THE MIDLAND COMPANY
7000 Midland Boulevard
Amelia, Ohio 45102-2607
July 25, 2006
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
United States Securities and Exchange Commission
Washington, D.C. 20549
RE: | The Midland Company Form 10-K for fiscal year ended December 31, 2005 File No. 1-06026 |
Dear Mr. Rosenberg:
This letter sets forth below the detailed responses of The Midland Company (the “Company”) to the comments of the Staff of the Commission in its letter to the Company dated June 27, 2006, with respect to the above referenced Form 10-K filing of the Company. In responding to the Staff’s comments, we have utilized the headings and numbering system in the Staff’s letter. This letter has been filed with the Commission as correspondence through EDGAR.
Form 10-K for fiscal year ended December 31, 2005
Management’s Discussion and Analysis
Results of Operations, page 19
1. | YourMD&Adiscussionin“underwritingresults”omitsquantificationofthespecificfactorsunderlyingthechangeinyourunderwritingresults.Pleaseprovideareviseddiscussionindisclosure-typeformatthatquantifiesthefactorsunderlyingthechangeinyourunderwritingresultsandinparticulardiscussestheimpactofyourreinsuranceactivitiesandchangeinprioryearreserveestimatesforeachperiodpresented.Also,provideanexpandeddiscussionandquantificationofthehistoricalandexpectedcontinuingimpactonyouroperatingresultsrelatedtothefollowingeventsoractivities. |
• | Catastrophes in 2005 including “reinstatement premiums and other catastrophe related items.” |
• | The 2001 exit from the commercial liability product line and related reserve deficiencies and reserve releases. |
• | Reserve overstatements relatedtothemotorcycle,excessandsurplus andpersonalliabilitylinesofbusiness.Explain thedegreetowhichtheselinesare“inherently lesspredictable”ascomparedtoyour traditionalpropertycoverage. |
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• | Rateincreasesandcorrectiveunderwritingactions intheresidentialpropertyandrecreationalcasualty segments. |
• | Theactivitiesthatproduced suchsignificantimprovementinoperating resultsforthe“allother”segmentin theperiods2003-2005. |
Response – Midland acknowledges the Staff’s comments and intends to make the appropriate modifications to all future filings, beginning with the Form 10-Q for the period ending June 30, 2006. The revised disclosures will include the following as appropriate: |
• | Catastrophesin2005including“reinstatementpremiumsandothercatastropherelateditems.” |
HurricaneKatrina,alongwithhurricanesRitaandWilma,producedhigherthannormalcatastrophelossesin2005.Weestimatethatthesehigherthannormalcatastrophelosses,afterconsideringreinsurancerecoveries,reinstatementpremiumsandthecostofpurchasingthirdandfourtheventcovers,reducedpre-taxearningsbyapproximately$13.7million,or$0.46pershare(diluted). |
PleaseseeourresponsetoComment#10forfurtherdiscussionregardingtheimpactofreinsuranceonour2005resultsanddiscussionregardingtheimpactthesehighercatastrophelosseswillhaveonour2006resultsintheformofhigherreinsurancecosts. |
• | The2001exitfromthecommercialliabilityproductlineandrelatedreservedeficienciesandreservereleases. |
InSeptember2001,AmericanModernexitedthemanufacturedhousingparkanddealercommercialliabilitybusiness.Wehavenooutstandingunearnedpremiumrelatedtothisbusiness.During2003,weexperiencedhigherthanexpectedlossesrelatedtothisline.Duetotheadversedevelopment,AmericanModernstrengthenedreserves,inthelatterpartof2003,toaddressthefuturerun-offclaims.In2004and2005,AmericanModernexperiencedfavorabledevelopmentintheclaimssettledforthoseyears,duetolowerthananticipatedseverity,andbelievesthattheremaininglossreservesrecordedat12/31/05areadequatetocoverourlossexposuresfortheremainderoftherun-offperiod. |
Theimprovementinprofitabilityin2004comparedto2003isdueprimarilytotheactionstakentoaddresstherun-offofourexitedmanufacturedhousingparkanddealercommercialliabilitybusiness.During2003,therun-offofthisexitedbusinessreducedpre-taxincomeby$12.1million,or$0.44pershare(diluted).In2004,therun-offoftheseexitedlinesincreasedpre-taxincomeby$2.9million,or$0.10pershare(diluted). |
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Wealsoexperiencedfavorabledevelopmentintheclaimssettledin2005relatedtoourexitedmanufacturedhousingparkanddealercommercialliabilitybusinessastheselinescontributed$2.5millionofpre-taxincome,or$0.08pershare(diluted). |
• | Reserveoverstatementsrelatedtothemotorcycle,excessandsurplusandpersonalliabilitylinesofbusiness.Explainthedegreetowhichtheselinesare“inherentlylesspredictable”ascomparedtoyourtraditionalpropertycoverage. |
Response— Midland acknowledges the Staff’s comment and intends to make the appropriate modifications to all future filings, beginning with the Form 10-K for the period ending December 31, 2006. Such modification will include the incorporation of the following additional or modified language. |
Theredundancyinthemotorcycle,excessandsurpluslines,exitedcommerciallines,andtheliabilitycomponentofourotherpersonallinesbusinessin2004and2005wasgeneratedfromtheactualclosingofclaimsforamountslessthanthatrecordedasacasebasereserveattheendoftheprecedingyear.Theredundantreserveswerereleasedasclaimsweresettledinthenormalcourseofbusiness.Asclaimsaresettled,thisknowledgeandotherfactsareusedinadjustingcurrentreservesandsettingreservesinthefuture.Thecasebaselossdevelopmentpatternsexperiencedoverthelastfewyears,alongwithourhistoricaldevelopmentpatterns,havebeenconsideredinourestimationoftheincurredbutnotreportedlossreserves. |
PleaseseeourresponsetoComment#8forfurtherdiscussionregardingourinsurancelossreservepoliciesandprocedures. |
• | Rateincreasesandcorrectiveunderwritingactionsintheresidentialpropertyandrecreationalcasualty segments. |
Midland acknowledges the Staff’s comment and intends to make the appropriate modifications to all future filings, beginning with the Form 10-Q for the period ending June 30, 2006. Such modification will include the incorporation of the following additional or modified language. |
AmericanModernhasobtained,andwillcontinuetoseektoobtain,rateincreaseswhennecessarytoensureprofitabilityinourvariousproductlines.Infact,AmericanModernhasachievedrateincreasesaveraging2.9%,4.5%and5.5%in2005,2004and2003,respectively,relatedtoitsmanufacturedhousingproduct.AmericanModernhasachievedrateincreasesaveraging5.9%,10.0%and8.4%in2005,2004and2003,respectively,relatedtoitssitebuiltdwellingproduct.Inadditiontotheserateincreases,refinedproductreviewsperformedinconjunctionwithourbusinesspartners,combinedwiththeunderwritingimprovementsrealizedfromourmodernLINKsystem,haveincreasedourabilitytoachieveourdesiredprofitabilityinourResidentialPropertylines. |
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AsforourRecreationalCasualtylines,AmericanModernhasachievedrateincreasesaveraging7.4%,19.0%and21.0%in2005,2004and2003,respectively,relatedtoitsmotorcycleproduct.AmericanModernhasalsoachievedrateincreasesrangingfrom5%to9%relatedtoitsotherrecreationalcasualtyproductssuchaswatercraftandrecreationalvehicles.Inadditiontotheserateincreases,AmericanModernhasimplementedseveralunderwritingmodificationssuchas1)restrictionsoncertaintypesofcoveragesandcoastalexposures,2)implementationofamoresophisticatedmotorcyclemake/modeltabletoimproveaccuracyofclassandidentificationofineligibleunits,3)increasedutilizationofMotorVehicleReportsand4)utilizationofourmodernLINKsystem. |
Withrespectto2006,wewouldanticipateanyrateincreasestobeinthelowsingledigitrange. |
• | The activities that produced such significant improvement in operating results for the “all other” segment in the periods 2003-2005. |
Asmentionedinthepreviouscommercialliabilitybulletpoint,theimprovementinprofitabilityin2004comparedto2003isdueprimarilytotheactionstakentoaddresstherun-offofourexitedmanufacturedhousingparkanddealercommercialliabilitybusiness.During2003,therun-offofthisexitedbusinessreducedpre-taxincomeby$12.1million,or$0.44pershare(diluted).In2004,therun-offoftheseexitedlinesincreasedpre-taxincomeby$2.9million,or$0.10pershare(diluted). |
InSeptember2001,AmericanModernexitedthemanufacturedhousingparkanddealercommercialliabilitybusiness.Wehavenooutstandingunearnedpremiumrelatedtothisbusiness.During2003,weexperiencedhigherthanexpectedlossesrelatedtothisline.Duetotheadversedevelopment,AmericanModernstrengthenedreserves,inthelatterpartof2003,toaddressthefuturerun-offclaims.In2004,AmericanModernhasexperiencedfavorabledevelopmentintheclaimssettledfortheyearandbelievesthatthelossexposureisadequatelyreservedfortheremainderoftherun-offperiod. |
Theimprovementinprofitabilityin2005comparedto2004isdueprimarilytotheincreasedprofitabilityrelatedtoourexcessandsurpluslinesbusiness,whichwasdrivenbyincreasedpremiumvolume,andouropenlotdealerbusiness. |
Althoughweexpecttoseesomevariabilityintheunderwritingresultsexperiencedinourexcessandsurpluslinesbusinessandouropenlotdealerbusiness,weexpecttocontinuetoseeprofitabilityrelatedtotheseproductlinesin2006andtheyearsbeyond. |
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2. | Pleaseexpandyourdiscussion,relatingtothenature,purposeandeffectonresultsofoperationsofcededreinsurancetransactions.Inparticular,explainthefactorsunderlyingtheincreaseincededwrittenpremiumsfrom$69.6millionin2004to$107.1millionin2005.Providethisinformationindisclosure-typeformat. |
Response— Midland acknowledges the Staff’s comments and intends to make the appropriate modifications to all future filings, beginning with the June 30, 2006 Form 10-Q. The revised disclosures will include language similar to the following: |
Theincreaseincededpremiumsisduepartiallytoa$14.7millionincreaseinreinstatementpremiumsin2005comparedto2004.Reinstatementpremiums,whichareconsideredcededwrittenpremiums,relatedtopurchasingadditionalreinsuranceinresponsetotheseverehurricaneseasonexperiencedin2005.Theincreaseincededpremiumsisalsoduepartiallytoa$9.5millionincreaserelatedtoourexcessandsurpluslinesbusiness.Theincreaseincededexcessandsurpluslinespremiumsisduetotherelatedincreaseingrossexcessandsurpluslineswrittenpremiumswherewecedeapproximately50%ofthepremiumsgeneratedfromourlargestpartner.Wealsoexperienceda$9.3millionincreaseincededcreditlifepremiumswhichwasduetoanincreaseingrosswrittenpremiumsrelatingtoanaccountwherealargeportionofthepremiumswerecededbacktotheproducingagent’sreinsurancecompany.Theremainderoftheincreasewasrelatedtovariousreinsurancerelationshipswithcertainbusinesspartners. |
PleaseseeourresponsetoComment#10forfurtherdiscussionregardingourcededreinsuranceactivities. |
Aggregate Contractual Obligations and Off Balance Sheet Arrangements, page 28
3. | WewereunabletolocatethedisclosurerequiredbyItem303(a)(4)ofRegulationS-Krelatingtooff-balancesheetarrangements.Pleaseprovidethisinformationindisclosure-typeformatorstatethatnosucharrangementsexist. |
Response– The disclosure required by Item 303 (a) (4) of Regulation S-K relating to off-balance sheet arrangements was omitted as no such arrangements existed as of December 31, 2005. In future filings the Company will provide the following disclosure regarding off-balance sheet arrangements. |
Wedonotutilizeanyspecial-purposefinancingvehiclesorhaveanyundisclosedoff-balancesheetarrangements.Similarly,theCompanyholdsnofair-valuecontractsforwhichalackofmarketplacequotationswouldnecessitatetheuseoffairvaluetechniques. |
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Critical Accounting Policies
Insurance Policy Loss Reserves and Reinsurance Risks, page 35
Webelieveyourdisclosureregardingtheestimationofinsurancelossreserves couldbeimprovedtobetterexplainthejudgmentsanduncertaintiessurrounding thisestimateandthepotentialimpactonyourfinancialstatements.Webelieve inordertomeettheprincipalobjectivesofMD&A,thisdisclosureshouldenable theinvestortounderstandonalineofbusinessbasis1)management’sprocess forestablishingtheestimate,2)thereasonsforchangesinthehistorical estimate,3)whetherandtowhatextentmanagementhasadjustedtheir assumptionsusedinthemostrecentestimatefortrendsorotherfactors identifiedfrompastexperienceand4)thepotentialvariabilityinthemost recentestimateandtheimpactthisvariabilitymayhaveonreportedresults, financialconditionandliquidity.Pleasekeepthisobjectiveinmindin draftingyourresponsestothefollowingcomments.
4. | Youprovideageneralexplanationofreservemethodologiesbutdonotdisclosethespecificreservemethodologiesforeachofyourmajorlinesofbusiness.AsindicatedinourpriorcommentletterdatedJune7,2004,webelievethatinvestors’understandingofthejudgmentsanduncertaintiesinherentinthisestimationprocessisparticularlyimportant.Pleaseprovidethefollowinginformationbylineofbusinessinadisclosure-typeformat. |
• | Describemorespecificallythemethodologiesusedtodeterminetheultimateliabilityforeachlineofbusiness.Forexample,thismightincludeadiscussionofalternativemodelsused,thestrengthsandweaknessesofeachmodelandanexplanationofwhyaspecificmodelwasultimatelychosenovertheothermodelsconsidered.Includeanexpandeddiscussionof“judgmentaltechniques”thatyouusewhenstatisticaldataisinsufficientorunavailable. |
• | ExplainyourprocessforcalculatingtheIBNRreserve.Itisourunderstandingthatcompaniesmaycalculatethisreservebyestimatingtheultimateliabilityfirstandthenreducingthatamountbycumulativepaidclaimsandcasereservesbuttheremaybeothermethodsaswell. |
• | Weunderstandthatyouestablisha“bestestimate”foryourinsurancelossreserves,basedonhistoricalpatternsandotherassumptions.Ifmultiplepointestimatesweregeneratedtodeterminea“bestestimate”,describethedifferentvaluesforthesepointestimates.Includeadiscussionofwhyonepointestimatewasselectedoverotherpointestimates. |
• | Recordedlossreservesforpropertyandcasualtyinsurersgenerallyincludeaprovisionforuncertainty,whichisintendedtocapturetheuncertaintyinmeasuringallthefactorsinherentinthelossreservingprocess.Suchaprovisionmaybeexplicit(i.e.represented |
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bytheexcessofrecordedreservesoveractuarialindications)orimplicitintheassumptionsettingprocess.Youappeartohaveestablishedsuchprovisionsinyourmotorcycle,excessandsurplusandpersonalliabilitylines,whichyoudescribeas“inherentlylesspredictable.”Sothatinvestorscanbetterunderstandthejudgmentsanduncertaintiesinyourlossreservingprocess,describehowyouprovidefortheseuncertaintiesinyourreserveestimationprocessandquantifytherelatedexplicitandimplicitprovisionsbylineofbusinessforeachperiodpresented. |
• | Describethenatureandfrequencyofyourproceduresfordeterminingtheadequacyoflossreserves.Indicatehowtheseproceduresdifferbetweenyourinterimandannualreserveverifications. |
Response – We have combined the response to this comment with our response to Comment #8. |
5. | Pleasedescribeindisclosure-typeformatthosekeyassumptionsthatmateriallyaffectyourestimateofthereserveforlossandlossadjustmentexpenses. |
a. | Foreachofyourkeyassumptionsandforyourprovisionforuncertainty,quantifyandexplainwhatcausedthemtochangehistoricallyovertheperiodspresented. |
b. | Discusswhetherandtowhatextentmanagementhasadjustedeachofthekeyassumptionsandtheprovisionforuncertaintyusedincalculatingthemostrecentestimateofthereserve,giventhehistoricalchanges,currenttrendsobservedand/orotherfactorsdiscussedina.above.Thisdiscussionshouldreconcilethehistoricalchanges,thecurrenttrendsand/orotherfactorsobservedtowhatmanagementhascalculatedasitsmostrecentkeyassumptions. |
Response– We have combined the response to this comment with our response to Comment #8. |
6. | Youindicatethatoriginallossestimatesforcommercialliabilityinsurancesoldtomanufacturedhousingparkoperatorsanddealerswerenotadequateandthatsubsequentreservestrengtheningresultedinanoverstatementofthesereserves.Also,youstatethatreservesforthemotorcycle,excessandsurplusandpersonalliabilitylinesofbusinesswereoverestimated.Thesignificantreservereleasesin2004and2005appeartohavebeencausedbytheseoverstatementsofprioryearreserves.Whileyouattributethesechangesinlossdevelopmenttospecificproductlinesandevents,youdidnotadequatelydiscussthevariationbetweeninitialassumptionsandactualexperience,justifythetimingofsuchchangesinestimate,orexplainhowthisrecentexperiencehaschangedyourexpectation |
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abouttheimpactofemerginglosstrendsonfutureoperatingresults.AsindicatedinourpriorcommentletterdatedJune7,2004,webelievethatinvestors’understandingofthetimingofchangestokeyassumptionstoproperlyreflectemergingnewtrendsinyourlossexperienceisparticularlyimportant.Pleaseprovideanexpandeddiscussionindisclosure-typeformatthatincludesquantificationofthedifferencebetweenyourinitialreserveassumptionsandactualexperience,theneweventsorinformationconsideredinrevisingyourassumptions,suchasinternalandexternaltrenddata,andhowyouprovidedforthecontinuingimpactofsuchexperiencetrendsinyourreserveestimateforeachyearpresented.Ensureyourdisclosureadequatelyjustifiesthetimingofeachchangeinestimate,suchaswhyrecognitionoccurredintheperiodsthatitdidandwasnotrequiredinearlierperiods. |
Midland acknowledges the Staff’s comment and intends to make the appropriate modifications to all future filings, beginning with the Form 10-K for the period ending December 31, 2006. Such modification will include the incorporation of the following additional or modified language. |
Theredundancyinthemotorcycle,excessandsurpluslines,exitedcommerciallines,andtheliabilitycomponentofourotherpersonallinesbusinessin2004and2005wasgeneratedfromtheactualclosingofclaimsforamountslessthanthatrecordedasacasebasereserveattheendoftheprecedingyear.Theredundantreserveswerereleasedasclaimsweresettledinthenormalcourseofbusiness.Asclaimsaresettled,thisknowledgeandotherfactsareusedinadjustingcurrentreservesandsettingreservesinthefuture.Thecasebaselossdevelopmentpatternsexperiencedoverthelastfewyears,alongwithourhistoricaldevelopmentpatterns,havebeenconsideredinourestimationoftheincurredbutnotreportedlossreserves. |
PleaseseeourresponsetoComment#8forfurtherdiscussionregardingourinsurancelossreservepoliciesand procedures. |
7. | Youstate“thelikelihoodthatactuallossdevelopmentpatternswilldiffersignificantlyfrompastexperienceislow.”However,in2005and2004,theimpactofchangesinprioryearreserveestimatesonyouroperatingresultswasmaterial.Please explain this apparentinconsistency. |
Response —MidlandacknowledgestheStaff’scomment.Infuturefilings,wewillrefrainfromtheuseofthisstatementastherewillbesomedegreeofvariationfromourestimatesandactualoperatingresults.PleaseseeourexpandeddiscussionofthevariabilityininsurancepolicylossreservesinComment#8below. |
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8. | Youdisclosethata1%increaseinthe2005lossandlossexpenseratiowouldreduceincomebeforetaxesby$6.3million.Thisdisclosuredoesnotappeartoaccomplishtheobjectiveofprovidingthe“reasonablylikely”variabilityinthemostrecentestimate,particularlyforthemotorcycle,excessandsurpluslinesandpersonalliabilitylines,whichyoudescribeas“inherentlylesspredictable.”Pleaseprovideexpandedsensitivityanalysisindisclosure-typeformatthatquantifiestheimpactthat“reasonablylikely”changesinyourkeyreserveassumptionswouldhaveonreportedresults,financialpositionandliquidity.Pleaseincludeinyourresponseanexplanationofhowyoudetermined“reasonablylikely.”Pleaseincludeadescriptionoftherelationshipbetweenyourrevisedsensitivityanalysisandthelossreserverangepreparedbyyourexternalconsultingactuaries,whichwas$134millionto$153millionatDecember31,2005. |
ResponseforComments4,5,7&8–Midland acknowledges the Staff’s comments and intends to make the appropriate modifications to all future filings, beginning with the Form 10-Q for the period ending June 30, 2006. The revised disclosure will be as follows: (additional or modified language in bold). |
Insurance Policy Loss Reserves: |
OneoftheCompany’smostsignificantestimatesrelatestoourpropertyandcasualtylossandlossadjustmentreserves.Thevastmajorityofourinsurancerisksarepersonallinespropertyinnature.Personallinespropertyrisksareprevalentinourresidentialpropertyandfinancialinstitutionssegments,whichcollectivelyaccountedforapproximately70percentofour2005grosswrittenpremiums.Asmallerportionofourbusinessrelatestoliabilityrisks,atgenerallylowerlimits,whichtendtoexperiencelosspayoutsoverlongerperiodsoftime,andareinherentlylesspredictableascomparedtothepersonallinespropertyrisks.Welimitourexposureontheserisksthroughreinsurance.Ourindemnityexposureoneachindividualliabilityriskiscappedat$250,000.Ourrecreationalcasualtysegmentandourexcessandsurpluslines,whichisincludedinthe“allother”segment,tendtogeneratethebulkofthisliabilityexposure.Thecompanydoesnothavelongtailbusinesssuchasasbestos,environmentalremediation,productliabilityorotherhighlyuncertainexposures. |
American Modern’s reserve for insurance losses is based on past experience of settling known claims as well as estimating those not yet reported. While management believes the amounts are fairly stated, the ultimate liability, once fully developed, may be more than or less than that provided. Management and its actuaries, both internal and external, regularly review these liabilities and adjustments are made as necessary in the current period. |
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Duetothepredominatelyshort-tailpropertynatureofourbusiness,themostsignificantcomponentofourlossreservesarecasebaselossreservesandoutstandingchecksanddrafts.Thesetypesoflossreservesarebasedoninformationrelatedtospecificfactsandcircumstancesrelatedtoreportedclaims.Theshorttail,personallinesbiasofourbusinessresultsinsettlingclaimsratherquickly.Weestimatethat90percentofourpropertyclaimsaresettledwithin30daysofbeingreportedtous.Themajorityofourclaimsaresettleddirectlybycompanyemployeeadjusters,whoreceiveextensivetrainingandaverageapproximatelyfiveyearsofclaimsexperience.December31,2005casebaselossreservesandoutstandingchecksanddraftscomprisedapproximately78%ofourinsurancelossreserves. |
Ourpropertyandcasualtynetlossreserves,whichincludestheimpactofreinsuranceanddoesnotconsideroutstandingchecksanddraftswereasfollowsatDecember31: |
($ in millions) | 2005 | 2004 | |||||||
---|---|---|---|---|---|---|---|---|---|
P&C Net Case Base Reserves | $ 103.9 | $ 118.4 | |||||||
P&C Net Incurred But Not Reported Reserves | 44.2 | 47.9 | |||||||
Net Property and Casualty Loss Reserves | $ 148.1 | $ 166.3 | |||||||
Net Property and Casualty Loss Reserves | $ 148.1 | $ 166.3 | |||||||
P&C Reinsurance Recoverables | 53.8 | 31.4 | |||||||
P&C Gross Loss Reserves | 201.9 | 197.7 | |||||||
Life and Other Gross Loss Reserves | 14.4 | 13.4 | |||||||
Outstanding Checks and Drafts | 38.4 | 21.8 | |||||||
Consolidated Gross Loss Reserves | $ 254.7 | $ 232.9 | |||||||
Ournetpropertyandcasualtylossreservesrepresented40%and49%ofthestatutorypropertyandcasualtysurplusatDecember31,2005and2004,respectively.Incomparison,thepercentageofstatutorylossreservestostatutorysurplusforthepropertyandcasualtyindustryaveragesapproximately120%,whichdemonstratestheshort-tailnatureofourbusiness. |
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Asignificantamountofjudgmentisusedinestablishingcasebaselossreserves,althoughgenerally,casebaselossreservestendtobelesssubjectiveandlessvolatilethanincurredbutnotreportedlossreserves.Casebaselossreservesarebasedonthefactsandcircumstancesoftheclaimreported.However,thefollowing factorscontributetothevariabilityinestablishingcasebaselossreserves: |
• | The timing of information received. As more information becomes available, (i.e. through physical inspections, actual claim settlement, etc.) case reserves are adjusted appropriately to reflect the new information. |
• | Theliabilityclaimsaregenerallymoredifficulttoassessandreserveduetotheircomplexityandgenerallytakealongerperiodoftimetosettle.Thesetypesofclaimsaremorelikelytoinvolvemultipleparties,whichaddstotheclaimcomplexityandlengthenstheclaimsettlementprocess. |
• | Theincreaseindemandforreplacementmaterialsandlabor(demandsurge),specificallyafteralargescalecatastrophicevent,whichmaycontributetoinadequatecasereserve. |
Duetotheshorttailnatureofourbusiness,incurredbutnotreportedlossreservestendtobemorestableascomparedtoothercompaniesintheinsuranceindustry.Webelievethefollowingrepresenttheprimary risks to our ability to estimate incurred butnotreportedlossreserves: |
• | Significant changes in reporting and payment patterns |
• | Changesinclaimcosttrendsthatarenotreflectedinthehistoricaldatausedtoestimatelossreserves |
• | Lackofhistoricaldataandcompanyspecificexperienceinnewerlinesofbusiness,suchasmotorcycleandexcessandsurplus |
• | Courtdecisionsandlegislationexpandingunanticipatedcoverageexpansionsonpastandexistingpoliciesorthirdpartyassessmentsthatdeviatefromhistoricalpatterns |
Managementperiodicallyreviewsthedevelopmentofcasebaselossreservesbytheexposurecharacteristicsandbylineofbusiness.ThereviewofcasebaselossreservedevelopmentassistsManagementinrefiningestimatedlossesonexistingcasebaseclaimsaswellasreservingforfuturecasebaseclaims.Potentialredundancyordeficiencyinthecasebaselossreservesisconsideredintheincurredbutnotreportedlossreserves.Theincurredbutnotreportedlossreserveisadministeredintotalratherthanbylineofbusiness,althoughManagementconsidersvarioustrends,reservedevelopment,typesofcoveragesandotherfactorsbylineofbusinesstoassessthetotalincurredbutnotreportedreserve. |
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The recorded insurance loss reserves at the balance sheet date represent the Company’s best estimate, based on historical patterns and other assumptions, of its liabilities at that date. Management, along with the Company’s internal actuaries, periodically reviews the level of loss reserves against actual loss development. This retrospective review is the primary criteria used in refining the levels of loss reserves recorded in the financial statements.Management also meets quarterly with an appointed external actuary and considers results of statistical procedures performed by the external actuary in refining the recorded loss reserves. Management compares the Company’s estimate of loss reserves to ranges prepared by its external consulting actuaries to ensure that such estimates are within the actuaries’ acceptable range. The external actuaries perform an extensive review of loss reserves at year end using generally accepted actuarial guidelines along with reviews throughout the year to ensure that the recorded loss reserves appear reasonable.The statistical procedures performed each quarter and at year-end are similar in nature, but the year-end procedures also encompasses additional statutory reporting procedures. In order to determine the incurred-but-not-reported loss reserve, an estimate of the ultimate liability is made and is then reduced by cumulative paid claims and case reserves. The external actuaries utilize a variety of actuarial and statistical methods in assessing incurred-but-not-reported loss reserves. These methods may include, but are not limited to: |
• | The Incurred Loss Development Method |
• | The Paid Loss Development Method |
• | The Hindsight Average Claim Cost Method |
• | Bornhuetter/Ferguson (Paid and Incurred) Methods |
Multiplepointestimatesarenotgeneratedindeterminingincurred-butnotreportedlossreserves.Thepersonallinespropertylinesrelymoreheavilyontheincurredlossdevelopmentmethod,duetotheshort-tailnatureoftheselinesandcasebasereservestendto bemoreaccurateintheselinesascomparedtolonger-taillines.Whiletheincurredlossdevelopmentmethodisconsideredinthelonger-tailliabilitylines,particularlyinolderaccidentyears,allmethodsareconsideredinsettingincurred-but-not-reportedreserves. |
InordertoaffirmtheCompany’srecordedreserveforlossandlossadjustmentexpense,whichrepresentsmanagement’sbestestimate,ourexternalactuariesperformstatisticalworktodetermineanacceptablerangeforlossreserves.Theactuariesapplyaconsistentmethodologyincomputingtheacceptablerange.Theactuariesutilizestatisticalmodelswhichrequiretheuseofassumptions.Therewerenosignificantchangesintheunderlyingsignificantassumptionsincalculatingtheincurredbutnotreportedrangein2005or2004.Severalofthekeyassumptionsareincludedbelow. |
• | Weutilizedevelopmentfactors,whicharelargelybasedonhistoricaltrendsforreportingandpaymentpatternsalongwithcurrentpracticesandphilosophies.Wealsomakeassumptionsforfactorssuchaslossadjustmentexpenseandsalvage and subrogation. |
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• | Theincurred-but-not-reportedlossreservewilladequatelyaddressanydeficiencyorredundancyinourcasebasereserves. |
• | Innewerlinesofbusiness,mostnotablymotorcycleandexcessandsurplus,thecompanydoesnothavealonghistoryoflossdevelopmentpatterns,thereforeweplacehigherrelianceonindustrylossdevelopmentpatternsforultimatelosses. |
Management does not foresee any significant change in the manner in which it records its reserve for insurance losses. |
At December 31, 2005, loss reserves, net of reinsurance recoverables, for our property and casualty companies totaled $148.1 million.The consulting actuary computes an acceptable range for property and casualty reserves, which affirms the recorded balance if the recorded amount is within the range. The Company’s estimate was affirmed by the actuaries’ estimated range for net loss reserves of $134.0 million to $153.0 million.The range is based on a “reasonable best case” and “reasonable worst case” with varying development patterns across our lines of business. We believe that recorded loss reserves at any point within this range would be a reasonable estimate. Thus, it appears reasonably likely that actual results may fall at any point within this range. If losses develop to the low end point of the range, our operating results would benefit by $14.1 million (pre-tax), whereas if actual losses develop to the high end point of the range, our operating results would be lowered by $5.1 million (pre-tax). If actual losses develop to the low-end or high-end of the range, we believe that the impact to our financial position or liquidity would not be material. |
Includedinthetotallossreservesdiscussedaboveisourincurredbutnotreportedlossreserves.Withrespecttotheincurredbutnotreportedlossreservesspecifically,webelievea5%variationisreasonablypossiblebasedonourhistoricaltrends.BasedonourrecordednetincurredbutnotreportedbalanceatDecember31,2005,a5%variationwouldimpactourfinancialresultsbyapproximately$2.2million(pre-tax),or$0.07pershare(after-tax). |
Webelieveitisunlikelythatultimatepayoutswillsignificantlyexceedtheanticipatedamountstotheextentthatwouldmateriallyimpactournormaloperations.However,ifultimatepayoutsdosignificantly exceed the expected amounts, the Company has several potential options to utilize in order to satisfy the additional obligations. For example, the Company could liquidate a portion of its investment portfolio or draw on conventional short-term credit lines available, at costs not exceeding prime rates. The Company believes either of these options would be sufficient to meet any increases in required loss payments. |
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Slowness to recognize or respond to new or unexpected loss patterns, such as those caused by the risk factors listed herein as well as in the Company’s Safe Harbor Statement, could lead to a shortage in reserves, which would lead to a higher loss and loss expense ratio; each percentage point increase in the loss and loss expense ratio would reduce income before taxes by $6.3 million based on 2005 earned premiums. |
9. | Pleasediscussandquantifyindisclosure-typeformattheeffectthatyourcededreinsurancehadonresultsofoperations,cashflowsandfinancialpositionfortheperiodspresented.Also,discusschangesmadetoyourpastreinsurancestrategiesindevelopingyourcurrentstrategiesandtheexpectedeffectthatthosechangesmayhaveonyourfutureresultsofoperations,cashflowsandfinancialposition.Describeandquantifyanylimitationsinyourabilitytocedefuturelossesonabasisconsistentwithhistoricalresultsandtherelatedimpactonexpectedoperatingresultsandliquidityandcapitalresources.Suchlimitationscouldrelatetochangesinreinsurance market conditions, a restructuring of your reinsurance treaties or theabsenceofremaininglimitsforspecificaccidentyearsunderexistingtreaties. |
Response–WehavecombinedtheresponsetothiscommentwithourresponsetoComment#10. |
10. | Yourreinsurancecededactivitiesappeartohaveamaterialimpactonyourresultsofoperations,andyouraccountingfortherelatedcostofreinsuranceappearstorequireestimates.Pleaseprovideanexpandeddiscussionindisclosure-typeformatofyouraccountingforreinsurancetransactions.Includeadescriptionandquantificationofthejudgmentsanduncertaintiessurroundingestimatesmadeinthisprocess.Also,withinyourresponse,pleaseprovidethefollowinginformation: |
• | Describe the type of reinsurance (i.e. prospective or retrospective) and process for computing your cost of reinsurance, including the method used (e.g. interest or recovery method for retroactive contracts) and key assumptions in your calculation. |
• | Clarifyhowcostofreinsuranceisamortizedandprofitsharingandcedingcommissionsareearned. |
• | Quantifytheamountbywhichestimatedgrosslossesonthe2005hurricanesexceededcoverageprovidedundervariousreinsurancetreaties. |
• | Includeadescriptionandquantificationoftheadditionalreinsurancecoveragepurchasedtocoveremerginglossesfromthe2005hurricanes.Explainhowyoucomputedthe$.42impacton2006earningspershareandclarify the extent to which you expectthisadverseimpacttocontinuebeyond2006. |
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Response– Midland acknowledges the Staff’s comments and intends to make the appropriate modifications to all future filings, beginning with the June 30, 2006 Form 10-Q. The revised disclosures will include the following: |
AmericanModernparticipatesinseveralreinsurancecontractswithvariousreinsurers.TheCompany’sprimaryreasonsforenteringreinsurancecontractsaretoreduceitsexposureonparticularrisksandclassesofrisksaswellastoprotectagainstlargeaccumulatedlossesresultingfromcatastrophes.Additionalreasonsare: |
1. | ToreducetotalliabilitiestoalevelappropriateforAmericanModern’scapitalandsurplus. |
2. | Toprovidefinancialcapacitytoacceptrisksandpoliciesinvolvingamountslargerthancouldotherwisebeaccepted. |
3. | Tofacilitaterelationshipswithbusinesspartnerswhowanttoparticipateintheinsuranceriskthroughtheirownreinsurancecompanies. |
TheCompanyutilizesexcessoflossreinsuranceprogramsinordertoreduceitsexposureonparticularrisksandclassesofrisks(excessoflossperrisk)aswellastoprotectagainstlargeaccumulatedlossesresultingfromcatastrophes(excessoflossperoccurrence).Underexcessreinsurance,theinsurerlimitsitsliabilitytoalloraparticularportionofapredetermineddeductibleorretention.Therefore,thereinsurer’sportionofthelossdependsonthesizeoftheloss. |
ExcessofLossperoccurrencereinsurancerequirestheinsurertopayallclaimsuptoastatedamountorretentionlimitonalllossesarisingfromasingleoccurrence.Thereinsurerpaysclaimsinexcessoftheretentionlimits.TheprimarypurposeofthisreinsuranceforAmericanModernistoprotecttheCompanyfromtheaccumulationoflossesarisingfromhurricanesoranyotherwidespreadweatherrelateddisaster.Thisreinsuranceisalsoknownascatastrophereinsurance. |
TheCompany’sreinsurancetreatiesareprospectivereinsuranceagreements,containnoadjustablefeatures,anddonotincludeanyprofitsharingprovisions.Thecostsassociatedwiththesereinsurancetreatiesarecalculatedandexpensedbasedonthesubjectearnedpremiumrecordedinrevenuemultipliedbythecorrespondingrate.Anycedingcommissionisrecordedaccordingtothetermsofthereinsurancetreatybasedonthepercentageofthecorrespondingpremiums.Cededcommissionsaredeferredandrecognizedasincomeoverthelifeofthecorrespondingpolicies.Thetermistypicallynomorethantwelvemonthsduetotheshort-tailnatureofourbusiness.Thecostsassociatedwithourcatastrophereinsuranceprogramaregenerallyamortizedoverthetermofthecoverageonapro-ratabasis. |
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Duetothenatureofournon-catastropherelatedreinsuranceprograms,theresultsofoperationsrelatedtotheseprogramsdidnotsignificantlyfluctuateduringthethreeyearperiodendedDecember31,2005. |
However,ouroperatingresultswereimpactedtovaryingdegreesbyourcatastrophereinsuranceprogramoverthepastthreeyears.Catastrophereinsurancecosts,includingreinstatements,totaled$31.9million,$16.9millionand$12.2millionduring2005,2004and2003,respectively.TheCompany’sgrosscatastrophelossesfor2005,2004and2003were$232.1million,$67.1millionand$46.6million,respectively,ofwhich$179.4million,$21.1millionand$9.4million,respectively,wererecoveredthroughourcatastrophereinsurers. |
HurricaneKatrina,thecostlieststorminU.Shistory,exceededthelimitsoftheCompany’s2005catastrophereinsuranceprogrambyapproximately$1.9million,netoftax. |
Our2006catastrophereinsurancestructureissimilartothe2005programwitha$3.0millionincreaseinretention,from$7millionto$10million,andthepurchaseofanadditional$40millionofprotectionontopofourprevious$110millioncover.Duetothevolatileweatherpatternsof2005,wewillabsorbasignificantincreaseinourbasereinsurancecostin2006whichwillnearlydoublethebasecostof2005.Thisincrease,alongwiththeadditionalcover,willadverselyimpactour2006pre-taxearningsbyapproximately$12.6million,or$0.42pershare(diluted). |
Whilethehurricaneactivityoverthepastcoupleofyearshassignificantlyincreasedthecostofobtainingreinsurance,ourstrongrelationshipswithourreinsurershaveallowedustoprovideexposuremanagementthatisconsistentwithouroverallriskmanagementstrategy.Inaddition,ourstrongrelationshipswithourreinsurersandourdisciplinedoverallexposuremanagementphilosophy,combinedwiththefinancialstrengthofthesereinsurers—86.74%ofourreinsurancecoverageisprovidedbyreinsurersratedAMBestAorbetter,allowustobeconfidentthatwewillbeabletoeffectivelymanageourexposuresinthefuture. |
11. | Whilereinsurancerecoverableincreasedfrom$45.5millionatDecember31,2004to$83.2millionatDecember31,2005,youcontinuetobelievethatnoallowanceforuncollectibleamountsisnecessary.Pleaseprovideexpandeddiscussionandquantificationindisclosure-typeformatofyourbasisforthisconclusion. |
Response–Asofthedateofthisletter,theCompanyhascollectedallofthereinsurancerecoverablebalancesrelatedtolossespaidasofDecember31,2005.Forreinsurancerecoverablesrelatedtolossesthatarenotyetpaid, |
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theCompanybelievesthatnoallowanceforuncollectibleaccountsisnecessaryprimarilyduetothecreditqualityofourreinsurers. |
PleaserefertoourCriticalAccountingPoliciesinthe2005Form10-Kforourbasisforconcludingthatnoallowanceforuncollectibleamountsisnecessary. |
Excerpt from 2005 Form 10-K: |
AmericanModernanditsindependentreinsurancebrokersregularlyconduct“marketsecurity”evaluationsofbothitscurrentandprospectivereinsurers.Suchevaluationsincludeacompletereviewofeachreinsurer’sfinancialconditionalongwithanassessmentofcreditriskconcentrationsarisingfromsimilargeographicregions,activitiesoreconomiccharacteristicsofthereinsurerstominimizeitsexposuretosignificantlossesfromreinsurerinsolvencies.Thespecificevaluationproceduresinclude,butarenotlimitedto,reviewingtheperiodicfinancialstatementsandratingsassignedtoeachreinsurerfromratingagenciessuchasS&P,Moody’sandA.M.Best.During2005,approximately85%oftheCompany’scatastrophereinsurershadanA.M.BestorS&Pratingof“A”orhigher.Inaddition,AmericanModernmay,insomecases,requirereinsurerstoestablishtrustfundsandmaintainlettersofcredittofurtherminimizepossibleexposures. |
AllreinsuranceamountsowedtoAmericanModernarecurrentandmanagementbelievesthatnoallowanceforuncollectibleaccountsrelatedtothisrecoverableisnecessary.Managementalsobelievesthereisnosignificantconcentrationofcreditriskarisingfromanysinglereinsurer. |
Notes to Consolidated Financial Statements
Note 11. Insurance Loss Reserves, page 57
12. | Pleaseexplainindisclosure-typeformatthedifferencebetweentotalincurredlossesandlossadjustmentexpensesshowninthistableandthecorrespondingcaptionintheconsolidatedstatementsofincome. |
Response–AsmentionedinNote11,thistableillustratestheactivityforthepropertyandcasualtycompaniesonly.The$5,059,000,$6,658,000and$5,621,000differencesfor2005,2004and2003,respectively,relatetotheincurredlossesandlossadjustmentexpensesrelatedtoourcreditlifecompanies. |
WewillprovideareconciliationoftheseamountsinNote11beginningwiththeForm10-KfortheperiodendingDecember31,2006. |
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13. | Pleaseexplainindisclosure-typeformatthedifferencebetweenreinsurancerecoverableshowninthistableandthecorrespondingamountsshownonpage32. |
Response—SimilartotheresponseinItem12above,thereinsurancerecoverableshowninthistableexcludestheunpaidlossrecoverableof$8,397,000and$6,509,000for2005and2004,respectively,relatedtoourcreditlifecompanies. |
WewillprovideareconciliationoftheseamountsinNote11beginningwiththeForm10-KfortheperiodendingDecember31,2006. |
We acknowledge that:
• | the Company is responsible for the adequacy and accuracy of the disclosures in our quarterly and annual filings; |
• | staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to a filing; |
• | The Company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities law of the United States. |
Sincerely,
/s/John I. Von Lehman
John I. Von Lehman
Executive Vice President,
Chief Financial Officer,
and Secretary
cc: | John W. Hayden President and Chief Executive Officer |
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