Insurance Company Subsidiaries are authorized to write
business, on either an admitted or surplus lines basis, in all
fifty states. Star is admitted in all fifty states. Williamsburg
is admitted in thirty-seven states, and is authorized to write
business on a surplus lines basis in one state. Savers is
admitted in five states and is authorized to write business on a
surplus lines basis in forty-six states. Ameritrust is admitted
in seven states. Our Insurance Company Subsidiaries primarily
offer workers compensation, commercial multiple peril,
general liability, inland marine, and other liability coverages.
For the year ended December 31, 2007, the workers
compensation line of business accounted for 33.7%, 38.1%, and
37.5% of gross written premiums, net earned premiums, and net
written premiums, respectively.
In 2001, 2000, and 1999, we eliminated a limited group of
unprofitable programs that were not aligned with our historic
and present business strategy. The uncertainty of future reserve
development on these discontinued programs has been reduced as a
result of aggressive claims handling and reserve strengthening.
However, while we believe we have adequate reserves, there can
be no assurances that there will not be additional losses in the
future relating to these programs. Outstanding reserves related
to these discontinued programs as of December 31, 2007 and
2006 were $3.3 million and $5.6 million, respectively.
In April 2007, we received an upgrade of our financial strength
rating by A.M. Best Company to A−
(Excellent), from B++ (Very Good) for our Insurance
Company Subsidiaries.
The following table summarizes gross written premiums, net
earned premiums, and net written premiums for the years ended
December 31, 2007, 2006, 2005, 2004, and 2003 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Written Premium
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
2004
|
|
|
%
|
|
|
2003
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
116,717
|
|
|
|
33.69
|
%
|
|
$
|
118,794
|
|
|
|
35.90
|
%
|
|
$
|
133,732
|
|
|
|
40.26
|
%
|
|
$
|
146,982
|
|
|
|
46.89
|
%
|
|
$
|
141,456
|
|
|
|
55.85
|
%
|
Commercial Multi-Peril
|
|
|
100,364
|
|
|
|
28.97
|
%
|
|
|
94,355
|
|
|
|
28.52
|
%
|
|
|
85,978
|
|
|
|
25.88
|
%
|
|
|
71,715
|
|
|
|
22.88
|
%
|
|
|
48,091
|
|
|
|
18.99
|
%
|
Inland Marine
|
|
|
11,629
|
|
|
|
3.36
|
%
|
|
|
12,837
|
|
|
|
3.88
|
%
|
|
|
12,467
|
|
|
|
3.75
|
%
|
|
|
10,925
|
|
|
|
3.48
|
%
|
|
|
9,758
|
|
|
|
3.85
|
%
|
Other Liability
|
|
|
28,550
|
|
|
|
8.24
|
%
|
|
|
20,001
|
|
|
|
6.04
|
%
|
|
|
16,167
|
|
|
|
4.87
|
%
|
|
|
15,248
|
|
|
|
4.86
|
%
|
|
|
10,473
|
|
|
|
4.13
|
%
|
Other Commercial Auto Liability
|
|
|
61,119
|
|
|
|
17.64
|
%
|
|
|
59,308
|
|
|
|
17.92
|
%
|
|
|
59,144
|
|
|
|
17.80
|
%
|
|
|
48,070
|
|
|
|
15.33
|
%
|
|
|
26,902
|
|
|
|
10.62
|
%
|
All Other Lines
|
|
|
28,072
|
|
|
|
8.10
|
%
|
|
|
25,577
|
|
|
|
7.73
|
%
|
|
|
24,721
|
|
|
|
7.44
|
%
|
|
|
20,553
|
|
|
|
6.56
|
%
|
|
|
16,600
|
|
|
|
6.55
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
346,451
|
|
|
|
100.00
|
%
|
|
$
|
330,872
|
|
|
|
100.00
|
%
|
|
$
|
332,209
|
|
|
|
100.00
|
%
|
|
$
|
313,493
|
|
|
|
100.00
|
%
|
|
$
|
253,280
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Earned Premium
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
2004
|
|
|
%
|
|
|
2003
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
102,256
|
|
|
|
38.13
|
%
|
|
$
|
108,085
|
|
|
|
42.40
|
%
|
|
$
|
119,423
|
|
|
|
47.78
|
%
|
|
$
|
117,914
|
|
|
|
54.97
|
%
|
|
$
|
93,324
|
|
|
|
61.72
|
%
|
Commercial Multi-Peril
|
|
|
71,049
|
|
|
|
26.49
|
%
|
|
|
63,138
|
|
|
|
24.77
|
%
|
|
|
54,829
|
|
|
|
21.94
|
%
|
|
|
43,701
|
|
|
|
20.37
|
%
|
|
|
26,075
|
|
|
|
17.24
|
%
|
Inland Marine
|
|
|
1,165
|
|
|
|
0.43
|
%
|
|
|
1,528
|
|
|
|
0.60
|
%
|
|
|
1,727
|
|
|
|
0.69
|
%
|
|
|
1,628
|
|
|
|
0.76
|
%
|
|
|
1,556
|
|
|
|
1.03
|
%
|
Other Liability
|
|
|
15,571
|
|
|
|
5.81
|
%
|
|
|
10,433
|
|
|
|
4.09
|
%
|
|
|
8,072
|
|
|
|
3.23
|
%
|
|
|
6,416
|
|
|
|
2.99
|
%
|
|
|
4,849
|
|
|
|
3.21
|
%
|
Other Commercial Auto Liability
|
|
|
53,469
|
|
|
|
19.94
|
%
|
|
|
49,341
|
|
|
|
19.36
|
%
|
|
|
45,374
|
|
|
|
18.15
|
%
|
|
|
29,274
|
|
|
|
13.65
|
%
|
|
|
12,940
|
|
|
|
8.56
|
%
|
All Other Lines
|
|
|
24,687
|
|
|
|
9.20
|
%
|
|
|
22,395
|
|
|
|
8.79
|
%
|
|
|
20,534
|
|
|
|
8.21
|
%
|
|
|
15,560
|
|
|
|
7.25
|
%
|
|
|
12,461
|
|
|
|
8.24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
268,197
|
|
|
|
100.00
|
%
|
|
$
|
254,920
|
|
|
|
100.00
|
%
|
|
$
|
249,959
|
|
|
|
100.00
|
%
|
|
$
|
214,493
|
|
|
|
100.00
|
%
|
|
$
|
151,205
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Written Premium
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
|
2004
|
|
|
%
|
|
|
2003
|
|
|
%
|
|
|
Workers Compensation
|
|
$
|
105,003
|
|
|
|
37.47
|
%
|
|
$
|
104,846
|
|
|
|
39.92
|
%
|
|
$
|
117,287
|
|
|
|
45.44
|
%
|
|
$
|
122,896
|
|
|
|
52.53
|
%
|
|
$
|
111,572
|
|
|
|
58.78
|
%
|
Commercial Multi-Peril
|
|
|
76,280
|
|
|
|
27.22
|
%
|
|
|
67,504
|
|
|
|
25.70
|
%
|
|
|
59,870
|
|
|
|
23.19
|
%
|
|
|
46,351
|
|
|
|
19.81
|
%
|
|
|
36,628
|
|
|
|
19.30
|
%
|
Inland Marine
|
|
|
1,212
|
|
|
|
0.43
|
%
|
|
|
1,271
|
|
|
|
0.48
|
%
|
|
|
1,690
|
|
|
|
0.65
|
%
|
|
|
1,630
|
|
|
|
0.70
|
%
|
|
|
1,500
|
|
|
|
0.79
|
%
|
Other Liability
|
|
|
18,915
|
|
|
|
6.75
|
%
|
|
|
12,384
|
|
|
|
4.71
|
%
|
|
|
8,004
|
|
|
|
3.10
|
%
|
|
|
7,568
|
|
|
|
3.23
|
%
|
|
|
6,278
|
|
|
|
3.31
|
%
|
Other Commercial Auto Liability
|
|
|
52,798
|
|
|
|
18.84
|
%
|
|
|
52,950
|
|
|
|
20.16
|
%
|
|
|
49,122
|
|
|
|
19.03
|
%
|
|
|
37,762
|
|
|
|
16.14
|
%
|
|
|
19,599
|
|
|
|
10.32
|
%
|
All Other Lines
|
|
|
26,003
|
|
|
|
9.28
|
%
|
|
|
23,713
|
|
|
|
9.03
|
%
|
|
|
22,161
|
|
|
|
8.59
|
%
|
|
|
17,754
|
|
|
|
7.59
|
%
|
|
|
14,250
|
|
|
|
7.51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
280,211
|
|
|
|
100.00
|
%
|
|
$
|
262,668
|
|
|
|
100.00
|
%
|
|
$
|
258,134
|
|
|
|
100.00
|
%
|
|
$
|
233,961
|
|
|
|
100.00
|
%
|
|
$
|
189,827
|
|
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Since 2004, there has been a shift in our mix of business, which
was intended to diversify our product line and produce more
predictable, stable results. The mix of business has impacted
our expense ratio, as the percentage of workers
compensation premium in relation to our other lines of business
has declined from a high of approximately 56% in 2003 to
approximately 34% in 2007. The decline in workers
compensation premium from 2004 is primarily due to our decision
to exit a limited number of small programs that were no longer
meeting our pricing standards, 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 has declined due to
reduction of premium writings in the state of Florida as pricing
competition has intensified and due to mandatory rate deceases
in Florida, Massachusetts and Nevada. We do believe the benefit
changes and other actions we have taken in those states have
allowed us to maintain underwriting profitability even in these
more competitive environments. 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
programs partners, 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. Overall, both net written
premium and net earned premium have increased over the same time
frame, largely as a result of the increase in the amount of
premium we retain versus premium ceded to excess of loss
reinsurers.
Reserves
The following table shows the development of reserves for unpaid
losses and loss adjustment expenses (LAE) from 1998
through 2007 for our Insurance Company Subsidiaries including
PICL, and the deconsolidation impact of American Indemnity.
In accordance with SFAS 113, the bottom portion of the
table shows the impact of reinsurance for the years 1998 through
2007, 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 3 Liability for Losses and Loss
Adjustment Expenses of the Notes to the Consolidated
Financial
11
MEADOWBROOK
INSURANCE GROUP, INC.
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,
|
|
|
|
1998
|
|
|
1999
|
|
|
2000
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
|
(In thousands)
|
|
|
Reserves for losses and LAE at end of period
|
|
$
|
84,254
|
|
|
$
|
127,500
|
|
|
$
|
172,862
|
|
|
$
|
198,653
|
|
|
$
|
193,116
|
|
|
$
|
192,019
|
|
|
$
|
226,996
|
|
|
$
|
271,423
|
|
|
$
|
302,655
|
|
|
$
|
341,541
|
|
Deconsolidation of subsidiary(1)
|
|
|
(147
|
)
|
|
|
(1,425
|
)
|
|
|
(3,744
|
)
|
|
|
(5,572
|
)
|
|
|
(2,973
|
)
|
|
|
(2,989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted reserves for losses and LAE at end of period
|
|
$
|
84,107
|
|
|
$
|
126,075
|
|
|
$
|
169,118
|
|
|
$
|
193,081
|
|
|
$
|
190,143
|
|
|
$
|
189,030
|
|
|
$
|
226,996
|
|
|
$
|
271,423
|
|
|
$
|
302,655
|
|
|
$
|
341,541
|
|
Cumulative paid as of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year later
|
|
|
39,195
|
|
|
|
54,928
|
|
|
|
70,952
|
|
|
|
77,038
|
|
|
|
78,023
|
|
|
|
71,427
|
|
|
|
79,056
|
|
|
|
83,271
|
|
|
|
81,779
|
|
|
|
|
|
2 years later
|
|
|
56,763
|
|
|
|
90,416
|
|
|
|
115,669
|
|
|
|
130,816
|
|
|
|
122,180
|
|
|
|
118,729
|
|
|
|
124,685
|
|
|
|
133,809
|
|
|
|
|
|
|
|
|
|
3 years later
|
|
|
76,776
|
|
|
|
116,001
|
|
|
|
146,548
|
|
|
|
157,663
|
|
|
|
151,720
|
|
|
|
145,279
|
|
|
|
153,780
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4 years later
|
|
|
85,447
|
|
|
|
132,995
|
|
|
|
160,673
|
|
|
|
176,172
|
|
|
|
167,288
|
|
|
|
159,220
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 years later
|
|
|
93,009
|
|
|
|
139,939
|
|
|
|
171,992
|
|
|
|
186,847
|
|
|
|
174,778
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 years later
|
|
|
96,739
|
|
|
|
146,997
|
|
|
|
179,010
|
|
|
|
191,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 years later
|
|
|
101,433
|
|
|
|
150,514
|
|
|
|
182,954
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 years later
|
|
|
104,225
|
|
|
|
152,544
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9 years later
|
|
|
105,569
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves re-estimated as of end of year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year later
|
|
|
98,587
|
|
|
|
146,213
|
|
|
|
182,976
|
|
|
|
199,171
|
|
|
|
193,532
|
|
|
|
193,559
|
|
|
|
231,880
|
|
|
|
268,704
|
|
|
|
295,563
|
|
|
|
|
|
2 years later
|
|
|
106,487
|
|
|
|
144,453
|
|
|
|
186,191
|
|
|
|
205,017
|
|
|
|
196,448
|
|
|
|
203,394
|
|
|
|
227,462
|
|
|
|
263,069
|
|
|
|
|
|
|
|
|
|
3 years later
|
|
|
102,075
|
|
|
|
152,630
|
|
|
|
189,632
|
|
|
|
207,379
|
|
|
|
202,126
|
|
|
|
205,650
|
|
|
|
226,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4 years later
|
|
|
104,017
|
|
|
|
156,997
|
|
|
|
190,305
|
|
|
|
211,394
|
|
|
|
203,738
|
|
|
|
202,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5 years later
|
|
|
106,668
|
|
|
|
158,287
|
|
|
|
196,158
|
|
|
|
213,802
|
|
|
|
202,028
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6 years later
|
|
|
109,038
|
|
|
|
159,449
|
|
|
|
199,520
|
|
|
|
212,274
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 years later
|
|
|
110,541
|
|
|
|
161,376
|
|
|
|
198,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 years later
|
|
|
112,340
|
|
|
|
161,023
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9 years later
|
|
|
111,935
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative deficiency:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollars
|
|
$
|
(27,828
|
)
|
|
$
|
(34,948
|
)
|
|
$
|
(29,382
|
)
|
|
$
|
(19,193
|
)
|
|
$
|
(11,885
|
)
|
|
$
|
(13,718
|
)
|
|
$
|
559
|
|
|
$
|
8,354
|
|
|
$
|
7,092
|
|
|
|
|
|
Percentage
|
|
|
33.1
|
%
|
|
|
27.7
|
%
|
|
|
17.4
|
%
|
|
|
9.9
|
%
|
|
|
6.3
|
%
|
|
|
7.3
|
%
|
|
|
0.2
|
%
|
|
|
3.1
|
%
|
|
|
2.3
|
%
|
|
|
|
|
Net reserves
|
|
|
84,107
|
|
|
|
126,075
|
|
|
|
169,118
|
|
|
|
193,081
|
|
|
|
190,143
|
|
|
|
189,030
|
|
|
|
226,996
|
|
|
|
271,423
|
|
|
|
302,655
|
|
|
|
341,541
|
|
Ceded reserves
|
|
|
64,590
|
|
|
|
101,744
|
|
|
|
168,962
|
|
|
|
195,943
|
|
|
|
181,817
|
|
|
|
147,446
|
|
|
|
151,161
|
|
|
|
187,254
|
|
|
|
198,422
|
|
|
|
198,461
|
|
Gross reserves
|
|
|
148,697
|
|
|
|
227,819
|
|
|
|
338,080
|
|
|
|
389,024
|
|
|
|
371,960
|
|
|
|
336,476
|
|
|
|
378,157
|
|
|
|
458,677
|
|
|
|
501,077
|
|
|
|
540,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net re-estimated
|
|
|
111,935
|
|
|
|
161,023
|
|
|
|
198,500
|
|
|
|
212,274
|
|
|
|
202,028
|
|
|
|
202,748
|
|
|
|
226,437
|
|
|
|
263,069
|
|
|
|
295,563
|
|
|
|
|
|
Ceded re-estimated
|
|
|
107,654
|
|
|
|
178,143
|
|
|
|
260,841
|
|
|
|
286,528
|
|
|
|
255,523
|
|
|
|
244,468
|
|
|
|
205,638
|
|
|
|
205,037
|
|
|
|
196,575
|
|
|
|
|
|
Gross re-estimated
|
|
|
219,589
|
|
|
|
339,166
|
|
|
|
459,341
|
|
|
|
498,802
|
|
|
|
457,551
|
|
|
|
447,216
|
|
|
|
432,075
|
|
|
|
468,106
|
|
|
|
492,138
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cumulative (deficiency) redundancy
|
|
$
|
(70,892
|
)
|
|
$
|
(111,347
|
)
|
|
$
|
(121,261
|
)
|
|
$
|
(109,778
|
)
|
|
$
|
(85,591
|
)
|
|
$
|
(110,740
|
)
|
|
$
|
(53,918
|
)
|
|
$
|
(9,429
|
)
|
|
$
|
8,939
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
In accordance with FIN 46(R),
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, effective January 1, 2004, we
deconsolidated American Indemnity on a prospective basis in
accordance with the provisions of FIN 46(R). Accordingly,
we have adjusted the reserves and development within the above
table. The adoption of FIN 46(R) and the deconsolidation of
American Indemnity did not have a material impact on our
consolidated balance sheet or consolidated statement of income.
|
12
MEADOWBROOK
INSURANCE GROUP, INC.
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):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
GAAP reserves for losses and LAE
|
|
$
|
540,002
|
|
|
$
|
501,077
|
|
Reinsurance recoverables for unpaid losses
|
|
|
(198,461
|
)
|
|
|
(198,422
|
)
|
Allowances against reinsurance recoverables*
|
|
|
(833
|
)
|
|
|
(1,041
|
)
|
Non-regulated foreign insurance subsidiary; PICL**
|
|
|
|
|
|
|
(1,273
|
)
|
|
|
|
|
|
|
|
|
|
Statutory reserves for losses and LAE
|
|
$
|
340,708
|
|
|
$
|
300,341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
|
The GAAP allowance for reinsurance
recoverables is reported as a Schedule F penalty or a
non-admitted asset for statutory accounting.
|
|
**
|
|
PICL offered clients captive or
rent-a-captive
options. It was a foreign insurance company and, therefore, was
not included in the combined statutory financial statements
filed with the National Association of Insurance Commissioners
and state regulators. Effective September 30, 2007, Star
entered into a novation agreement with PICL in which Star
assumed a portion of PICLs assets and liabilities. PICL
was dissolved effective January 31, 2008.
|
For the year ended December 31, 2007, we reported a
decrease of $8.9 million in gross ultimate loss estimates
for accident years 2006 and prior, or 1.8% of
$501.1 million of gross losses and LAE reserves at
January 1, 2007. We reported a $7.1 million decrease
in net ultimate losses and LAE estimates for accident years 2006
and prior, or 2.3% of $302.7 million.
As a result of favorable development on prior accident
years reserves, the provision for losses and loss
adjustment expenses decreased by $7.1 million for calendar
year 2007 and $2.7 million for calendar year 2006. As a
result of adverse development on prior accident years
reserves, the provision for losses and loss adjustment expenses
increased by $4.9 million for calendar year 2005.
Investments
Information relating to our investment portfolio is included
within Note 2 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
Discloures about Market Risk.
Competition
and Pricing
We compete with other providers of risk management programs and
services, as well as, with traditional providers of commercial
insurance. Both the risk management and the traditional property
and casualty insurance markets are highly competitive. Our risk
management programs and services compete with products and
services offered by insurance companies, other providers of risk
management 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.
The market for risk management 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, and
general economic conditions. 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. Principle factors that are
considered by insureds include an analysis of the net present-
13
MEADOWBROOK
INSURANCE GROUP, INC.
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, 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 by
government agencies in the states in which they do business. The
nature and extent of such regulation varies from jurisdiction to
jurisdiction but typically 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
which 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. Such regulation is
generally intended for the protection of policyholders, rather
than security holders.
Holding
Company Regulatory Acts
In addition to the regulatory oversight of our Insurance Company
Subsidiaries, we are subject to regulation under the Michigan,
Missouri, California, and Florida Insurance Holding Company
System Regulatory Acts (the Holding Company Acts).
The Holding Company Acts contain certain reporting requirements
including those that require us to file information relating to
our capital structure, ownership, and financial condition and
general business operations of our Insurance Company
Subsidiaries. The Holding Company Acts contain certain reporting
and prior approval requirements with respect to transactions
among affiliates.
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
14
MEADOWBROOK
INSURANCE GROUP, INC.
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.
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.
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 is
organized under the Insurance Codes of Missouri. 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 and Missouri 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
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MEADOWBROOK
INSURANCE GROUP, INC.
by a member in that state. Assessments from insolvency funds
were $156,000, $306,000, and $664,000, respectively, for 2007,
2006, and 2005. Most of these payments are recoverable through
future policy surcharges and premium tax reductions.
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. Total assessments paid to all such
facilities were $2.6 million, $3.1 million, and
$3.0 million, respectively, for 2007, 2006, and 2005.
Restrictions
on Dividends and Risk-Based Capital
For information on Restrictions on Dividends and Risk-based
Capital which affect us please refer to Note 8
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.
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
December 2005 under the Terrorism Risk Insurance Extension Act
of 2005, TRIA was modified and extended through
December 31, 2007. On December 26, 2007, Congress
extended and expanded TRIA beyond 2007. 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.
Recently, as a result of comments made related to claims
handling practices by insurers in the wake of the 2005
hurricanes that struck the gulf coast states, Congress has
examined a possible repeal of the McCarran-Ferguson Act, which
allows insurers to compile and share loss data, develop standard
policy forms and manuals and predict future loss costs with
greater reliability, among other things. The ability of the
industry, under the exemption permitted in the McCarran-Ferguson
Act, to collect loss cost data and build a credible database as
a means of predicting future loss costs is an important part of
cost-based pricing. If the ability to collect this data were
removed, the predictability of future loss costs and the
reliability of pricing could be undermined. We are unable to
predict whether the McCarran-Ferguson Act will be repealed, or
that any such repeal, if enacted, would not have a material
adverse effect on our business and results of operations.
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MEADOWBROOK
INSURANCE GROUP, INC.
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 United States Securities and Exchange Commission
(SEC). You may read and copy materials we file with
the SEC at the SECs Public Reference Room at
101 F Street, NW, 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
Guidelines, Code of Conduct, and our Business Conduct Policy are
available on our website, or in print to any shareholder who
requests this information.
Corporate
Governance Listing Standards
On June 5, 2007, we submitted to the New York Stock
Exchange a certificate signed by our Chief Executive Officer
certifying that he was not aware of any violation by us of New
York Stock Exchanges corporate governance listing
standards.
We
face risks related to our proposed merger with ProCentury
Corporation
There are significant risks and uncertainties associated with
our proposed merger with ProCentury Corporation. For example,
the merger may not be consummated, or may not be consummated in
the third quarter of 2008 as anticipated, as a result of a
number of factors, including, but not limited to, the inability
to obtain required regulatory and shareholder approvals. In
addition, the integration of the combined businesses into the
combined entity may not be integrated successfully or such
integration may be more difficult, time-consuming or costly than
expected; expected revenue synergies and cost savings from the
merger may not be fully realized or realized within the expected
time frame; revenues following the merger may be lower than
expected; and customer and employee relationships and business
operations may be disrupted by the merger.
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.
We establish reserves for losses and expenses related to the
adjustment of losses for the insurance policies we write. 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:
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the amounts of claims settlements and awards
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legislative activity
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changes in inflation and economic conditions
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accuracy and timely reporting of claim information
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MEADOWBROOK
INSURANCE GROUP, INC.
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 its 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.
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.
Star, as the lead insurance company under the Inter-Company
Reinsurance Agreement, cedes insurance to other insurers 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. We transfer some of the risk we have assumed to
reinsurance companies in exchange for a portion of the premium
we receive in connection with the risk. 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. As of
December 31, 2007, our reinsurance recoverables on paid and
unpaid losses was $199.5 million.
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
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MEADOWBROOK
INSURANCE GROUP, INC.
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.
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 and our agents 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:
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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
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programs in which state-sponsored entities provide property
insurance in catastrophe-prone areas or other alternative market
types of coverage
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changing practices created by the internet, which has increased
competition within the insurance business
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These developments could make the property and casualty
insurance marketplace more competitive by increasing the supply
of insurance capacity. In that event, the current softer market
(a market of declining or stable pricing and generally lower
profit or underwriting margins) could continue or be accelerated
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:
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rising levels of actual costs that are not known by companies at
the time they price their products
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volatile and unpredictable developments, including man-made,
weather-related and other natural catastrophes or terrorist
attacks
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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
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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
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increases in medical costs beyond historic or expected annual
inflationary levels
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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
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MEADOWBROOK
INSURANCE GROUP, INC.
in demand and supply could produce underwriting results that
would have a negative impact on our financial condition and
results of operations.
Negative
developments within the workers compensation insurance
industry may adversely affect our financial condition and
results of operations.
Although we engage in other businesses, approximately 34% of our
premium was attributable to workers compensation insurance
for the year ended December 31, 2007. As a result, negative
developments within the economic, competitive or regulatory
conditions affecting the workers compensation insurance
industry may have an adverse effect on our financial condition
and results of operations. For example, if legislators in one of
our larger markets, such as Florida, Nevada, or Massachusetts,
were to enact legislation to increase the scope or amount of
benefits for employees under workers compensation
insurance policies without related premium increases or loss
control measures, this could negatively affect the workers
compensation insurance industry. In some states, workers
compensation insurance premium rates are determined by
regulation, and changes in mandated rates could reduce our
profitability. Negative developments within the workers
compensation insurance industry could have a greater effect on
us than on more diversified insurance companies with more
diversified lines of insurance.
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 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.
Because
our investment portfolio consists primarily of fixed income
securities, our investment income could suffer as a result of
fluctuations in interest rates and market
conditions.
We currently maintain and intend to continue to maintain an
investment portfolio consisting primarily of fixed income
securities. The fair value of these securities fluctuates
depending on changes in interest rates. Generally, the fair
market value of these investments increases or decreases in an
inverse relationship with changes in interest rates. Changes in
interest rates may result in fluctuations in the income derived
from, and the valuation of, our fixed income investments, which
could have an adverse effect on our financial condition and
results of operations.
Our investment portfolio includes mortgage-backed securities. As
of December 31, 2007, mortgage and asset-backed securities
constituted approximately 24.2% of our invested assets. As with
other fixed income investments, the fair market 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.
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MEADOWBROOK
INSURANCE GROUP, INC.
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 payments to our insureds.
Since we carry debt securities 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.
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:
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standards of solvency, including risk-based capital measurements
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restrictions on the nature, quality and concentration of
investments
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restrictions on the types of terms that we can include in the
insurance policies we offer
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required methods of accounting
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required reserves for unearned premiums, losses and other
purposes
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permissible underwriting and claims settlement practices
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potential 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
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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.
Also, the insurance industry has recently become the focus of
increased scrutiny by regulatory authorities relating to the
placement of insurance, as well as claims handling by insurers
in the wake of recent hurricane losses. Some states have adopted
new disclosure requirements relating to the placement of
insurance business, while other states are considering what
additional regulatory oversight might be required with regard to
claims handling activities of insurers. It is difficult to
predict the outcome of these regulatory activities, whether they
will expand into other areas of the business not yet
contemplated, whether activities and practices currently thought
of to be lawful will be characterized as unlawful and what form
of additional or new regulations may be finally adopted and what
impact, if any, such increase regulatory actions may have on our
business. We have received general industry-wide requests for
information from a few state insurance departments regarding
compensation with insurance agents. We responded to these
inquires. Subsequent to our responses, we have not received any
further inquiries or comments from the state insurance
departments.
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MEADOWBROOK
INSURANCE GROUP, INC.
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 collection of the premium by us. 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. Chapters 7A (the
Fair Price Act) and 7B (the Control Share
Act) of the Business Corporation Act apply to us and may
have an anti-takeover effect and may delay, defer 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 which resulted in the interested shareholder
becoming an interested shareholder or by virtue of proportionate
stock splits or stock dividends.
The Control Share Act establishes procedures governing
control share acquisitions of large public Michigan
corporations. A control share acquisition is defined as an
acquisition of shares by an acquiror which, when combined with
other shares held by that person or entity, would give the
acquiror voting power, alone or as part of a group, at or above
any of the following thresholds: 20%,
331/3%
or 50%. Under the Control Share Act, an acquiror may not vote
control shares unless the companys
disinterested shareholders (defined to exclude the acquiring
person, officers of the target company, and directors of the
target company who are also employees of the company) vote to
confer voting rights on the control shares. The Control Share
Act does not affect the voting rights of shares owned by an
acquiring person prior to the control share acquisition. The
Control Share Act entitles corporations to redeem control shares
from the acquiring person under certain circumstances. In other
cases, the Control Share Act confers dissenters right upon
all of the corporations shareholders except the acquiring
person.
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MEADOWBROOK
INSURANCE GROUP, INC.
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. Also, we have adopted a shareholder
rights plan, which if triggered would significantly dilute the
stock ownership percentage of anyone who acquires more than
fifteen percent of our shares without the approval of our Board
of Directors. The existence of our shareholder rights plan and
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 various states, such as
Michigan and Missouri, governing 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 offered hereby. If we cannot
obtain adequate capital on favorable terms or at all, our
business, operating results and financial condition could be
adversely affected.
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. 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, and results of
operations. We have existing employment or severance agreements
with Merton J. Segal, Robert S. Cubbin, Karen M. Spaun, Michael
G. Costello, Stephen Belden, Joseph E. Mattingly, James M.
Mahoney, Robert C. Spring, Archie S. McIntyre, and Kenn R.
Allen. We maintain a key person life insurance
policy on Robert S. Cubbin, our President and CEO.
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 intense 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
23
MEADOWBROOK
INSURANCE GROUP, INC.
failure to attract and retain the necessary personnel and
producers could have a material adverse effect on our business,
financial condition, and results of operations.
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
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. Either of these circumstances could
have a material adverse effect upon our financial condition,
operations 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 results of operations.
|
|
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. In December
2004, we relocated to the new office building. This new building
is 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.
Previously, we leased our corporate offices from an unaffiliated
third party.
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. We have negotiated an extension through
May 1, 2009. The unaffiliated third party continues to pay
interest during the extension period and has the option to pay
the principal balance, or $750,000 less in exchange for granting
us an ownership interest in the building.
Through our subsidiaries, we are also a party to various leases
for locations in which we have offices. We do not consider any
of these leases to be material.
24
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
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 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 SFAS No. 5, Accounting for
Contingencies, 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 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.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
None.
25
MEADOWBROOK
INSURANCE GROUP, INC.
PART II
|
|
Item 5.
|
Market
for 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, P.C.
Bloomfield Hills, MI
|
|
Transfer Agent & Registrar
LaSalle Bank National Association
Corporate Trust Shareholder Services
P.O. Box 3319
South Hackensack, NJ 07606-1919
Stock Listing
New York Stock Exchange
Symbol: MIG
|
|
Annual Meeting
The Annual Meeting of
Meadowbrook Shareholders
will be held at:
2:00 p.m.
May 9, 2008
Corporate Headquarters
26255 American Drive
Southfield, MI
|
Shareholder
Relations and
Form 10-K
A copy of our 2007 Annual Report and
Form 10-K,
as filed with the Securities and Exchange Commission, may be
obtained upon written request to our Investor Relations
Department at our corporate headquarters, or contact:
Karen M. Spaun, Senior Vice President and Chief Financial Officer
(248) 204-8178
karen.spaun@meadowbrook.com
Holly A. Moltane, Director of External Financial Reporting
(248) 204-8590
holly.moltane@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:
LaSalle Bank National Association
1-800-442-8134
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, 2007
|
|
High
|
|
|
Low
|
|
|
Dividends
|
|
First Quarter
|
|
$
|
11.68
|
|
|
$
|
9.10
|
|
|
|
Second Quarter
|
|
|
12.45
|
|
|
|
9.94
|
|
|
|
Third Quarter
|
|
|
11.57
|
|
|
|
8.02
|
|
|
|
Fourth Quarter
|
|
|
10.00
|
|
|
|
8.40
|
|
|
|
26
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
High
|
|
|
Low
|
|
|
Dividends
|
|
First Quarter
|
|
$
|
7.00
|
|
|
$
|
5.63
|
|
|
|
Second Quarter
|
|
|
8.91
|
|
|
|
6.68
|
|
|
|
Third Quarter
|
|
|
11.83
|
|
|
|
8.32
|
|
|
|
Fourth Quarter
|
|
|
12.48
|
|
|
|
8.78
|
|
|
|
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, 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 subsidiaries. We did not receive any
dividends from our Insurance Company Subsidiaries in 2007 or
2006.
Shareholders
of Record
As of March 3, 2008, there were approximately
249 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.
Recent
Sales of Unregistered Securities and Use of Proceeds from
Registered Securities
On July 19, 2007, we sold 6,437,500 shares of common
stock in a secondary public offering at a price of $9.65 per
share pursuant to a Registration Statement on
Form S-3
(Registration
No. 333-143244),
which was declared effective by the Securities and Exchange
Commission on July 6, 2007. The net proceeds we received
from the offering were approximately $58.6 million,
reflecting gross proceeds of $62.1 million, net of
underwriting fees of approximately $3.0 million and other
offering costs of approximately $500,000. During the period from
the offering through December 31, 2007, we used a portion
of the proceeds to reduce our outstanding line of credit balance
from $22.0 million to zero and for other general corporate
purposes.
Purchase
of Equity Securities by the Issuer
During the year ended December 31, 2007, we did not
purchase any of our securities.
27
MEADOWBROOK
INSURANCE GROUP, INC.
Performance
Graph
The following graph sets forth, for the five year period ended
December 31, 2007, 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, 2002 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
|
|
|
12/31/2002
|
|
|
12/31/2003
|
|
|
12/31/2004
|
|
|
12/31/2005
|
|
|
12/31/2006
|
|
|
12/31/2007
|
|
Meadowbrook Insurance Group, Inc.
|
|
|
|
100.00
|
|
|
|
|
170.56
|
|
|
|
|
201.21
|
|
|
|
|
235.48
|
|
|
|
|
398.79
|
|
|
|
|
379.44
|
|
|
|
Russell 2000
|
|
|
|
100.00
|
|
|
|
|
147.25
|
|
|
|
|
174.24
|
|
|
|
|
182.18
|
|
|
|
|
215.64
|
|
|
|
|
212.26
|
|
|
|
SNL Insurance $500M-$1B Index
|
|
|
|
100.00
|
|
|
|
|
138.64
|
|
|
|
|
168.56
|
|
|
|
|
152.61
|
|
|
|
|
167.02
|
|
|
|
|
159.80
|
|
|
|
28
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
Item 6.
|
Selected
Financial Data
|
MEADOWBROOK
INSURANCE GROUP, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
(In thousands, except per share and ratio data)
|
|
|
Income Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums
|
|
$
|
346,451
|
|
|
$
|
330,872
|
|
|
$
|
332,209
|
|
|
$
|
313,493
|
|
|
$
|
253,280
|
|
Net written premiums
|
|
|
280,211
|
|
|
|
262,668
|
|
|
|
258,134
|
|
|
|
233,961
|
|
|
|
189,827
|
|
Net earned premiums
|
|
|
268,197
|
|
|
|
254,920
|
|
|
|
249,959
|
|
|
|
214,493
|
|
|
|
151,205
|
|
Net commissions and fees
|
|
|
45,988
|
|
|
|
41,172
|
|
|
|
35,916
|
|
|
|
40,535
|
|
|
|
45,291
|
|
Net investment income
|
|
|
26,400
|
|
|
|
22,075
|
|
|
|
17,975
|
|
|
|
14,911
|
|
|
|
13,484
|
|
Net realized gains
|
|
|
150
|
|
|
|
69
|
|
|
|
167
|
|
|
|
339
|
|
|
|
823
|
|
Total revenue
|
|
|
340,735
|
|
|
|
318,236
|
|
|
|
304,017
|
|
|
|
270,278
|
|
|
|
210,803
|
|
Net losses and LAE
|
|
|
150,969
|
|
|
|
146,293
|
|
|
|
151,542
|
|
|
|
135,938
|
|
|
|
98,472
|
|
Policy acquisition and other underwriting expenses
|
|
|
53,717
|
|
|
|
50,479
|
|
|
|
44,439
|
|
|
|
33,424
|
|
|
|
23,606
|
|
Other administrative expenses
|
|
|
32,269
|
|
|
|
28,824
|
|
|
|
26,810
|
|
|
|
25,588
|
|
|
|
22,879
|
|
Salaries and employee benefits
|
|
|
56,433
|
|
|
|
54,569
|
|
|
|
51,331
|
|
|
|
52,297
|
|
|
|
48,238
|
|
Amortization expense
|
|
|
1,930
|
|
|
|
590
|
|
|
|
373
|
|
|
|
376
|
|
|
|
353
|
|
Interest expense
|
|
|
6,030
|
|
|
|
5,976
|
|
|
|
3,856
|
|
|
|
2,281
|
|
|
|
977
|
|
Income before income taxes and equity earnings of affiliates
|
|
|
39,387
|
|
|
|
31,505
|
|
|
|
25,666
|
|
|
|
20,374
|
|
|
|
16,278
|
|
Equity earnings of affiliates
|
|
|
331
|
|
|
|
128
|
|
|
|
1
|
|
|
|
39
|
|
|
|
3
|
|
Net income
|
|
|
27,992
|
|
|
|
22,034
|
|
|
|
17,910
|
|
|
|
14,061
|
|
|
|
10,099
|
|
Earnings per share Diluted
|
|
$
|
0.85
|
|
|
$
|
0.75
|
|
|
$
|
0.60
|
|
|
$
|
0.48
|
|
|
$
|
0.35
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments and cash and cash equivalents
|
|
$
|
651,601
|
|
|
$
|
527,600
|
|
|
$
|
460,233
|
|
|
$
|
402,156
|
|
|
$
|
324,235
|
|
Total assets
|
|
|
1,113,966
|
|
|
|
969,000
|
|
|
|
901,344
|
|
|
|
801,696
|
|
|
|
692,266
|
|
Loss and LAE reserves
|
|
|
540,002
|
|
|
|
501,077
|
|
|
|
458,677
|
|
|
|
378,157
|
|
|
|
339,465
|
|
Debt
|
|
|
|
|
|
|
7,000
|
|
|
|
7,000
|
|
|
|
12,144
|
|
|
|
17,506
|
|
Debentures
|
|
|
55,930
|
|
|
|
55,930
|
|
|
|
55,930
|
|
|
|
35,310
|
|
|
|
10,310
|
|
Shareholders equity
|
|
|
301,894
|
|
|
|
201,693
|
|
|
|
177,365
|
|
|
|
167,510
|
|
|
|
155,113
|
|
Book value per share
|
|
$
|
8.16
|
|
|
$
|
6.93
|
|
|
$
|
6.19
|
|
|
$
|
5.76
|
|
|
$
|
5.34
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP ratios (insurance companies only):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and LAE ratio(1)
|
|
|
61.2
|
%
|
|
|
62.3
|
%
|
|
|
65.2
|
%
|
|
|
67.9
|
%
|
|
|
70.1
|
%
|
Expense ratio(1)
|
|
|
34.2
|
%
|
|
|
34.5
|
%
|
|
|
33.5
|
%
|
|
|
33.5
|
%
|
|
|
34.3
|
%
|
Combined ratio
|
|
|
95.4
|
%
|
|
|
96.8
|
%
|
|
|
98.7
|
%
|
|
|
101.4
|
%
|
|
|
104.4
|
%
|
|
|
|
(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 sets forth the
intercompany fees, which are eliminated upon onsolidation. |
29
MEADOWBROOK
INSURANCE GROUP, INC.
Unconsolidated
GAAP data Ratio Calculation Table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
Net earned premiums
|
|
$
|
268,197
|
|
|
$
|
254,920
|
|
|
$
|
249,959
|
|
|
$
|
214,493
|
|
|
$
|
151,205
|
|
Consolidated net losses and LAE
|
|
$
|
150,969
|
|
|
$
|
146,293
|
|
|
$
|
151,542
|
|
|
$
|
135,938
|
|
|
$
|
98,472
|
|
Intercompany claim fees
|
|
|
13,058
|
|
|
|
12,553
|
|
|
|
11,523
|
|
|
|
9,691
|
|
|
|
7,514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated net losses and LAE
|
|
$
|
164,027
|
|
|
$
|
158,846
|
|
|
$
|
163,065
|
|
|
$
|
145,629
|
|
|
$
|
105,986
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP net loss and LAE ratio
|
|
|
61.2
|
%
|
|
|
62.3
|
%
|
|
|
65.2
|
%
|
|
|
67.9
|
%
|
|
|
70.1
|
%
|
Consolidated policy acquisition and other underwriting expenses
|
|
$
|
53,717
|
|
|
$
|
50,479
|
|
|
$
|
44,439
|
|
|
$
|
33,424
|
|
|
$
|
23,606
|
|
Intercompany administrative and other underwriting fees
|
|
|
37,890
|
|
|
|
37,442
|
|
|
|
39,231
|
|
|
|
38,359
|
|
|
|
28,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated policy acquisition and other underwriting expenses
|
|
$
|
91,607
|
|
|
$
|
87,921
|
|
|
$
|
83,670
|
|
|
$
|
71,783
|
|
|
$
|
51,902
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP expense ratio
|
|
|
34.2
|
%
|
|
|
34.5
|
%
|
|
|
33.5
|
%
|
|
|
33.5
|
%
|
|
|
34.3
|
%
|
GAAP combined ratio
|
|
|
95.4
|
%
|
|
|
96.8
|
%
|
|
|
98.7
|
%
|
|
|
101.4
|
%
|
|
|
104.4
|
%
|
Management uses the GAAP combined ratio and its components to
assess and benchmark underwriting performance.
The GAAP combined ratio is the sum of the GAAP loss and loss
adjustment expense ratio and the GAAP expense ratio. The GAAP
loss and loss adjustment expense ratio is the unconsolidated net
loss and loss adjustment expense in relation to net earned
premiums. The GAAP expense ratio is the unconsolidated policy
acquisition and other underwriting expenses in relation to net
earned premiums.
30
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.
Description
of Business
We are a publicly traded specialty risk management organization
offering a full range of insurance products and services,
focused on niche and specialty program business, which we
believe is under served by the standard insurance market.
Program business refers to an aggregation of individually
underwritten risks that have some unique characteristic and are
distributed through a select group of focused general agencies,
retail agencies and program administrators. We perform the
majority of underwriting and claims services associated with
these programs. We also provide property and casualty insurance
coverage and services through programs and specialty risk
management solutions for agents, professional and trade
associations, public entities and small to medium-sized
insureds. In addition, we also operate as an insurance agency
representing unaffiliated insurance companies in placing
insurance coverages for policyholders. We define our business
segments as specialty risk management operations and agency
operations.
In July 2007, we completed an offering of 6,437,500 additional
shares of newly issued common stock at $9.65 per share. The
gross proceeds of the offering were $62.1 million. The net
proceeds were $58.6 million. The net proceeds from the
offering are being utilized to support organic growth within our
underwriting operations, to fund select acquisitions and other
general corporate purposes. Upon receipt of the net proceeds, we
also reduced our outstanding line of credit balance from
$22.0 million to zero.
In June 2002, we sold 21,275,000 shares of newly issued
common stock at $3.10 per share in a public offering. After
deducting underwriting discounts, commissions, and expenses, we
received net proceeds from the offering of $60.5 million.
We utilized $57.5 million of the $60.5 million raised
in the public offering to pay down our line of credit by
$20.0 million and contributed $37.5 million to the
surplus of our Insurance Company Subsidiaries. The remaining
proceeds were used for general corporate purposes.
Since 2003, we have issued $30.9 million and
$25.0 million in junior subordinated debentures and senior
debentures, respectively. We received a total of
$53.3 million in net proceeds from the issuances of these
debentures, 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. These
debentures are callable after five years
31
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
from the date of issuance. Since the junior subordinated
debentures issued in 2003 are callable in 2008, we will be
reviewing the capital strategy associated with refinancing at
lower costs through debentures or equity.
Specialty
Risk Management Operations
Our specialty risk management operations segment, which includes
insurance company specialty programs and
fee-for-service
specialty programs, focuses on specialty or niche insurance
business. Specialty risk management 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, and inland marine.
Insurance coverage is provided primarily to associations or
similar groups of members and to specified classes of business
of our agent-partners. We recognize revenue related to the
services and coverages the specialty risk management operations
provides within seven categories: net earned premiums,
management fees, claims fees, loss control fees, reinsurance
placement, investment income, and net realized gains (losses).
With a
fee-for-service
program, or managed program, we earn
fee-for-service
revenue by providing management 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.
We provide three broad types of insurance company programs,
including fully insured, captives and client risk-sharing
programs. 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 share the operating results with the client or
client group through a reinsurance agreement with a 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. The captive and
rent-a-captive
structures are licensed 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. Therefore,
the transactions associated with the captive and
rent-a-captive
structures are accounted for under the provisions of
SFAS No. 113, Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration
Contracts.
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.
32
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
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.
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,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
268,197
|
|
|
$
|
254,920
|
|
|
$
|
249,959
|
|
Management fees
|
|
|
23,963
|
|
|
|
18,714
|
|
|
|
16,741
|
|
Claims fees
|
|
|
9,025
|
|
|
|
8,776
|
|
|
|
7,113
|
|
Loss control fees
|
|
|
2,151
|
|
|
|
2,216
|
|
|
|
2,260
|
|
Reinsurance placement
|
|
|
929
|
|
|
|
735
|
|
|
|
660
|
|
Investment income
|
|
|
25,487
|
|
|
|
21,115
|
|
|
|
17,692
|
|
Net realized gains
|
|
|
150
|
|
|
|
69
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty risk management
|
|
|
329,902
|
|
|
|
306,545
|
|
|
|
294,510
|
|
Agency operations
|
|
|
11,316
|
|
|
|
12,285
|
|
|
|
11,304
|
|
Holding Company interest income earned
|
|
|
913
|
|
|
|
960
|
|
|
|
365
|
|
Intersegment revenue
|
|
|
(1,396
|
)
|
|
|
(1,554
|
)
|
|
|
(2,162
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenue
|
|
$
|
340,735
|
|
|
$
|
318,236
|
|
|
$
|
304,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 represent
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
33
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
ultimate liability may be greater or less than the estimate. As
of December 31, 2007 and 2006, we have accrued
$540.0 million and $501.1 million of gross loss and
LAE reserves, respectively.
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, 2007 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Case
|
|
|
IBNR
|
|
|
Total
|
|
|
Direct
|
|
$
|
168,979
|
|
|
$
|
252,186
|
|
|
$
|
421,165
|
|
Assumed-Directly Managed(1)
|
|
|
25,313
|
|
|
|
61,123
|
|
|
|
86,436
|
|
Assumed-Residual Markets(2)
|
|
|
9,697
|
|
|
|
15,730
|
|
|
|
25,427
|
|
Assumed-Retroceded
|
|
|
1,372
|
|
|
|
356
|
|
|
|
1,728
|
|
Assumed-Other
|
|
|
3,272
|
|
|
|
1,974
|
|
|
|
5,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
208,633
|
|
|
|
331,369
|
|
|
|
540,002
|
|
Less Ceded
|
|
|
79,412
|
|
|
|
119,049
|
|
|
|
198,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
$
|
129,221
|
|
|
$
|
212,320
|
|
|
$
|
341,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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, which 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.
34
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, 2007
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Case
|
|
|
Net IBNR
|
|
|
Total
|
|
|
Workers Compensation
|
|
$
|
58,665
|
|
|
$
|
82,694
|
|
|
$
|
141,359
|
|
Residual Markets
|
|
|
9,697
|
|
|
|
15,731
|
|
|
|
25,428
|
|
Commercial Multiple Peril/General Liability
|
|
|
25,972
|
|
|
|
61,840
|
|
|
|
87,812
|
|
Commercial Automobile
|
|
|
30,081
|
|
|
|
39,345
|
|
|
|
69,426
|
|
Other
|
|
|
4,806
|
|
|
|
12,710
|
|
|
|
17,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
129,221
|
|
|
$
|
212,320
|
|
|
$
|
341,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 (loss(es))
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 ninety-eight percent 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, 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,
35
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Paid Roll-forward Method, and
Incurred Roll-forward 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.
36
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 two percent of our
total reserves at December 31, 2007.
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 less than three 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 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
37
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
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 losses and LAE
reserves 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, 2007 and 2006.
Variability
of Claim Reserve Estimates
By its nature, the estimate of ultimate loss 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, the actuarial
department derived expected payment patterns separately for each
major line of business. These patterns were applied to the
December 31, 2007 loss and settlement expense reserves to
generate estimated annual incremental loss and 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
$6.8 million effect on after tax net income. A variance of
this type would
38
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
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 effect differed by line of business but overall was
less than a one percent change in reserve adequacy or a
$2.2 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 three percent or less in the last two years but was ten to
thirty-three 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 enabled us to rapidly recognize
trends and underlying loss patterns, while being able to quickly
set more accurate reserves.
Our range of estimates table shows that presently we evaluate it
as going from favorable development of 7.8% 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, 2007
|
|
(in thousands)
|
|
Line of Business
|
|
Minimum Reserve Range
|
|
|
Maximum Reserve Range
|
|
|
Workers Compensation (including Residual Markets)
|
|
$
|
(10,959
|
)
|
|
|
(6.6
|
)%
|
|
$
|
5,672
|
|
|
|
3.4
|
%
|
Commercial Multiple Peril/General Liability
|
|
|
(8,894
|
)
|
|
|
(10.1
|
)%
|
|
|
9,694
|
|
|
|
11.0
|
%
|
Commercial Automobile
|
|
|
(4,892
|
)
|
|
|
(7.0
|
)%
|
|
|
3,116
|
|
|
|
4.5
|
%
|
Other
|
|
|
(2,057
|
)
|
|
|
(11.7
|
)%
|
|
|
2,368
|
|
|
|
13.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(26,802
|
)
|
|
|
(7.8
|
)%
|
|
$
|
20,850
|
|
|
|
6.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 49% percent of our total reserves at December 31,
2007. Workers compensation was our first line of business
and is still our largest.
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 currently represents 49% of the $87.8 million
reserves in this line of business, as of December 31, 2007.
39
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
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,
2007. The majority 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.
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, 2007 and 2006, reinsurance recoverables on
paid and unpaid losses were $199.5 million and
$202.7 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,
2007, 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 any of
our risk-sharing partners to meet their obligations.
Investments
and Other Than Temporary Impairments of Securities and
Unrealized Losses on 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 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. However, if
there is a decline in the fair value of an investment below its
cost and the decline is considered other than temporary, the
amount of decline below cost is charged to earnings.
Our investment portfolio is primarily invested in debt
securities classified as available for sale, with a
concentration in fixed income securities of a high quality. Our
investment philosophy is to maximize after-tax earnings and
maintain significant investments in tax-exempt bonds. Our policy
for the valuation of temporarily
40
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
impaired securities is to determine impairment based on analysis
of, but not limited to, the following factors: (1) rating
downgrade or other credit event (e.g., failure to pay interest
when due); (2) financial condition and near-term prospects
of the issuer, including any specific events which may influence
the operations of the issuer such as changes in technology or
discontinuance of a business segment; (3) prospects for the
issuers industry segment; and (4) intent and ability
to retain the investment for a period of time sufficient to
allow for anticipated recovery in market value. We evaluate our
investments in securities to determine other than temporary
impairment, no less than quarterly. Investments that are deemed
other than temporarily impaired are written down to their
estimated net fair value and the related losses recognized in
income. There were no impaired investments written down in 2007,
2006, and 2005. There can be no assurance, however, that
significant changes in the above factors in relation to our
investment portfolio, will not result in future impairment
charges.
Our investment portfolio includes investments in mortgage-backed
and agency-backed securities, however we do not have any direct
exposure to any
sub-prime
risks. Our asset-backed securities sector comprises only 4.2%,
or $26.6 million of our investment portfolio. Within this
sector, $2.8 million relates to home equity loans, of which
$1.2 million is insured. The remaining $23.8 million
primarily relates to credit cards, auto loans, and utility and
equipment loans. These asset-backed securities are adequately
collateralized, AAA- rated investment quality that we currently
expect will continue to perform. Our mortgage-backed securities
have no exposure to any
sub-prime
risks.
At December 31, 2007 and 2006, we had 160 and 293
securities that were in an unrealized loss position,
respectively. These investments all had unrealized losses of
less than ten percent. At December 31, 2007, 128 of those
investments, with an aggregate $122.2 million and
$1.3 million fair value and unrealized loss, respectively,
have been in an unrealized loss position for more than eighteen
months. At December 31, 2006, 128 of those investments,
with an aggregate $127.3 million and $3.1 million fair
value and unrealized loss, respectively, have been in an
unrealized loss position for more than eighteen months. As of
December 31, 2007 and 2006, gross unrealized losses on
available for sale securities were $1.9 million and
$5.1 million, respectively.
Revenue
Recognition
We recognize premiums written 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 an in force policy. Provisions for unearned premiums on
reinsurance assumed from others are made on the basis of ceding
reports when received and actuarial estimates.
For the year ending December 31, 2007, total assumed
written premiums were $39.2 million, of which
$31.0 million, relates to assumed business we manage
directly, and therefore, no estimation is involved. The
remaining $8.2 million of assumed written premiums includes
$6.9 million related to residual markets.
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.
In addition, certain premiums are subject to retrospective
premium adjustments. Premium is recognized over the term of the
insurance contract.
Fee income, which includes risk management consulting, loss
control, and claims administration services, is recognized in
the period the services are provided. Claims processing fees are
recognized as revenue over
41
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
the estimated life of the claims, or the estimated life of the
contract. For those contracts that provide services beyond the
contractually defined termination date of the related contracts,
fees are deferred in an amount equal to an estimate of our
obligation to continue to provide services.
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, 2007 and 2006,
the allowance for uncollectibles on receivables was
$2.7 million and $2.9 million, respectively.
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 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 SFAS No. 5, Accounting for
Contingencies, 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 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
Goodwill represents the excess of the purchase price over the
fair value of net assets of subsidiaries acquired. As required
by SFAS No. 142 Goodwill and Other Intangible
Assets, we no longer amortize goodwill and, at least
annually, we test all existing goodwill for impairment using a
fair value approach, on a reporting unit basis. Our annual
assessment date for goodwill impairment testing is October 1st.
We test for impairment more frequently if events or changes in
circumstances indicate that there may be an impairment to
goodwill. We carry goodwill on two reporting units within the
agency operations segment in the amount of $6.5 million and
three reporting units within the specialty risk management
operations segment in the amount of $37.0 million. Based on
our most recent evaluation of goodwill impairment, we determined
that no impairment to goodwill exists.
42
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Results
of Operations
Executive
Overview
Our overall results in 2007 continued to reflect growth of net
income in comparison to prior year. These improvements reflect
our commitment to selective growth, as well as our adherence to
strict corporate underwriting guidelines and price adequacy. We
continue to maintain strong underwriting discipline and growth
within our profitable programs. Our generally accepted
accounting principles (GAAP) combined ratio improved
1.4 percentage points to 95.4% in 2007 from 96.8% in 2006.
We also continue to experience solid growth in our fee-based
operations. Net operating income, excluding amortization,
increased 32.1% to $29.8 million, or $0.90 per diluted
share, compared to $22.6 million, or $0.76 per diluted
share in 2006.
Gross written premium increased $15.6 million, or 4.7%, to
$346.5 million in 2007, compared to $330.9 million in
2006. Our existing underwritten business, which excludes
residual market premium, was up $18.8 million, or 5.9% in
comparison to 2006. This growth included business from new
programs implemented in 2006. The growth in existing business
was slightly offset by a reduction in residual market premiums
that are assigned to us as a result of a decrease in the
estimate of the overall size of the residual market.
We continue to follow pricing guidelines mandated by our
corporate underwriting guidelines. Overall, our
year-to-date
rate change was down 1.7%, compared to industry average price
decreases of approximately 15%. We anticipate that rates will
continue to remain slightly down into 2008. We continue to be
selective on new program implementation by focusing only on
those programs that meet our underwriting guidelines and have a
proven history of profitability. Our statutory surplus increased
by $23.3 million in 2007 to $188.4 million, from
$165.1 million in 2006. Currently, our earned surplus is
$33.7 million, which represents our ability to dividend
from the Insurance Company Subsidiaries to our holding company
for capital strategies, such as acquisitions, dividends, debt
repayments, and share repurchases.
In April 2007, we received an upgrade of our financial strength
rating by A.M. Best Company to A−
(Excellent), from B++ (Very Good) for our Insurance
Company Subsidiaries. This rating upgrade validates our
commitment to create value through excellent underwriting and
consistent operating performance. We are continuing to implement
new insurance programs as a result of this upgrade from
A.M. Best and other business development strategies. We
have a comprehensive due diligence process that incorporates an
entity wide risk analysis, as well as an operational review.
While this process can be lengthy, we believe the initial work
leads to long term relationships with solid longer term
favorable underwriting performance. We believe we are in a good
position to achieve our top-line and bottom-line growth
objectives in 2008. In addition, subsequent to the
A.M. Best upgrade, we have renewed policies formerly
written on a fronted basis by a non-affiliated insurance company
and assumed by our Insurance Company Subsidiaries in exchange
for a 5.5% fronting fee. As this renewal process continues and
we earn the premium previously fronted, we expect to see this
reduction in cost reflected within our expense ratio.
In April 2007, we purchased certain business assets of
U.S. Specialty Underwriters, Inc. (USSU) for a
purchase price of $23.0 million. This purchase price was
comprised of $13.0 million in cash and $10.0 million
in our common stock. USSU is based in Cleveland, Ohio, and is a
specialty program manager that produces fee based income by
underwriting excess workers compensation coverage for a
select group of insurance companies. The total shares issued for
the $10.0 million portion of the purchase price was
907,935 shares. Under the terms of the Agreement, we
acquired the excess workers compensation business and
other related assets. In addition, we entered into a Management
Agreement with the shareholders of USSU. Under the terms and
conditions of the Management Agreement, the shareholders were
responsible for certain aspects of the administration and
management of the acquired business. The shareholders
consideration for the performance of their duties was in the
form of a Management Fee payable by us based on a share of net
income before interest, taxes, depreciation, and amortization.
In addition, we retained the option to terminate the Management
Agreement, at our discretion, based on a multiple of the
Management Fee calculated for the trailing twelve
43
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
months. On January 31, 2008, we exercised our option to
purchase the remainder of the economics related to the
acquisition of the USSU business, by eliminating the Management
Agreement for a payment of $21.5 million, which now
completes the transaction.
In July 2007, we completed an offering of 6,437,500 additional
shares of newly issued common stock at $9.65 per share. The
gross proceeds of the offering were $62.1 million. The net
proceeds were $58.6 million. The net proceeds from the
offering are being utilized to support organic growth within our
underwriting operations, to fund select acquisitions and for
other general corporate purposes. Upon receipt of the net
proceeds, we reduced our outstanding line of credit balance from
$22.0 million to zero.
On February 8, 2008, our Board of Directors declared a
quarterly dividend of $0.02 per common share. This is the first
quarterly dividend since the third quarter of 2001. Our Board of
Directors determined that reinstating the dividend best serves
shareholder interests by creating long-term value and is part of
our capital management strategy.
On February 20, 2008, we executed a definitive merger
agreement with ProCentury Corporation (ProCentury)
for a merger transaction valued at approximately
$272.6 million in cash and stock to be paid to ProCentury
shareholders. The combined entity will adopt and operate under
the Meadowbrook name and will continue to trade on the NYSE
under the ticker symbol MIG. Our Chief Executive
Officer, Robert S. Cubbin, will continue in his current role in
the post-merger combined entity and two ProCentury board members
are expected to join Meadowbrooks Board of Directors.
The merger is expected to expand and complement our specialty
lines capabilities with ProCenturys insurance
professionals and product expertise in the excess and surplus
lines market. We believe there are significant profitable
revenue growth opportunities, as well as cost savings
opportunities.
We expect to finance the cash portion of the purchase price
through a combination of cash and debt. Completion of the
transaction is subject to various closing conditions, including
the receipt of required regulatory and shareholder approval. We
expect to complete the merger in the third quarter of 2008.
2007
compared to 2006:
Net income improved $6.0 million, or 27.0%, to
$28.0 million, or $0.85 per diluted share, in 2007, from
net income of $22.0 million, or $0.75 per diluted share, in
2006. This improvement primarily reflects growth in underwriting
profits and an increase in net investment income. Net investment
income increased primarily from an overall increase in average
invested assets. Improvements in our overall underwriting
results reflect continued favorable development on prior year
losses and a slight reduction in the expense ratio. These
improvements were partially offset by amortization of
intangibles and interest expense associated with our acquisition
of the USSU business.
Revenues increased $22.5 million, or 7.1%, to
$340.7 million for the year ended December 31, 2007,
from $318.2 million for the comparable period in 2006. This
increase reflects a $13.3 million, or 5.2%, increase in net
earned premiums. The increase in net earned premiums was the
result of selective growth consistent with our corporate
underwriting guidelines and our controls over price adequacy,
partially offset by a reduction in residual market premiums that
are assigned to us as a result of a decrease in the estimate of
the overall size of the residual market. The increase in revenue
was also due to an overall increase in
fee-for-service
revenue, primarily as a result of our acquisition of the USSU
business. Total fees received in 2007 as a result of this
acquisition were $5.5 million. In addition, the increase in
revenue reflects a $4.3 million increase in investment
income, primarily the result of overall positive cash flow, a
slight increase in yield and to a lesser extent the cash
received from our equity offering in July 2007.
44
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
2006
compared to 2005:
Net income improved $4.1 million, or 23.0%, to
$22.0 million, or $0.75 per diluted share, in 2006, from
net income of $17.9 million, or $0.60 per diluted share, in
2005. This improvement was primarily the result of our selective
growth consistent with our corporate underwriting guidelines and
our controls over price adequacy. In addition, during 2005 we
increased our retention levels on certain reinsurance treaties,
which favorably impacted net earned premiums and net income for
2006, compared to 2005. Growth in our
fee-for-service
programs also contributed to the overall improvement in net
income in comparison to 2005.
Revenues increased $14.2 million, or 4.7%, to
$318.2 million for the year ended December 31, 2006,
from $304.0 million for the comparable period in 2005. This
increase reflects a $4.9 million, or 2.0%, increase in net
earned premiums. The increase in net earned premiums was the
result of our selective growth consistent with our corporate
underwriting guidelines and our controls over price adequacy, as
well as the favorable impact from an increase in our retention
levels on certain reinsurance treaties effective in 2005.
Offsetting the overall increase in net earned premiums for the
year ended December 31, 2006, was a reduction in audit
related premiums in comparison to 2005. The increase in revenue
was also the result of an overall increase in
fee-for-service
revenue, primarily as a result of new managed programs. In
addition, the increase in revenue reflects a $4.1 million
increase in investment income, primarily due to an increase in
average invested assets as a result of improved cashflow from
favorable underwriting results, an increase in the duration of
our reserves, and proceeds from the junior subordinated
debentures issued in the third quarter of 2005. The increase in
investment income was also the result of a slight increase in
yield.
Specialty
Risk Management Operations
The following table sets forth the revenues and results from
operations for our specialty risk management operations (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
268,197
|
|
|
$
|
254,920
|
|
|
$
|
249,959
|
|
Management fees
|
|
|
23,963
|
|
|
|
18,714
|
|
|
|
16,741
|
|
Claims fees
|
|
|
9,025
|
|
|
|
8,776
|
|
|
|
7,113
|
|
Loss control fees
|
|
|
2,151
|
|
|
|
2,216
|
|
|
|
2,260
|
|
Reinsurance placement
|
|
|
929
|
|
|
|
735
|
|
|
|
660
|
|
Investment income
|
|
|
25,487
|
|
|
|
21,115
|
|
|
|
17,692
|
|
Net realized gains
|
|
|
150
|
|
|
|
69
|
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
329,902
|
|
|
$
|
306,545
|
|
|
$
|
294,510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax income Specialty risk management operations
|
|
$
|
47,898
|
|
|
$
|
38,292
|
|
|
$
|
29,546
|
|
2007
compared to 2006:
Revenues from specialty risk management operations increased
$23.4 million, or 7.6%, to $329.9 million for the year
ended December 31, 2007, from $306.5 million for the
comparable period in 2006.
Net earned premiums increased $13.3 million, or 5.2%, to
$268.2 million for the year ended December 31, 2007,
from $254.9 million in the comparable period in 2006. As
previously indicated, this increase was the result of selective
growth consistent with our corporate underwriting guidelines and
our controls over price adequacy, partially offset by the
reduction in residual market premiums and mandatory rate
decreases in the Nevada, Florida and Massachusetts workers
compensation lines of business.
45
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Management fees increased $5.3 million, or 28.0%, to
$24.0 million, for the year ended December 31, 2007,
from $18.7 million for the comparable period in 2006. This
increase was related to fees received as a result of our
acquisition of the USSU business. Total fees received in 2007 as
a result of the USSU acquisition were $5.5 million.
Slightly offsetting these fees was a slight decrease in fees in
our Northeast operations. This decrease in fees primarily
related to a decrease in premium volume due to reduced rates in
the self-insured markets on which the fees are based, because of
mandatory rate reductions and an increase in competition.
Claim fees remained relatively flat for 2007 compared to 2006.
Net investment income increased $4.4 million, or 20.7%, to
$25.5 million in 2007, from $21.1 million in 2006.
Average invested assets increased $79.2 million, or 16.0%,
to $573.1 million in 2007, from $493.9 million in
2006. The increase in average invested assets primarily relates
to the cash flows from operations, resulting from continued
favorable underwriting results, increased fee revenue, and the
lengthening of the duration of our reserves. The increase in the
duration of our reserves reflects 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 is now a larger
proportion of reserves. In addition, the increase in average
invested assets reflects cash flows from our equity offering in
July. The invested proceeds from the equity offering added
approximately $600,000 to the overall net investment income for
the year. The average investment yield for 2007 was 4.61%,
compared to 4.47% in 2006. The current pre-tax book yield was
4.5%. The current after-tax book yield was 3.41%, compared to
3.28% in 2006. This increase is primarily the result of the
increase in market interest rates, and the purchase of assets of
longer duration to take advantage of higher yields. The duration
of the investment portfolio is 4.3 years at
December 31, 2007, compared to 3.9 years at
December 31, 2006.
Specialty risk management operations generated pre-tax income of
$47.9 million for the year ended December 31, 2007,
compared to pre-tax income of $38.3 million for the year
ended December 31, 2006. This increase in pre-tax income
primarily reflects expansion of cash margins on our fee revenue,
an increase in net investment income, increased underwriting
profits, favorable development in prior accident year reserves,
and a slightly lower expense ratio. The GAAP combined ratio was
95.4% for the year ended December 31, 2007, compared to
96.8% for the comparable period in 2006.
Net losses and loss adjustment expenses (LAE)
increased $4.7 million, or 3.2%, to $151.0 million for
the year ended December 31, 2007, from $146.3 million
for the same period in 2006. Our loss and LAE ratio improved
1.1 percentage points to 61.2% for the year ended
December 31, 2007, from 62.3% for the same period in 2006.
This ratio is the unconsolidated net loss and LAE in relation to
net earned premiums. This improvement reflects the impact of
overall favorable development on prior accident year reserves of
1.5 percentage points from the December 31, 2006
reserves. The improvement was primarily within the workers
compensation and professional liability lines of business,
partially offset by an increase in the ultimate loss projections
within the general liability line of business. The unfavorable
development within the general liability line of business
reflects a claim reserving process change for an excess
liability program. Additional discussion of our reserve activity
is described below within the Other Items
Reserves section.
Our expense ratio for the year ended December 31, 2007 was
34.2%, compared to 34.5% in 2006. This ratio is the
unconsolidated policy acquisition and other underwriting
expenses in relation to net earned premiums.
2006
compared to 2005:
Revenues from specialty risk management operations increased
$12.0 million, or 4.1%, to $306.5 million for the year
ended December 31, 2006, from $294.5 million for the
comparable period in 2005.
Net earned premiums increased $4.9 million, or 2.0%, to
$254.9 million for the year ended December 31, 2006,
from $250.0 million in the comparable period in 2005. This
increase was primarily the result of selective
46
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
growth consistent with our corporate underwriting guidelines and
our controls over price adequacy, as well as the favorable
impact from an increase in our retention levels on certain
reinsurance treaties. Offsetting these increases was an overall
decrease in audit related premiums in comparison to 2005,
reflecting improvements in the estimation of exposures during
the underwriting cycle.
Management fees increased $2.0 million, or 11.8%, to
$18.7 million, for the year ended December 31, 2006,
from $16.7 million for the comparable period in 2005. This
increase was primarily the result of a Florida-based program
implemented in the second quarter of 2005. In addition, this
increase was the result of growth in a specific New
England-based program. Also contributing to the overall increase
in management fees was the recognition of $250,000 from a
profit-based revenue sharing payment related to a specific
managed program.
Claim fees increased $1.7 million, or 23.4%, to
$8.8 million, from $7.1 million for the comparable
period in 2005. This increase was primarily the result of our
2006 entry into the self-insured workers compensation
market in Nevada. In addition, this increase was the result of
increases in revenue related to a specific Minnesota-based
program, as well as a Florida-based program, which was
implemented in the second quarter of 2005.
Net investment income increased $4.1 million, or 22.8%, to
$22.1 million in 2006, from $18.0 million in 2005.
Average invested assets increased $69.6 million, or 16.4%,
to $493.9 million in 2006, from $424.3 million in
2005. The increase in average invested assets reflects cash
flows from underwriting activities primarily from favorable
underwriting results and an increase in the duration of our
reserves. The increase in the duration of our reserves reflects
the impact of our public entity excess program, which was
implemented at the end of 2003. This program has a longer
duration than the average reserves on our remaining programs and
is a larger proportion of reserves. In addition, the
$19.4 million in net proceeds received from capital raised
in 2005 through the issuances of debentures increased average
invested assets. The average investment yield for 2006 was
4.47%, compared to 4.24% in 2005. The current pre-tax book yield
was 4.35%. The current after-tax book yield was 3.28%, compared
to 3.06% in 2005. This increase is primarily the result of the
shift in our investment portfolio to tax-exempt investments. The
duration of the investment portfolio is 3.9 years.
Specialty risk management operations generated pre-tax income of
$38.3 million for the year ended December 31, 2006,
compared to pre-tax income of $29.5 million for the year
ended December 31, 2005. This increase in pre-tax income
demonstrates a continued improvement in underwriting results as
a result of our controlled growth in premium volume and our
continued focus on leveraging of fixed costs. The GAAP combined
ratio was 96.8% for the year ended December 31, 2006,
compared to 98.7% for the comparable period in 2005.
Net losses and loss adjustment expenses (LAE)
decreased $5.2 million, or 3.5%, to $146.3 million for
the year ended December 31, 2006, from $151.5 million
for the same period in 2005. Our loss and LAE ratio improved
2.9 percentage points to 62.3% for the year ended
December 31, 2006, from 65.2% for the same period in 2005.
This ratio is the unconsolidated net loss and LAE in relation to
net earned premiums. The accident year loss ratio remained flat
at 63.4% for 2006, compared to 63.3% in 2005. The favorable
development in our loss ratio was primarily the result of
improvement in frequency and claim settlements within the
professional liability line of business. In addition,
workers compensation residual market experience improved
as a result of lower market share assessments and lower loss
reserves on the industry pooled experience. Both 2006 and 2005,
were adversely impacted by a single large workers
compensation claim. The increase was $1.5 million and
$900,000 in 2006 and 2005, respectively. Excluding the adverse
impact of this claim, overall workers compensation
reflected improvement in claim settlements relative to their
collective case reserves. The experience within the general
liability line of business also improved due to favorable case
reserve settlements in 2006, in comparison to 2005. These
improvements were partially offset by a single property claim of
$1.9 million within a California-based agricultural
program. Allowances within other reserve categories,
collectively, did not contribute to the development in 2006,
compared to 2005 where
47
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
we experienced approximately $1.3 million in adverse
development related to allowances on reinsurance recoverables.
Our expense ratio for the year ended December 31, 2006 was
34.5%, compared to 33.5% in 2005. This ratio is the
unconsolidated policy acquisition and other underwriting
expenses in relation to net earned premiums. The increase in our
expense ratio in comparison to 2005 reflects a reduction in an
accrual for estimated profit-based ceding commissions on an
excess reinsurance treaty for a specific commercial
transportation program. This decrease was the result of
unfavorable loss development on a limited number of excess of
loss claims from prior accident years and added
$1.6 million to our expenses, or 0.6 percentage points
to our expense ratio for the year, as compared to a favorable
impact on the 2005 expense ratio of $1.1 million, or
0.5 percentage points. As of December 31, 2006, the
remaining accrual was less than $150,000; therefore, we do not
anticipate any further unfavorable adjustments. Offsetting this
increase in the expense ratio was a reduction in insurance
related assessments primarily related to the guaranty fund in
Florida and Nevada.
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,
|
|
|
2007
|
|
2006
|
|
2005
|
|
Net commission
|
|
$
|
11,316
|
|
|
$
|
12,285
|
|
|
$
|
11,304
|
|
Pre-tax income(1)
|
|
$
|
2,087
|
|
|
$
|
2,609
|
|
|
$
|
3,241
|
|
|
|
|
(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, 2007, 2006, and 2005, the
allocation of corporate overhead to the agency operations
segment was $2.8 million, $3.3 million, and
$3.2 million, respectively. These balances include an
allocation to our Insurance & Benefit Consultants
agency business that was previously allocated to specialty risk
management operations. For the years ended December 31,
2006 and 2005, pre-tax income for agency operations was
overstated and specialty risk management was understated by
$342,000 and $102,000, respectively.
|
2007
compared to 2006:
Revenue from agency operations, which consists primarily of
agency commission revenue, decreased $969,000, or 7.9%, to
$11.3 million for the year ended December 31, 2007,
from $12.3 million for the comparable period in 2006. This
decrease was primarily the result of a reduction in premium on
client renewals due to a more competitive pricing environment
primarily on larger Michigan accounts.
Agency operations generated pre-tax income, after the allocation
of corporate overhead, of $2.1 million for the year ended
December 31, 2007, compared to $2.6 million for the
comparable period in 2006. The decrease in the pre-tax income
was primarily attributable to the decrease in agency commission
revenue mentioned above.
2006
compared to 2005:
Revenue from agency operations, which consists primarily of
agency commission revenue, increased $1.0 million, or 8.7%,
to $12.3 million for the year ended December 31, 2006,
from $11.3 million for the comparable period in 2005. This
increase was primarily the result of the November 2005
acquisition of a Florida-based retail agency and an increase in
profit sharing commissions in comparison to 2005. Offsetting
these increases was a decrease in commission revenue as a result
of a reduction in premium on client renewals due to a more
competitive pricing environment.
48
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Agency operations generated pre-tax income, after the allocation
of corporate overhead, of $2.6 million for the year ended
December 31, 2006, compared to $3.2 million for the
comparable period in 2005. This decrease in pre-tax income in
comparison to 2005 was primarily the result of a slight increase
in operating expenses coupled with the decrease in commission
revenue, as noted above, offset by the favorable impact from the
Florida-based retail agency acquisition.
Other
Items
Reserves
At December 31, 2007, our best estimate for the ultimate
liability for loss and LAE reserves, net of reinsurance
recoverables, was $341.5 million. We established a
reasonable range of reserves of approximately
$314.7 million to $362.4 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)
|
|
$
|
155,828
|
|
|
$
|
172,459
|
|
|
$
|
166,787
|
|
Commercial Multiple Peril / General Liability
|
|
|
78,918
|
|
|
|
97,506
|
|
|
|
87,812
|
|
Commercial Automobile
|
|
|
64,534
|
|
|
|
72,542
|
|
|
|
69,426
|
|
Other
|
|
|
15,459
|
|
|
|
19,884
|
|
|
|
17,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Reserves
|
|
$
|
314,739
|
|
|
$
|
362,391
|
|
|
$
|
341,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 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, 2007, 2006, and
2005.
For the year ended December 31, 2007, we reported a
decrease in net ultimate loss estimates for accident years 2006
and prior of $7.1 million, or 2.3% of $302.7 million
of net loss and LAE reserves at December 31, 2006. The
decrease in net ultimate loss estimates reflected revisions in
the estimated reserves as a result of actual claims activity in
calendar year 2007 that differed from the projected activity.
There were no significant
49
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
changes in the key assumptions utilized in the analysis and
calculations of our reserves during 2007 and 2006. 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
|
|
2006
|
|
|
Year
|
|
|
Years
|
|
|
Incurred
|
|
|
Year
|
|
|
Years
|
|
|
Paid
|
|
|
2007
|
|
|
Workers Compensation
|
|
$
|
137,113
|
|
|
$
|
58,965
|
|
|
$
|
(11,428
|
)
|
|
$
|
47,537
|
|
|
$
|
8,150
|
|
|
$
|
35,141
|
|
|
$
|
43,291
|
|
|
$
|
141,359
|
|
Residual Markets
|
|
|
26,098
|
|
|
|
9,678
|
|
|
|
(3,053
|
)
|
|
|
6,625
|
|
|
|
3,451
|
|
|
|
3,844
|
|
|
|
7,295
|
|
|
|
25,428
|
|
Commercial Multiple Peril/General Liability
|
|
|
63,056
|
|
|
|
28,721
|
|
|
|
12,509
|
|
|
|
41,230
|
|
|
|
683
|
|
|
|
15,791
|
|
|
|
16,474
|
|
|
|
87,812
|
|
Commercial Automobile
|
|
|
54,642
|
|
|
|
45,820
|
|
|
|
847
|
|
|
|
46,667
|
|
|
|
11,691
|
|
|
|
20,192
|
|
|
|
31,883
|
|
|
|
69,426
|
|
Other
|
|
|
21,746
|
|
|
|
14,876
|
|
|
|
(5,966
|
)
|
|
|
8,910
|
|
|
|
6,328
|
|
|
|
6,812
|
|
|
|
13,140
|
|
|
|
17,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Reserves
|
|
|
302,655
|
|
|
$
|
158,060
|
|
|
$
|
(7,091
|
)
|
|
$
|
150,969
|
|
|
$
|
30,303
|
|
|
$
|
81,780
|
|
|
$
|
112,083
|
|
|
|
341,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance Recoverable
|
|
|
198,422
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
198,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
|
|
$
|
501,077
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
540,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Re-Estimated
|
|
|
Development
|
|
|
|
|
|
|
Reserves at
|
|
|
as a
|
|
|
|
Reserves at
|
|
|
December 31,
|
|
|
Percentage of
|
|
|
|
December 31,
|
|
|
2007
|
|
|
Prior Year
|
|
Line of Business
|
|
2006
|
|
|
on Prior Years
|
|
|
Reserves
|
|
|
Workers Compensation
|
|
$
|
137,113
|
|
|
$
|
125,685
|
|
|
|
(8.3
|
)%
|
Commercial Multiple Peril/General Liability
|
|
|
63,056
|
|
|
|
75,565
|
|
|
|
19.8
|
%
|
Commercial Automobile
|
|
|
54,642
|
|
|
|
55,489
|
|
|
|
1.6
|
%
|
Other
|
|
|
21,746
|
|
|
|
15,780
|
|
|
|
(27.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total
|
|
|
276,557
|
|
|
|
272,519
|
|
|
|
(1.5
|
)%
|
Residual Markets
|
|
|
26,098
|
|
|
|
23,045
|
|
|
|
(11.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Reserves
|
|
$
|
302,655
|
|
|
$
|
295,564
|
|
|
|
(2.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Workers
Compensation Excluding Residual Markets
The projected net ultimate loss estimate for the workers
compensation line of business, excluding residual markets,
decreased $11.4 million, or 8.3% of net workers
compensation reserves. This net overall decrease reflects
decreases of $1.1 million, $3.8 million,
$2.9 million, $557,000, and $1.1 million in accident
years 2006, 2005, 2004, 2003, and 2000, respectively. These
decreases reflect better than expected experience for many of
our workers compensation programs, including those in
Nevada, Florida, and a multi-state association program. The
actual losses on reported claims were less than the prior
actuarial projections and, therefore, ultimate loss estimates
were reduced. The change in ultimate loss estimates for all
other accident years was insignificant.
Commercial
Multiple Peril/General Liability
The commercial multiple peril and general liability line of
business had an increase in net ultimate loss estimates of
$12.5 million, or 19.8% of net commercial multiple peril
and general liability reserves. The net increase reflects
increases of $2.8 million, $1.6 million,
$5.6 million, and $811,000 in the ultimate loss estimates
for accident years 2006, 2005, 2004 and 2003, respectively,
which were primarily due to larger than
50
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
expected claim emergence in a Florida-based program. The larger
than expected claim emergence within this Florida-based program
was the result of accelerated claim activity on a handful of
incurred losses and greater claims frequency from a claim
reserving process change. This may be attributable to more
aggressive investigation on possible losses and more dedicated
resources on claim handling, resulting in case reserving
changes, rather than worsening results. While this program had
unfavorable development in prior accident year reserves, the
current and inception to date profits remain positive and within
our corporate guidelines for return on surplus. 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 increased $847,000, or 1.6% of net
commercial automobile reserves. This net overall increase
reflects increases of $2.3 million and $1.5 million in
accident years 2005 and 2004, respectively. These increases
primarily reflect higher than expected emergence of claim
activity in a Southeast-based and West coast-based program.
These increases were offset by a decrease of $2.5 million
in accident year 2006. The decrease in this accident year
reflects favorable development within a West coast-based program
and a Southeast-based 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 $6.0 million, or 27.4% of net reserves.
This net decrease reflects decreases of $1.6 million,
$2.2 million, $1.2 million, and $771,000, in the net
ultimate loss estimate for accident years 2006, 2005, 2004 and
2003, respectively. These decreases were due to better than
expected case reserve development during the calendar year in
the professional liability programs. 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 estimates of
$3.1 million, or 11.7% of net reserves. This decrease
reflects reductions of $1.8 million, $958,000, and $490,000
in accident years 2005, 2004 and 2003, respectively. We record
loss reserves as reported by the 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 quarter.
The change in ultimate loss estimates for all other accident
years was insignificant.
Salaries
and Employee Benefits
Salaries and employee benefits increased $1.8 million, or
3.4%, to $56.4 million in 2007, from $54.6 million for
the comparable period in 2006. This increase was primarily due
to merit increases, our acquisition of the USSU business, and
variable compensation attributable to our performance. Overall,
our headcount remained flat for 2007.
Salaries and employee benefits increased $3.3 million, or
6.3%, to $54.6 million in 2006, from $51.3 million for
the comparable period in 2005. This increase primarily reflects
an increase in variable compensation. In addition, this increase
was the result of an increase in staffing levels, primarily as a
result of the additions of our Florida-based retail agency and
our entry into the self-insured workers compensation
market in Nevada. Excluding those additions, overall staffing
levels for 2006 were slightly higher in comparison to 2005.
Additional discussion of our variable compensation plan is
described below under Variable Compensation.
51
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Other
Administrative Expenses
Other administrative expenses increased $3.5 million, or
12.0%, to $32.3 million in 2007, from $28.8 million in
2006. Other administrative expenses increased in comparison to
2006 as a result of our acquisition of the USSU business,
primarily due to the management fee associated with this
acquisition. In addition, this increase was the result of
information technology initiatives. Offsetting the increases
related to the USSU business were decreases related to
policyholder dividends, as well as various decreases in other
general operating expenses in comparison to 2006.
Other administrative expenses increased $2.0 million, or
7.5%, to $28.8 million in 2006, from $26.8 million in
2005. A portion of this increase was the result of the expenses
associated with the additions of our Florida-based agency and
our entry into the self-insured workers compensation
market in Nevada. In addition, the increase in other
administrative expenses was the result of information technology
enhancements and various increases in other general operating
expenses in comparison to 2005.
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 2007, 2006, and 2005 was
$1.9 million, $590,000, and $373,000, respectively.
Amortization expense per dilutive share for 2007, 2006, and 2005
was $0.06, $0.02, and $0.01, respectively. Amortization expense
primarily relates to the customer relationships acquired with
the Florida-based agency operation in 2005 and the acquisition
of the USSU business in 2007. The increase in amortization
expense in 2007 was related to our acquisition of the USSU
business.
Interest
Expense
Interest expense for 2007, 2006, and 2005 was $6.0 million,
$6.0 million, and $3.9 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. 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, we reduced this outstanding
balance to zero. The increase in interest expense in 2006,
compared to 2005 was related to the issuance of the junior
subordinated debentures issued in the third quarter of 2005, as
well as an overall increase in the average interest rates.
The average outstanding balance on our line of credit was
$8.8 million, $10.6 million, and $9.0 million in
2007, 2006, and 2005, respectively. The average interest rate,
excluding our debentures, was approximately 6.7%, 6.5%, and
4.8%, in 2007, 2006, and 2005, respectively.
Income
Taxes
Income tax expense, which includes both federal and state taxes,
for 2007, 2006 and 2005, was $11.7 million,
$9.6 million, and $7.8 million, or 29.8%, 30.5% and
30.2% of income before taxes, respectively. The decrease in our
tax rate from 2006 to 2007 primarily reflects a higher level of
tax exempt securities in our investment portfolio, slightly
offset by a higher level of income within our fee-based
operations, which are taxed at a 35% rate. Our tax exempt
securities as a percentage of total invested assets were 43.6%,
41.0%, and 29.9% for 2007, 2006, and 2005, respectively.
52
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Liquidity
and Capital Resources
Our principal sources of funds, which include both regulated and
non-regulated cash flows, are insurance premiums, investment
income, proceeds from the maturity and sale of invested assets,
risk management fees, and agency commissions. Funds are
primarily used for the payment of claims, commissions, salaries
and employee benefits, other operating expenses,
shareholders dividends, share repurchases, and debt
service. Our regulated sources of funds are insurance premiums,
investment income, and proceeds from the maturity and sale of
invested assets. These regulated funds are used for the payment
of claims, policy acquisition and other underwriting expenses,
and taxes relating to the regulated portion of net income. Our
non-regulated sources of funds are in the form of commission
revenue, outside management fees, and intercompany management
fees. Our capital resources include both non-regulated cash flow
and excess capital in our Insurance Company Subsidiaries, which
is defined as the dividend Star may issue without prior approval
from our regulators. We review the excess capital in aggregate
to determine the use of such capital. The general uses are as
follows, contributions to our Insurance Company Subsidiaries to
support premium growth, make select acquisitions, service debt,
pay shareholders dividends, repurchase shares, investments
in technology, or other expenses of the holding company. The
following table illustrates net income, excluding interest,
depreciation, and amortization, between our regulated and
non-regulated subsidiaries, which reconciles to our consolidated
statement of income and statement of cash flows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Net income
|
|
$
|
27,992
|
|
|
$
|
22,034
|
|
|
$
|
17,910
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulated Subsidiaries:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
25,595
|
|
|
$
|
19,712
|
|
|
$
|
13,508
|
|
Adjustments to reconcile net income to net cash provided by
operating activities
|
|
|
696
|
|
|
|
3,033
|
|
|
|
3,003
|
|
Changes in operating assets and liabilities
|
|
|
55,533
|
|
|
|
46,915
|
|
|
|
59,784
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments
|
|
|
56,229
|
|
|
|
49,948
|
|
|
|
62,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
81,824
|
|
|
$
|
69,660
|
|
|
$
|
76,295
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-regulated Subsidiaries:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,397
|
|
|
$
|
2,322
|
|
|
$
|
4,402
|
|
Depreciation
|
|
|
3,147
|
|
|
|
2,553
|
|
|
|
2,452
|
|
Amortization
|
|
|
1,930
|
|
|
|
590
|
|
|
|
198
|
|
Interest
|
|
|
6,030
|
|
|
|
5,976
|
|
|
|
3,856
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income, excluding interest, depreciation, and amortization
|
|
|
13,504
|
|
|
|
11,441
|
|
|
|
10,908
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net income to net cash provided by
operating activities
|
|
|
5,877
|
|
|
|
3,161
|
|
|
|
4,444
|
|
Changes in operating assets and liabilities
|
|
|
(1,491
|
)
|
|
|
(852
|
)
|
|
|
(3,194
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments
|
|
|
4,386
|
|
|
|
2,309
|
|
|
|
1,250
|
|
53
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Depreciation
|
|
|
(3,147
|
)
|
|
|
(2,553
|
)
|
|
|
(2,452
|
)
|
Amortization
|
|
|
(1,930
|
)
|
|
|
(590
|
)
|
|
|
(198
|
)
|
Interest
|
|
|
(6,030
|
)
|
|
|
(5,976
|
)
|
|
|
(3,856
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
6,783
|
|
|
$
|
4,631
|
|
|
$
|
5,652
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated total adjustments
|
|
|
60,615
|
|
|
|
52,257
|
|
|
|
64,037
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net cash provided by operating activities
|
|
$
|
88,607
|
|
|
$
|
74,291
|
|
|
$
|
81,947
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flow provided by operations was $88.6 million in 2007,
compared to $74.3 million in 2006. Cash flow provided by
operations in 2005 was $81.9 million.
2007
compared to 2006:
Regulated subsidiaries cash flow provided by operations
for the year ended December 31, 2007, was
$81.8 million, compared to $69.7 million for the
comparable period in 2006. This increase is the result of growth
in our underwritten business and timing of premium and
reinsurance recoverable collections. In addition, an increase in
investment income as a result of growth in our investment
portfolio contributed to the increase. Partially offsetting
these improvements was an increase in payments related to policy
acquisition costs and insurance related assessments.
Non-regulated subsidiaries cash flow provided by
operations for the year ended December 31, 2007, was
$6.8 million, compared to $4.6 million for the
comparable period in 2006. The increase in cash flow from
operations is primarily the result of an increase in the
collection of commission and fees due to the USSU business
acquisition. This increase in cash flow was partially offset by
variable compensation payments related to our long-term
incentive plan, which were made in the first quarter of 2007 and
related to 2006 performance and profitability.
We continue to anticipate a temporary increase in cash outflows
related to our investments in technology as we enhance our
operating systems and controls. We believe these temporary
increases will not affect our liquidity, debt covenants, or
other key financial measures.
2006
compared to 2005:
Regulated subsidiaries cash flow provided by operations
for the year ended December 31, 2006, was
$69.7 million, compared to $76.3 million for the
comparable period in 2005. This decrease was primarily the
result of timing in relation to reinsurance payments. This
decrease was slightly offset as a result of improved
underwriting results, lower paid losses in proportion to
incurred losses, and an increase in investment income.
Non-regulated subsidiaries cash flow provided by
operations for the year ended December 31, 2006, was
$4.6 million, compared to $5.7 million for the
comparable period in 2005. This decrease in cash flow in
comparison to 2005 was primarily the result of a decrease in net
income. The decrease in net income was primarily attributable to
an increase in interest expense related to the issuance of the
junior subordinated debentures issued in the third quarter of
2005 and an overall increase in the average interest rates. In
addition, the decrease in net income was the result of an
increase in administrative costs related to the additions of our
Florida-based agency and our entry into the self-insured
workers compensation market in Nevada, as well as an
increase due to information technology enhancements. These
increases were offset by an overall increase in
fee-for-service
and agency commission revenue.
54
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Other
Items
Long-term
Debt
The following table summarizes the principal amounts and
variables associated with our long-term debt (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
|
|
Year of
|
|
|
|
Year
|
|
|
|
|
|
|
|
Rate at
|
|
Principal
|
|
Issuance
|
|
Description
|
|
Callable
|
|
|
Year Due
|
|
|
Interest Rate Terms
|
|
12/31/07
|
|
Amount
|
|
|
2003
|
|
Junior subordinated debentures
|
|
|
2008
|
|
|
|
2033
|
|
|
Three-month LIBOR, plus 4.05%
|
|
|
9.28
|
%
|
|
$
|
10,310
|
|
2004
|
|
Senior debentures
|
|
|
2009
|
|
|
|
2034
|
|
|
Three-month LIBOR, plus 4.00%
|
|
|
8.87
|
%
|
|
|
13,000
|
|
2004
|
|
Senior debentures
|
|
|
2009
|
|
|
|
2034
|
|
|
Three-month LIBOR, plus 4.20%
|
|
|
9.23
|
%
|
|
|
12,000
|
|
2005
|
|
Junior subordinated debentures
|
|
|
2010
|
|
|
|
2035
|
|
|
Three-month LIBOR, plus 3.58%
|
|
|
8.57
|
%
|
|
|
20,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
$
|
55,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We received a total of $53.3 million in net proceeds from
the issuances of the above long-term debt, of which $26.2 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.
Since the junior subordinated debentures issued in 2003 are
callable in 2008, we will be reviewing the capital strategy
associated with refinancing at lower costs through debentures or
equity.
Interest
Rate Swaps
In October 2005, we entered into two interest rate swap
transactions to mitigate our interest rate risk on
$5.0 million and $20.0 million of our senior
debentures and trust preferred securities, respectively. In
accordance with Statement of Financial Accounting Standards
(SFAS) No. 133 Accounting for
Derivative Instruments and Hedging Activities, these
interest rate swap transactions were 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
is recognized as an adjustment to interest expense.
The first interest rate swap transaction, which relates to
$5.0 million of our $12.0 million issuance of senior
debentures, has an effective date of October 6, 2005 and an
ending date of May 24, 2009. We are required to make
certain quarterly fixed rate payments calculated on a notional
amount of $5.0 million,
non-amortizing,
based on a fixed annual interest rate of 8.925%. The
counterparty is obligated to make
55
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
quarterly floating rate payments to us, referencing the same
notional amount, based on the three-month LIBOR, plus 4.20%.
The second interest rate swap transaction, which relates to
$20.0 million of our $20.0 million issuance of trust
preferred securities, has an effective date of October 6,
2005 and ending date of September 16, 2010. We are required
to make quarterly fixed rate payments calculated on a notional
amount of $20.0 million,
non-amortizing,
based on a fixed annual interest rate of 8.34%. The counterparty
is obligated to make quarterly floating rate payments to us,
referencing the same notional amount, based on the three-month
LIBOR, plus 3.58%.
In relation to the above interest rate swaps, the net interest
income received for the years ended December 31 2007 and 2006,
was approximately $172,000 and $67,000, respectively. For the
year ended December 31, 2005, the net interest expense
incurred was approximately $4,000. The total fair value of the
interest rate swaps as of December 31, 2007 and 2006, was
approximately ($545,000) and $200,000, respectively. Accumulated
other comprehensive income at December 31, 2007 and 2006,
included accumulated (loss) income on the cash flow hedge, net
of taxes, of approximately ($484,000) and $121,000, respectively.
Revolving
Line of Credit
In April 2007, we executed an amendment to our current revolving
credit agreement with our bank. The amendments included an
extension of the term to September 30, 2010, an increase to
the available borrowings of up to $35.0 million, and a
reduction of the variable interest rate basis to a range between
75 to 175 basis points above LIBOR. We use the revolving
line of credit to meet short-term working capital needs. Under
the revolving line of credit, we and certain of our
non-regulated subsidiaries pledged security interests in certain
property and assets of named subsidiaries.
At December 31, 2007, we did not have an outstanding
balance on the revolving line of credit. In July 2007, we
completed a secondary equity offering in which we received net
proceeds of approximately $58.6 million. Upon receipt of
the net proceeds, we reduced our outstanding line of credit
balance to zero. At December 31, 2006, we had an
outstanding balance of $7.0 million on the revolving line
of credit.
The revolving line of credit provides for interest at a variable
rate based, at our option, upon either a prime based rate or
LIBOR-based rate. In addition, the revolving line of credit also
provides for an unused facility fee of 15 basis points on
any unused balance. On prime based borrowings, the applicable
margin ranges from 75 to 25 basis points below prime. On
LIBOR-based borrowings, the applicable margin ranges from 75 to
175 basis points above LIBOR. The margin for all loans is
dependent on the sum of non-regulated earnings before interest,
taxes, depreciation, amortization, and non-cash impairment
charges related to intangible assets for the preceding four
quarters, plus dividends paid or payable to us from subsidiaries
during such period (Adjusted EBITDA). At
December 31, 2007, we did not have any LIBOR-based
borrowings outstanding. At December 31, 2006, the weighted
average interest rate for LIBOR-based borrowings outstanding was
6.7%.
Debt covenants consist of: (1) maintenance of
the ratio of Adjusted EBITDA to interest expense of 2.0 to 1.0,
(2) minimum net worth of $130.0 million and increasing
annually, commencing June 30, 2005, by fifty percent of the
prior years positive net income, (3) minimum
A.M. Best rating of B, and (4) on an
annual basis, a minimum Risk Based Capital Ratio for Star of
1.75 to 1.00. As of December 31, 2007, we were in
compliance with these covenants.
Investment
Portfolio
As of December 31, 2007 and 2006, the recorded values of
our investment portfolio, including cash and cash equivalents,
were $651.6 million and $527.6 million, respectively.
The debt securities in the investment
56
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
portfolio, at December 31, 2007, were 97.7% investment
grade A− or above bonds as defined by Standard and
Poors.
While our investment portfolio includes investments in
mortgage-backed and agency-backed securities, we do not have any
direct exposure to any
sub-prime
risks. Our asset-backed securities sector comprises only 4.2%,
or $26.6 million of our investment portfolio. Within this
sector, $2.8 million relates to home equity loans, of which
$1.2 million is insured. The remaining $23.8 million
primarily relates to credit cards, auto loans, and utility and
equipment loans. These asset-backed securities are adequately
collateralized, AAA- rated investment quality that we currently
expect will continue to perform. Our mortgage-backed securities
have no exposure to any
sub-prime
risks.
Shareholders
Equity
Shareholders equity increased to $301.9 million, or a
book value of $8.16 per common share, at December 31, 2007,
compared to $201.7 million, or a book value of $6.93 per
common share, at December 31, 2006. This per share increase
in book value primarily reflects the impact of our equity
offering in July 2007,
year-to-date
earnings, and an increase in unrealized gains, net of deferred
income tax, of $4.3 million. Return on beginning equity was
13.9% in 2007, compared to 12.4% in 2006.
On July 19, 2007, we completed a secondary offering of
6,437,500 additional shares of our common stock at a price of
$9.65 per share. Including the underwriting discount associated
with the offering and other related expenses, we received total
net proceeds of approximately $58.6 million. These net
proceeds are being utilized to support organic growth within our
underwriting operations, to fund select acquisitions and for
other general corporate purposes. Upon receipt of the net
proceeds, we reduced our outstanding line of credit balance from
$22.0 million to zero.
In April 2007, we purchased the business of USSU for a purchase
price of $23.0 million. This purchased price was comprised
of $13.0 million in cash and $10.0 million in our
common stock. Total additional shares issued for the
$10.0 million portion of the purchase price were
907,935 shares.
On February 8, 2007, our Board of Directors and the
Compensation Committee of the Board of Directors approved the
distribution of our LTIP award for the
2004-2006
plan years, which included both a cash and stock award. The
stock portion of the LTIP award was valued at $2.5 million,
which resulted in the issuance of 579,496 shares of our
common stock. Of the 579,496 shares issued,
191,570 shares were retired for payment of the
participants associated withholding taxes related to the
compensation recognized by the participant. Refer to
Note 2 Stock Options, Long Term Incentive
Plan, and Deferred Compensation Plan for further detail. The
retirement of the shares for the associated withholding taxes
reduced our paid in capital by $1.8 million.
On October 26, 2007, our Board of Directors authorized
management to purchase up to 1,000,000 shares, or
approximately 3%, of our common stock in market transactions for
a period not to exceed twenty-four months. Our prior plan
expired on October 27, 2007. For the years ended
December 31, 2007 and 2006, we did not repurchase any
common stock under either plan. As of December 31, 2007, we
have available up to 1,000,000 shares to be purchased.
On February 8, 2008, our Board of Directors declared a
quarterly dividend of $0.02 per common share. The dividend is
payable on March 31, 2008, to shareholders of record as of
March 14, 2008. Our Board of Directors did not declare any
dividends in 2007 or 2006. 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 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
subsidiaries. We did not receive any dividends from our
Insurance Company Subsidiaries in 2007 or 2006.
57
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Acquisition
In April 2007, we acquired the business of USSU for a purchase
price of $23.0 million. Under the terms of the Agreement,
we acquired the excess workers compensation business and
other related assets. USSU is based in Cleveland, Ohio, and is a
specialty program manager that produces fee based income by
underwriting excess workers compensation coverage for a
select group of insurance companies.
Goodwill associated with this acquisition was approximately
$12.0 million. In addition, we recorded an increase to
other intangible assets of approximately $9.5 million.
These other intangible assets related to customer relationships
acquired with the acquisition. We determined that the estimated
useful life of the other intangible assets to be approximately
five years. As such, we will amortize the $9.5 million in
other intangible assets over a five year period.
In addition, we entered into a Management Agreement with the
former owners of USSU. Under the terms the Management Agreement,
the former owners were responsible for certain aspects of the
daily administration and management of the USSU business. Their
consideration for the performance of these duties was in the
form of a management fee payable by us based on a share of net
income before interest, taxes, depreciation, and amortization.
We retained the option to terminate the Management Agreement, at
our discretion, based on a multiple of the management fee
calculated for the trailing twelve months. On January 31,
2008, we exercised this option to purchase the remainder of the
economics related to the acquisition of the USSU business, by
eliminating the Management Agreement for a payment of
$21.5 million, which now completes the transaction. As a
result of this purchase, we recorded an increase to other
intangible assets of approximately $11.4 million and an
increase to goodwill of approximately $10.1 million.
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,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Net earned premiums
|
|
$
|
268,197
|
|
|
$
|
254,920
|
|
|
$
|
249,959
|
|
Less: Consolidated net loss and LAE
|
|
|
150,969
|
|
|
|
146,293
|
|
|
|
151,542
|
|
Intercompany claim fees
|
|
|
13,058
|
|
|
|
12,553
|
|
|
|
11,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated net loss and LAE
|
|
|
164,027
|
|
|
|
158,846
|
|
|
|
163,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated policy acquisition and other underwriting expenses
|
|
|
53,717
|
|
|
|
50,479
|
|
|
|
44,439
|
|
Intercompany administrative and other underwriting fees
|
|
|
37,890
|
|
|
|
37,442
|
|
|
|
39,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unconsolidated policy acquisition and other underwriting expenses
|
|
|
91,607
|
|
|
|
87,921
|
|
|
|
83,670
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting income
|
|
$
|
12,563
|
|
|
$
|
8,153
|
|
|
$
|
3,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
GAAP combined ratio as reported
|
|
|
95.4
|
%
|
|
|
96.8
|
%
|
|
|
98.7
|
%
|
Specialty risk management operations pre-tax income
|
|
$
|
47,898
|
|
|
$
|
38,292
|
|
|
$
|
29,546
|
|
Less: Underwriting income
|
|
|
12,563
|
|
|
|
8,153
|
|
|
|
3,224
|
|
Net investment income and capital gains
|
|
|
26,550
|
|
|
|
22,144
|
|
|
|
18,142
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee-based operations pre-tax income
|
|
|
8,785
|
|
|
|
7,995
|
|
|
|
8,180
|
|
Agency operations pre-tax income
|
|
|
2,087
|
|
|
|
2,609
|
|
|
|
3,241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
fee-for-service
pre-tax income
|
|
$
|
10,872
|
|
|
$
|
10,604
|
|
|
$
|
11,421
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP expense ratio as reported
|
|
|
34.2
|
%
|
|
|
34.5
|
%
|
|
|
33.5
|
%
|
Adjustment to include pre-tax income from total
fee-for-service
income(1)
|
|
|
4.1
|
%
|
|
|
4.2
|
%
|
|
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP expense ratio as adjusted
|
|
|
30.1
|
%
|
|
|
30.3
|
%
|
|
|
28.9
|
%
|
GAAP loss and LAE ratio as reported
|
|
|
61.2
|
%
|
|
|
62.3
|
%
|
|
|
65.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP combined ratio as adjusted
|
|
|
91.3
|
%
|
|
|
92.6
|
%
|
|
|
94.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation of consolidated pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty risk management operations pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fee-based operations pre-tax income
|
|
$
|
8,785
|
|
|
$
|
7,995
|
|
|
$
|
8,180
|
|
Underwriting income
|
|
|
12,563
|
|
|
|
8,153
|
|
|
|
3,224
|
|
Net investment income and capital gains
|
|
|
26,550
|
|
|
|
22,144
|
|
|
|
18,142
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total specialty risk management operations pre-tax income
|
|
|
47,898
|
|
|
|
38,292
|
|
|
|
29,546
|
|
Agency operations pre-tax income
|
|
|
2,087
|
|
|
|
2,609
|
|
|
|
3,241
|
|
Less: Holding company expenses
|
|
|
2,638
|
|
|
|
2,830
|
|
|
|
2,892
|
|
Interest expense
|
|
|
6,030
|
|
|
|
5,976
|
|
|
|
3,856
|
|
Amortization expense
|
|
|
1,930
|
|
|
|
590
|
|
|
|
373
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated pre-tax income
|
|
$
|
39,387
|
|
|
$
|
31,505
|
|
|
$
|
25,666
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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. |
Regulatory
A significant portion of our consolidated assets represent
assets of our Insurance Company Subsidiaries. The State of
Michigan Office of Financial and Insurance Services
(OFIS), restricts the amount of funds that may be
transferred to us in the form of dividends, loans or advances.
These restrictions in general, are as follows: the maximum
discretionary dividend that may be declared, based on data from
the preceding calendar year, is the greater of each insurance
companys net income (excluding realized capital gains) or
ten percent of the insurance companys surplus (excluding
unrealized gains). These dividends are further limited by a
clause in the Michigan law that prohibits an insurer from
declaring dividends except out of surplus earnings of the
company. Earned surplus balances are calculated on a quarterly
basis. Since Star is the parent insurance company, its maximum
dividend calculation represents the combined Insurance Company
Subsidiaries surplus. At December 31, 2007,
Stars earned surplus position was positive
$33.7 million. At December 31, 2006, Star had positive
earned surplus of $13.2 million. Based upon Stars
statutory financial statements as of December 31, 2007,
Star would have the potential to pay a dividend of up to
$18.8 million without the prior approval of OFIS. No
statutory dividends were paid during 2007 or 2006.
59
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Our Insurance Company Subsidiaries are required to maintain
certain deposits with regulatory authorities, which totaled
$115.2 million and $148.8 million at December 31,
2007 and 2006, respectively.
Contractual
Obligations and Commitments
The following table is a summary of our contractual obligations
and commitments as of December 31, 2007 (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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lines of Credit(1)
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Note Payable, non-interest bearing
|
|
|
4,300
|
|
|
|
2,150
|
|
|
|
2,150
|
|
|
|
|
|
|
|
|
|
Long-Term Debt(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior debentures due 2034; issued $13.0 million, April
2004 with variable interest
|
|
|
13,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,000
|
|
Senior debentures due 2034; issued $12.0 million, May 2004
with variable interest
|
|
|
12,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,000
|
|
Junior subordinated debentures due 2035; issued
$20.6 million, September 2005, with variable interest
|
|
|
20,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,620
|
|
Junior subordinated debentures due 2033; issued
$10.3 million, September 2003, with variable interest
|
|
|
10,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Long-Term Debt
|
|
|
60,230
|
|
|
|
2,150
|
|
|
|
2,150
|
|
|
|
|
|
|
|
55,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Payable(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest on Lines of Credit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest on Long-Term Debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior debentures due 2034; issued $13.0 million, April
2004 with variable interest
|
|
|
8,071
|
|
|
|
1,153
|
|
|
|
2,306
|
|
|
|
2,306
|
|
|
|
2,306
|
|
Senior debentures due 2034; issued $12.0 million, May 2004
with variable interest
|
|
|
7,722
|
|
|
|
1,092
|
|
|
|
2,200
|
|
|
|
2,215
|
|
|
|
2,215
|
|
Junior subordinated debentures due 2035; issued
$20.6 million, September 2005, with variable interest
|
|
|
12,231
|
|
|
|
1,721
|
|
|
|
3,442
|
|
|
|
3,534
|
|
|
|
3,534
|
|
60
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less Than
|
|
|
One to
|
|
|
Three to
|
|
|
More Than
|
|
|
|
Total
|
|
|
One Year
|
|
|
Three Years
|
|
|
Five Years
|
|
|
Five Years
|
|
|
Junior subordinated debentures due 2033; issued
$10.3 million, September 2003, with variable interest
|
|
|
6,411
|
|
|
|
916
|
|
|
|
1,831
|
|
|
|
1,832
|
|
|
|
1,832
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest Payable
|
|
|
34,435
|
|
|
|
4,882
|
|
|
|
9,779
|
|
|
|
9,887
|
|
|
|
9,887
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease obligations(4)
|
|
|
16,797
|
|
|
|
4,904
|
|
|
|
6,892
|
|
|
|
3,444
|
|
|
|
1,557
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regulated companies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses(5)
|
|
|
540,002
|
|
|
|
139,109
|
|
|
|
192,243
|
|
|
|
100,231
|
|
|
|
108,419
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
651,464
|
|
|
$
|
151,045
|
|
|
$
|
211,064
|
|
|
$
|
113,562
|
|
|
$
|
175,793
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Relates to our revolving line of credit. |
|
(2) |
|
Five year call feature associated with debentures, estimated
seven year repayment. |
|
(3) |
|
For interest rate terms and actual rates on long-term debt in
effect as of December 31, 2007, refer to the Long-term
Debt section within Other Items of the Liquidity
and Capital Resources section of Managements
Discussion and Analysis. Estimates of interest expense for
future periods are based on the most current interest rates in
effect: on $13.0 million senior debentures at 8.87%; on
$12.0 million senior debentures at 9.23%; on
$20.6 million junior subordinated debentures at 8.57%; and
on $10.3 million junior subordinated debentures at 8.88%.
The assumption that the loans will be repaid at the end of seven
years is based on managements best estimate of the life of
the debentures. |
In addition, there are two interest rate swaps associated with
our long-term debt. The first interest rate swap relates to
$5.0 million of our $12.0 million of senior
debentures, which has a fixed interest rate of 8.925% with an
ending date of May 24, 2009. The second interest rate swap
relates to $20.0 million of our $20.6 million junior
subordinated debentures, which has a fixed interest rate of
8.34% with an ending date of September 16, 2010.
|
|
|
(4) |
|
Consists of rental obligations under real estate leases related
to branch offices. In addition, includes amounts related to
equipment leases. |
|
(5) |
|
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 $198.5 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 $31.5 million, $69.9 million,
$46.1 million, and $51.0 million, respectively,
resulting in net losses and loss adjustment expenses of
$107.6 million, $122.4 million, $54.1 million,
and $57.4 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
61
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
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.
Both the Bonus Plan and the LTIP are administered by the
Compensation Committee 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, 2007, 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 2.8 to 1.0 and 2.25 to
1.0, respectively. As of December 31, 2007, on a statutory
consolidated basis, gross and net premium leverage ratios were
1.8 to 1.0 and 1.5 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 2007, our
Insurance Company Subsidiaries did not generate any ratios that
departed from the usual value range.
In April 2007, we received an upgrade of our financial strength
rating by A.M. Best Company to A−
(Excellent), from B++ (Very Good) for our Insurance
Company Subsidiaries.
62
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Reinsurance
Considerations
We seek to manage the risk exposure of our Insurance Company
Subsidiaries 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, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance Premium Ceded
|
|
|
Reinsurance Recoverable
|
|
|
A.M. Best
|
Reinsurer
|
|
December 31, 2007
|
|
|
December 31, 2007
|
|
|
Rating
|
|
|
(In thousands)
|
|
|
(In thousands)
|
|
|
|
|
Employers Reinsurance Corporation
|
|
$
|
4,582
|
|
|
$
|
84,880
|
|
|
|
A+
|
|
Munich American Reinsurance
|
|
|
5,653
|
|
|
|
12,269
|
|
|
|
A+
|
|
Aspen Insurance UK Ltd.
|
|
|
5,140
|
|
|
|
11,125
|
|
|
|
A
|
|
Motors Insurance Company
|
|
|
4,213
|
|
|
|
11,948
|
|
|
|
A−
|
|
Lloyds Syndicate Number 4472
|
|
|
3,832
|
|
|
|
5,324
|
|
|
|
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.
We have historically maintained an allowance for the potential
exposure to uncollectibility of certain reinsurance balances. At
the end of each quarter, an analysis of these exposures is
conducted to determine the potential exposure to
uncollectibility. The following table sets forth our exposure to
uncollectible reinsurance and related allowances for years
ending December 31, 2007 and 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
December 31, 2006
|
|
|
|
Non Risk
|
|
|
Risk
|
|
|
|
|
|
Non Risk
|
|
|
Risk
|
|
|
|
|
|
|
Sharing(1)
|
|
|
Sharing(2)
|
|
|
Total
|
|
|
Sharing(1)
|
|
|
Sharing(2)
|
|
|
Total
|
|
|
Gross exposure
|
|
$
|
4,959
|
|
|
$
|
7,150
|
|
|
$
|
12,109
|
|
|
$
|
6,863
|
|
|
$
|
7,952
|
|
|
$
|
14,815
|
|
Collateral or other security
|
|
|
(1
|
)
|
|
|
(3,114
|
)
|
|
|
(3,115
|
)
|
|
|
(170
|
)
|
|
|
(3,453
|
)
|
|
|
(3,623
|
)
|
Allowance
|
|
|
(4,873
|
)
|
|
|
(3,268
|
)
|
|
|
(8,141
|
)
|
|
|
(6,693
|
)
|
|
|
(3,038
|
)
|
|
|
(9,731
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net exposure
|
|
$
|
85
|
|
|
$
|
768
|
|
|
$
|
853
|
|
|
$
|
|
|
|
$
|
1,461
|
|
|
$
|
1,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Balances related to three unaffiliated insurance companies,
which are under regulatory liquidation or control, for which
allowances have been established; all other admitted reinsurers
have an A.M. Best rating of A− or better. |
63
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
|
|
|
(2) |
|
Balances related to risk-sharing partners, which have either
captive or
rent-a-captive
quota-share reinsurance contracts with us. |
Intercompany
Pooling Agreement
Intercompany pooling or reinsurance agreements are commonly
entered into between affiliated insurance companies, so as to
allow the companies to utilize the capital and surplus of all of
the companies, rather than each individual company. Under
pooling arrangements, companies share in the insurance business
that is underwritten and allocate the combined premium, losses
and related expenses between the companies within the pooling
arrangement. The Insurance Company Subsidiaries entered into an
Inter-Company Reinsurance Agreement (the Pooling
Agreement). This Pooling Agreement includes Star,
Ameritrust Insurance Corporation (Ameritrust),
Savers Property and Casualty Insurance Company
(Savers) and Williamsburg National Insurance Company
(Williamsburg). Pursuant to the Pooling Agreement,
Savers, Ameritrust and Williamsburg have agreed to cede to Star
and Star has agreed to reinsure 100% of the liabilities and
expenses of Savers, Ameritrust and Williamsburg, relating to all
insurance and reinsurance policies issued by them. In return,
Star agreed to cede and Savers, Ameritrust and Williamsburg have
agreed to reinsure Star for their respective percentages of the
liabilities and expenses of Star. Annually, we examine the
Pooling Agreement for any changes to the ceded percentage for
the liabilities and expenses. Any changes to the Pooling
Agreement must be submitted to the applicable regulatory
authorities for approval.
Off-Balance
Sheet Arrangements
As of December 31, 2007, 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, beginning in 2008. The conversion feature of this note
is considered an embedded derivative pursuant to
SFAS No. 133, and therefore is accounted for
separately from the note. At December 31, 2007, the
estimated fair value of the derivative is not material to the
financial statements.
Recent
Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 157, Fair Value
Measurements. SFAS No. 157 defines fair
value and establishes a framework for measuring fair value in
accordance with generally accepted accounting principles.
SFAS No. 157 also requires expanded disclosures about
(1) the extent to which companies measure assets and
liabilities at fair value, (2) the methods and assumptions
used to measure fair value and (3) the effect of fair value
measures on earnings. SFAS No. 157 is effective for
fiscal years beginning after November 15, 2007. We will
adopt SFAS No. 157 on January 1, 2008. We do not
believe the adoption of SFAS No. 157 will have a
material impact on our consolidated financial condition or
results of operations.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB
Statement No. 115. SFAS No. 159 permits
entities the option to measure many financial instruments and
certain other assets and liabilities at fair value on an
64
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
instrument-by-instrument
basis as of specified election dates. This election is
irrevocable. The objective of SFAS No. 159 is to
improve financial reporting and reduce the volatility in
reported earnings caused by measuring related assets and
liabilities differently. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007. We did not
elect the fair value option for existing eligible items under
SFAS No. 159; therefore there will be no impact to our
consolidated financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations.
SFAS No. 141(R) provides revised guidance on how an
acquirer recognizes and measures in its financial statements,
the identifiable assets acquired, the liabilities assumed, and
any noncontrolling interest in the acquiree. In addition, it
provides revised guidance on the recognition and measurement of
goodwill acquired in the business combination.
SFAS No. 141(R) also establishes disclosure
requirements to enable the evaluation of the nature and
financial effects of the business combination.
SFAS No. 141(R) is effective for business combinations
completed on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008,
or January 1, 2009. We do not expect the provisions of
SFAS No. 141(R) to have a material effect on our
consolidated financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements an amendment of Accounting Research
Bulletin No. 51. SFAS No. 160
establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 is
effective for fiscal years beginning after December 15,
2008. We will evaluate the impact of SFAS No. 160, but
believe the adoption of SFAS No. 160 will not impact
our consolidated financial statements.
Related
Party Transactions
At December 31, 2007 and 2006, respectively, we held an
$870,000 and $871,000 note receivable, including $209,000 of
accrued interest at December 31, 2007, from one of our
executive officers. Accrued interest at December 31, 2006
was $210,000. 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, 2007, the rate was 6.2%. The loan is partially
collateralized by 64,718 shares of our common stock under a
stock pledge agreement. For the years ended December 31,
2007 and 2006, $43,800 and $31,500, respectively, have been paid
against the accrued interest on the loan. On June 1, 2001,
the officer entered into an employment agreement which provides
the note is a non-recourse loan and our sole legal remedy in the
event of a default is the right to reclaim the shares pledged
under the stock pledge agreement. As of December 31, 2007,
the cumulative amount that has been paid against this loan was
$162,800. Refer to Note 16 Related Party
Transaction for further information.
Subsequent
Events
U.S.
Specialty Underwriters, Inc.
In April 2007, we entered into an agreement to acquire the
excess workers compensation business of
U.S. Specialty Underwriters, Inc. (USSU) for a
purchase price of $23.0 million. In addition, we entered
into a Management Agreement with the former owners of USSU.
Under the terms the Management Agreement, the former owners were
responsible for certain aspects of the daily administration and
management of the USSU business. Their consideration for the
performance of these duties was in the form of a management fee
payable by us based on a share of net income before interest,
taxes, depreciation, and amortization. We retained the option to
terminate the Management Agreement, at our discretion, based on
a multiple of the management fee calculated for the trailing
twelve months.
65
MEADOWBROOK
INSURANCE GROUP, INC.
MANAGEMENTS
DISCUSSION AND ANALYSIS continued
Effective January 31, 2008, we exercised this option to
purchase the remainder of the economics related to the
acquisition of the USSU business, by eliminating the Management
Agreement for a payment of $21.5 million, which now
completes the transaction. As a result of this purchase, we
recorded an increase to other intangible assets of approximately
$11.4 million and an increase to goodwill of approximately
$10.1 million.
Merger
Agreement with ProCentury Corporation
On February 20, 2008, we executed a definitive merger
agreement with ProCentury Corporation (ProCentury)
for a merger transaction valued at approximately
$272.6 million in cash and stock to be paid to ProCentury
shareholders. The combined entity will adopt and operate under
the Meadowbrook name and will continue to trade on the NYSE
under the ticker symbol MIG.
Each ProCentury shareholder will have the option to elect to
receive cash or Meadowbrook stock, subject to proration so that
the maximum total cash consideration will not exceed 45% of the
total consideration paid in order to preserve the tax-free
exchange of the stock consideration. As long as
Meadowbrooks
30-day
volume-weighted average price preceding the election date, which
will be at least five days before the closing of the
transaction, is between $8.00 and $10.50, the exchange ratio
will vary such that the stock consideration equals $20.00 per
share based on such
30-day
average price. Above or below this range for Meadowbrooks
stock price, the exchange ratio will be fixed as if the
30-day
volume-weighted average price preceding the election date
equaled $10.50 or $8.00, as applicable. Outstanding options to
purchase ProCentury common shares will become fully vested and
option holders can either exercise such options and, in
connection with the closing, elect to receive the form of merger
consideration described above for the ProCentury shares acquired
on exercise or agree to have their options cancelled in exchange
for a per share cash payment equal to the difference between
$20.00 and the exercise price of their options.
We expect to finance the cash portion of the purchase price
through a combination of cash and debt. Completion of the
transaction is subject to various closing conditions, including
the receipt of required regulatory and shareholder approvals.
The transaction is expected to be completed in the third quarter
of 2008.
66
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, 2007. 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, 2007, our fixed income
portfolio had a modified duration of 4.22, compared to 3.93 at
December 31, 2006.
At December 31, 2007, the fair value of our investment
portfolio was $610.8 million. Our market risk to the
investment portfolio is interest rate risk associated with debt
securities. Our exposure to equity price risk is not
significant. Our investment philosophy is one of maximizing
after-tax earnings and has historically included significant
investments in tax-exempt bonds. We continued to increase our
holdings of tax-exempt securities based on our return to
profitability and 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, 2006. 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 rounded and in thousands.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rates Down 100bps
|
|
|
Rates Unchanged
|
|
|
Rates Up 100bps
|
|
|
Market Value
|
|
$
|
637,372
|
|
|
$
|
610,682
|
|
|
$
|
582,995
|
|
Yield to Maturity or Call
|
|
|
3.28
|
%
|
|
|
4.28
|
%
|
|
|
5.28
|
%
|
Effective Duration
|
|
|
4.14
|
|
|
|
4.42
|
|
|
|
4.68
|
|
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 loss 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, 2007 and 2006, we
had debentures of $55.9 million. At this level, a
100 basis point (1%) change in market rates would change
annual interest expense by $559,000.
In October 2005, we entered into two interest rate swap
transactions to mitigate our interest rate risk on
$5.0 million and $20.0 million of our senior
debentures and trust preferred securities, respectively. We
accrue for these transactions in accordance with
SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities, as subsequently
amended. These interest rate swap transactions have been
designated as a cash flow hedges and are deemed highly effective
hedges under SFAS No. 133. In accordance with
SFAS No. 133, these interest rate swap transactions
are recorded at fair value on the balance sheet and the
effective portion of
67
MEADOWBROOK
INSURANCE GROUP, INC.
any changes in fair value are accounted for within other
comprehensive income. The interest differential to be paid or
received is being accrued and is being recognized as an
adjustment to interest expense.
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, 2007, we did not have an outstanding balance
on this revolving line of credit. At December 31, 2006, we
had $7.0 million outstanding on this revolving line of
credit. At this level, a 100 basis point (1%) change in
market rates would have changed interest expense by $70,000.
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
Refer to list of Financial Statement Schedules and
Note 19 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, 2007, 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 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
68
MEADOWBROOK
INSURANCE GROUP, INC.
over financial reporting as of December 31, 2007. 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, 2007, our internal controls over financial
reporting was 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, 2007, 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 9, 2008, 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, and Compensation Committee
Interlocks and Insider Participation of our Proxy
Statement relating to our Annual Meeting of Shareholders to be
held on May 9, 2008, which is hereby incorporated by
reference.
|
|
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 9, 2008,
which is hereby incorporated by reference.
69
MEADOWBROOK
INSURANCE GROUP, INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
132,052
|
|
|
$
|
14.51
|
|
|
|
771,468
|
|
Equity compensation plans not approved by security holders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
132,052
|
|
|
$
|
14.51
|
|
|
|
771,468
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 9, 2008,
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 9, 2008,
which is hereby incorporated by reference.
70
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:
|
|
|
|
|
|
|
|
|
|
|
|
72
|
|
|
|
|
|
|
|
|
73
|
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
75
|
|
|
|
|
|
|
|
|
76
|
|
|
|
|
|
|
|
|
77
|
|
|
|
|
|
|
|
|
78
|
|
|
|
|
|
|
|
|
79-109
|
|
|
2.
|
|
|
Financial Statement Schedules
|
|
|
|
|
|
|
|
|
|
|
|
110
|
|
|
|
|
|
|
|
|
111-114
|
|
|
|
|
|
|
|
|
115-117
|
|
|
|
|
|
|
|
|
118
|
|
|
|
|
|
|
|
|
119
|
|
|
|
|
|
|
|
|
120
|
|
|
3.
|
|
|
Exhibits: The Exhibits listed on the accompanying
Exhibit Index immediately following the financial statement
schedule are filed as part of, or incorporated by reference
into, this
Form 10-K
|
|
|
|
|
Management Services Agreement |
Management Services Agreement |
Land Contract Amendment |
Compliance Program/Code of Conduct |
List of Subsidiaries |
Consent of Independent Registered Public Accounting Firm |
Power of Attorney |
Certification of Robert S. Cubbin, Chief Executive Officer, pursuant to Rule 13a-14(a) |
Certification of Karen M. Spaun, Chief Financial Officer, pursuant to Rule 13-14(a) |
Certification pursuant to Section 906, signed by Robert S. Cubbin, Chief Executive Officer |
Certification pursuant to Section 906, signed by Karen M. Spaun, Chief Financial Officer |
71
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Meadowbrook Insurance Group, Inc.:
We have audited the accompanying consolidated balance sheets of
Meadowbrook Insurance Group, Inc. as of December 31, 2007
and 2006, and the related consolidated statements of income,
comprehensive income, shareholders equity, and cash flows
for each of the three years in the period ended
December 31, 2007. Our audits also included the financial
statement schedules listed in the Index at Item 15(a).
These financial statements and schedules are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these financial statements and schedules
based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Meadowbrook Insurance Group, Inc. at
December 31, 2007 and 2006, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2007, in conformity with
U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when
considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the
information set forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
Meadowbrook Insurance Group, Inc.s internal control over
financial reporting as of December 31, 2007, based on
criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated March 14, 2008
expressed an unqualified opinion thereon.
Detroit, Michigan
March 14, 2008
72
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
Meadowbrook Insurance Group, Inc.:
We have audited Meadowbrook Insurance Group, Inc.s
internal control over financial reporting as of
December 31, 2007 based on criteria established in Internal
Control Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Meadowbrook Insurance Group, Inc.s management
is responsible for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness
of internal control over financial reporting included in the
accompanying Managements Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion
on the companys internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control 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 become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, Meadowbrook Insurance Group, Inc. maintained, in
all material respects, effective internal control over financial
reporting as of December 31, 2007, based on the COSO
criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Meadowbrook Insurance Group, Inc.
as of December 31, 2007 and 2006, and the related
consolidated statements of income, comprehensive income,
shareholders equity, and cash flows for each of the three
years in the period ended December 31, 2007 and our report
dated March 14, 2008 expressed an unqualified opinion
thereon.
Detroit, Michigan
March 14, 2008
73
MEADOWBROOK
INSURANCE GROUP, INC.
CONSOLIDATED
BALANCE SHEET
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands,
|
|
|
|
except share data)
|
|
|
ASSETS
|
Investments
|
|
|
|
|
|
|
|
|
Debt securities available for sale, at fair value (amortized
cost of $604,829 and $486,213 in 2007 and 2006, respectively)
|
|
$
|
610,756
|
|
|
$
|
484,724
|
|
Cash and cash equivalents
|
|
|
40,845
|
|
|
|
42,876
|
|
Accrued investment income
|
|
|
6,473
|
|
|
|
5,884
|
|
Premiums and agent balances receivable (net of allowance of
$2,747 and $2,948 in 2007 and 2006, respectively)
|
|
|
87,341
|
|
|
|
85,578
|
|
Reinsurance recoverable on:
|
|
|
|
|
|
|
|
|
Paid losses
|
|
|
1,053
|
|
|
|
4,257
|
|
Unpaid losses
|
|
|
198,461
|
|
|
|
198,422
|
|
Prepaid reinsurance premiums
|
|
|
17,763
|
|
|
|
20,425
|
|
Deferred policy acquisition costs
|
|
|
26,926
|
|
|
|
27,902
|
|
Deferred income taxes, net
|
|
|
14,936
|
|
|
|
15,732
|
|
Goodwill
|
|
|
43,497
|
|
|
|
31,502
|
|
Other assets
|
|
|
65,915
|
|
|
|
51,698
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,113,966
|
|
|
$
|
969,000
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY
|
Liabilities
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses
|
|
$
|
540,002
|
|
|
$
|
501,077
|
|
Unearned premiums
|
|
|
153,927
|
|
|
|
144,575
|
|
Debt
|
|
|
|
|
|
|
7,000
|
|
Debentures
|
|
|
55,930
|
|
|
|
55,930
|
|
Accounts payable and accrued expenses
|
|
|
22,604
|
|
|
|
25,384
|
|
Reinsurance funds held and balances payable
|
|
|
16,416
|
|
|
|
15,124
|
|
Payable to insurance companies
|
|
|
6,231
|
|
|
|
5,442
|
|
Other liabilities
|
|
|
16,962
|
|
|
|
12,775
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
812,072
|
|
|
|
767,307
|
|
|
|
|
|
|
|
|
|
|
Shareholders Equity
|
|
|
|
|
|
|
|
|
Common stock, $0.01 stated value; authorized
75,000,000 shares; 36,996,287 and 29,107,818 shares
issued and outstanding
|
|
|
370
|
|
|
|
291
|
|
Additional paid-in capital
|
|
|
194,621
|
|
|
|
126,828
|
|
Retained earnings
|
|
|
104,274
|
|
|
|
76,282
|
|
Note receivable from officer
|
|
|
(870
|
)
|
|
|
(871
|
)
|
Accumulated other comprehensive income (loss)
|
|
|
3,499
|
|
|
|
(837
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
301,894
|
|
|
|
201,693
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
1,113,966
|
|
|
$
|
969,000
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the Consolidated
Financial Statements.
74
MEADOWBROOK
INSURANCE GROUP, INC.
CONSOLIDATED
STATEMENT OF INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except share and per share data)
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
$
|
337,099
|
|
|
$
|
327,287
|
|
|
$
|
325,522
|
|
Ceded
|
|
|
(68,902
|
)
|
|
|
(72,367
|
)
|
|
|
(75,563
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
|
268,197
|
|
|
|
254,920
|
|
|
|
249,959
|
|
Net commissions and fees
|
|
|
45,988
|
|
|
|
41,172
|
|
|
|
35,916
|
|
Net investment income
|
|
|
26,400
|
|
|
|
22,075
|
|
|
|
17,975
|
|
Net realized gains
|
|
|
150
|
|
|
|
69
|
|
|
|
167
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
340,735
|
|
|
|
318,236
|
|
|
|
304,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses
|
|
|
191,885
|
|
|
|
212,383
|
|
|
|
237,775
|
|
Reinsurance recoveries
|
|
|
(40,916
|
)
|
|
|
(66,090
|
)
|
|
|
(86,233
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses
|
|
|
150,969
|
|
|
|
146,293
|
|
|
|
151,542
|
|
Salaries and employee benefits
|
|
|
56,433
|
|
|
|
54,569
|
|
|
|
51,331
|
|
Policy acquisition and other underwriting expenses
|
|
|
53,717
|
|
|
|
50,479
|
|
|
|
44,439
|
|
Other administrative expenses
|
|
|
32,269
|
|
|
|
28,824
|
|
|
|
26,810
|
|
Amortization expense
|
|
|
1,930
|
|
|
|
590
|
|
|
|
373
|
|
Interest expense
|
|
|
6,030
|
|
|
|
5,976
|
|
|
|
3,856
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
301,348
|
|
|
|
286,731
|
|
|
|
278,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes and equity earnings
|
|
|
39,387
|
|
|
|
31,505
|
|
|
|
25,666
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal and state income tax expense
|
|
|
11,726
|
|
|
|
9,599
|
|
|
|
7,757
|
|
Equity earnings of affiliates
|
|
|
331
|
|
|
|
128
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
27,992
|
|
|
$
|
22,034
|
|
|
$
|
17,910
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.85
|
|
|
$
|
0.76
|
|
|
$
|
0.62
|
|
Diluted
|
|
$
|
0.85
|
|
|
$
|
0.75
|
|
|
$
|
0.60
|
|
Weighted average number of common shares
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
33,007,200
|
|
|
|
28,963,228
|
|
|
|
28,961,229
|
|
Diluted
|
|
|
33,101,965
|
|
|
|
29,566,141
|
|
|
|
29,653,067
|
|
The accompanying notes are an integral part of the Consolidated
Financial Statements.
75
MEADOWBROOK
INSURANCE GROUP, INC.
CONSOLIDATED
STATEMENT OF COMPREHENSIVE INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
Net income
|
|
$
|
27,992
|
|
|
$
|
22,034
|
|
|
$
|
17,910
|
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on securities
|
|
|
4,810
|
|
|
|
152
|
|
|
|
(6,023
|
)
|
Net deferred derivative (loss) gain hedging activity
|
|
|
(484
|
)
|
|
|
121
|
|
|
|
9
|
|
Less: reclassification adjustment for gains included in net
income
|
|
|
10
|
|
|
|
20
|
|
|
|
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|