Exhibit 13.2
SUMMARY OF RESULTS
Net Income was $283.1 million ($4.17 per common share) for the year ended December 31, 2006, compared to $255.5 million ($3.70 per common share) for the year ended December 31, 2005. Operating results in the Company’s business segments improved overall in 2006, compared to 2005. These results are discussed throughout this Management’s Discussion and Analysis of Results of Operations and Financial Condition. Results in 2005 include a benefit of approximately $14 million for Federal income tax adjustments related to tax years ended December 31, 2002 and 2001.
Earned Premiums were $2,478.7 million in 2006, compared to $2,478.3 million in 2005. Increased Earned Premiums in the Life and Health Insurance segment and the Unitrin Direct segment were offset by decreased Earned Premiums in the Unitrin Specialty segment, the Unitrin Business Insurance segment and the Kemper Auto and Home segment.
Consumer Finance Revenues increased by $27.6 million in 2006 due primarily to a higher level of loans outstanding, partially offset by lower interest rates.
Net Investment Income increased by $23.0 million in 2006 due to higher yields on investments and, to a lesser extent, higher levels of investments.
Other Income was $16.3 million in 2006, compared to $9.5 million in 2005. Other Income in both 2006 and 2005 resulted primarily from sales of office buildings used in the Company’s insurance operations.
Net Realized Investment Gains was $26.5 million in 2006, compared to $56.9 million in 2005. Net Realized Investment Gains in 2006 included pretax gains of $28.8 million from sales of equity securities, pretax losses of $2.8 million to write down certain securities and pretax gains of $0.9 million from sales of investment real estate. Net Realized Investment Gains in 2005 included pretax gains of $39.4 million from sales of investment real estate, pretax gains of $29.8 million from sales of equity securities and pretax losses of $10.3 million to write down certain securities. The Company cannot anticipate when or if similar investment gains and losses may occur in the future.
CRITICAL ACCOUNTING ESTIMATES
The Company’s subsidiaries conduct their businesses in three industries: property and casualty insurance, life and health insurance and consumer finance. Accordingly, the Company is subject to several industry-specific accounting principles under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The process of estimation is inherently uncertain. Accordingly, actual results could ultimately differ materially from the estimated amounts reported in a company’s financial statements. Different assumptions are likely to result in different estimates of reported amounts. The Company’s critical accounting policies most sensitive to estimates include the valuation of investments, the valuation of property and casualty insurance reserves for losses and loss adjustment expenses (“LAE”), the valuation of the reserve for loan losses, the assessment of recoverability of goodwill and the valuation of postretirement benefit obligations.
Valuation of Investments
Except for the Company’s investment in the common stock of Intermec, Inc. (“Intermec”), which is accounted for under the equity method of accounting, the Company’s investments in fixed maturities, preferred stocks and common stocks are classified as available for sale and are reported at fair value under GAAP. Fair values of these investments are estimated using quoted market prices where available. For securities not actively traded, fair values are estimated using values obtained from independent pricing services or broker dealers. To estimate the value of these investments, independent pricing services and broker dealers employ various models that take into consideration such factors, among others, as the credit rating of the issuer, duration of the security, yields on comparably rated publicly traded securities and risk-free yield curves. The actual value at which such securities could actually be sold or settled with a willing buyer or seller may differ from such estimated fair values depending on a number of factors including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
Except for investments accounted for under the equity method of accounting, based on the Company’s intent with respect to a particular investment at the time of investment, the Company is generally required to classify its investments in fixed maturities, preferred stocks and common stocks into one of three investment categories under GAAP:
The classification of the investment may affect the Company’s reported results. For investments classified as trading, the Company is required to recognize changes in the fair values into income for the period reported. For investments in fixed maturities classified as held to maturity, the Company is required to carry the investment at amortized cost, with only the amortization occurring during the period recognized into income.
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CRITICAL ACCOUNTING ESTIMATES[CONTINUED]
Valuation of Investments [continued]
Changes in the fair value of investments classified as available for sale are not recognized to income during the period, but rather are recognized as a separate component of equity until realized. Investments accounted for under the equity method of accounting are valued at cost plus cumulative undistributed earnings and not at fair value. Had the Company reported all the changes in the fair values of its investments in fixed maturities, preferred stock and common stock, including its investment in Intermec, and other equity securities into income, the Company’s reported net income for the year ended December 31, 2006, would have decreased by $43.2 million.
The Company regularly reviews its investments for factors that may indicate that a decline in the fair value of an investment below its cost or amortized cost is other than temporary. Some factors considered in evaluating whether or not a decline in fair value is other than temporary include:
| | a) | The Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value; |
| | b) | The duration and extent to which the fair value has been less than cost; and |
| | c) | The financial condition and prospects of the issuer. |
Such reviews are inherently uncertain in that the value of the investment may not fully recover or may decline further in future periods resulting in realized losses.
Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses
Property and casualty insurance reserves for losses and LAE are reported using the Company’s estimate of its ultimate liability for losses and LAE for claims that occurred prior to the end of any given accounting period but have not yet been paid. The Company had $1,432.6 million and $1,531.5 million of gross loss and LAE reserves at December 31, 2006 and 2005, respectively. Property and Casualty Insurance Reserves by business segment at December 31, 2006 and 2005, were:
| | | | | | |
DOLLARS IN MILLIONS | | 2006 | | 2005 |
Kemper Auto and Home | | $ | 534.1 | | $ | 553.6 |
Unitrin Specialty | | | 293.4 | | | 295.8 |
Unitrin Direct | | | 106.8 | | | 99.4 |
Unitrin Business Insurance | | | 397.9 | | | 419.7 |
Life and Health Insurance | | | 6.9 | | | 31.2 |
Unallocated Ceded Reserves | | | 93.5 | | | 131.8 |
| | | | | | |
Total Property and Casualty Insurance Reserves | | $ | 1,432.6 | | $ | 1,531.5 |
| | | | | | |
Certain reserves acquired in connection with a business acquisition from SCOR Reinsurance Company (“SCOR”) in 2002 (the “Unallocated Ceded Reserves”) are reinsured by an insurance subsidiary of SCOR (See Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). The Company does not allocate these reserves to its business segments.
In estimating reserves, the Company’s actuaries exercise professional judgment and must consider, and are influenced by, many variables that are difficult to quantify. Accordingly, the process of estimating and establishing reserves for losses and LAE for property and casualty insurance is inherently uncertain and the actual ultimate net cost of a claim may vary materially from the estimated amount reserved. The reserving process is particularly imprecise for claims involving asbestos, environmental matters, construction defect and other emerging and/or long-tailed exposures which may not be discovered or reported until years after the insurance policy period has ended.
The Company’s actuaries generally estimate reserves at least quarterly for most product lines and/or coverage levels using accident quarters or accident months spanning 10 or more years depending on the size of the product line and/or coverage level or emerging issues relating to them. The Company’s actuaries use a variety of generally accepted actuarial loss reserving estimation methodologies including, but not limited to, the following:
| | • | | Incurred Loss Development Methodology; |
| | • | | Paid Loss Development Methodology; |
| | • | | Bornhuetter-Ferguson Incurred Loss Methodology; |
| | • | | Bornhuetter-Ferguson Paid Loss Methodology; and |
| | • | | Frequency and Severity Methodology. |
The Company’s actuaries generally review the results of at least four of these estimation methodologies, two based on paid data and two based on incurred data, to initially estimate loss and LAE reserves and to determine if a change in prior estimates is required. In some cases, the methodologies produce a cluster of estimates with a tight band of indicated possible outcomes. In other cases, however, the methodologies produce conflicting results and wider bands of indicated possible outcomes. However, such bands do not necessarily constitute a range of outcomes, nor does management or the Company’s actuaries calculate a range of outcomes.
At a minimum, the Company analyzes 45 product and/or coverage levels, for over 40 separate prior accident quarters for both losses and LAE using many of the loss reserving methodologies identified above.
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Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses [continued]
In all, there are over 10,000 combinations of accident quarters, coverage levels, and generally accepted actuarial estimation methodologies used to estimate the Company’s unpaid losses and LAE. In some cases, the Company’s actuaries make adjustments to these loss reserving methodologies or use additional generally accepted actuarial estimation methodologies to estimate ultimate losses and LAE.
For each accident quarter, the point estimate selected by the Company’s actuaries is not necessarily one of the points produced by any particular one of the methodologies utilized, but often is another point that takes into consideration each of the points produced by the several loss reserving methodologies used. In some cases, for a particular product, the current accident quarter may not have enough paid claims data to rely upon, leading the Company’s actuaries to conclude that the incurred loss development methodology provides a better estimate than the paid loss development methodology. Therefore, the Company’s actuaries may give more weight to the incurred loss methodology for that particular accident quarter. As an accident quarter ages for that same product, the actuary may gain more confidence in the paid loss methodology and begin to give more weight to the paid loss methodology. The Company’s actuaries’ quarterly selections are summed by product and/or coverage levels to create the actuarial indication of the ultimate losses. More often than not, the actuarial indication for a particular product line and accident quarter is most heavily weighted towards the incurred loss development methodology, particularly for short-tail lines such as personal automobile. Historically, the incurred loss development methodology has been more reliable in predicting ultimate losses for these lines, especially in the more recent accident quarters, when compared with the paid loss development methodology. In the event of a wide variation among results generated by the different projection methodologies, the Company’s actuaries further analyze the data using additional techniques.
In estimating reserves, the Company’s actuaries exercise professional judgment and must consider, and are influenced by, many variables that are difficult to quantify, such as:
| | • | | Changes in the level of minimum case reserves, and the automatic aging of those minimum case reserves; |
| | • | | Changes to claims practices including, but not limited to, changes in the reporting and impact of large losses, adequacy of case reserves, implementation of new systems for handling claims, turnover of claims department staffs, timing and depth of the audit review of claims handling procedures; |
| | • | | Changes in underwriting practices; |
| | • | | Changes in the mix of business by class and policy limit within product line; |
| | • | | Growth in new lines of business; |
| | • | | Changes in the attachment points of the Company’s reinsurance programs; |
| | • | | Medical costs including, but not limited to, the ability to assess the extent of injuries and the impact of inflation; |
| | • | | Repair costs including, but not limited to, the impact of inflation and the availability of labor and materials; |
| | • | | Changes in the judicial environment including, but not limited to, the interpretation of policy provisions, the impact of jury awards and changes in case law; and |
| | • | | Changes in state regulatory requirements. |
A change in any one or more of the foregoing factors is likely to result in a projected ultimate net claim loss and LAE that is different from the previously estimated reserve and/or previous frequency and severity trends. Such changes in estimates may be material.
For example, the Company’s actuaries review frequency (number of claims per policy or exposure), severity (dollars of loss per claim) and average premium (dollars of premium per exposure). Actual frequency and severity experienced will vary depending on changes in mix by class of insured risk. Similarly, the actual frequency and rate of recovery from reinsurance will vary depending on changes in the attachment point for reinsurance. In particular, in periods of high growth or expansion into new markets, there may be additional uncertainty in estimating the ultimate losses and LAE. The contributing factors of this potential risk are changes in the Company’s mix by policy limit and mix of business by state or jurisdiction.
Actuaries use historical experience and trends as predictors of how losses and LAE will emerge over time. However, historical experience may not necessarily be indicative of how actual losses and LAE will emerge. Changes in reserve adequacy, changes in minimum case reserves and changes in internal claims handling could impact the timing and recognition of incurred claims and produce an estimate that is either too high or too low if not adjusted for by the actuary. For example, if, due to changes in claims handling, actual claims are settled more rapidly than they were settled historically, the estimate produced by the paid loss development methodology would tend to be overstated if the actuary did not identify and adjust for the impact of the changes in claims handling. Similarly, if, due to changes in claims handling, actual claim reserves are set at levels higher than past experience, the estimate produced by the incurred loss development methodology would tend to be overstated if the actuary did not identify and adjust for the impact of the changes in claims handling.
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s senior actuary and senior management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the
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Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses [continued]
improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third-party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools. Total recorded reserves have been consistently higher than the actuarial indication of reserves. Total recorded reserves for losses and LAE were 3.9%, 3.7% and 3.6% higher than the actuarial indication of reserves at December 31, 2006, 2005 and 2004, respectively. Total recorded reserves as a percentage of the actuarial indication of reserves increased in 2006 due primarily to the decrease in Unallocated Ceded Reserves and reserves for losses and LAE from Hurricanes Katrina, Rita and Wilma. The recorded reserves for the Unallocated Ceded Reserves and these hurricanes were equal to the actuarial indication.
The Company’s goal is to ensure its total reserves for property and casualty insurance losses and LAE are adequate to cover all costs, while sustaining minimal variation from the time reserves for losses and LAE are initially estimated until losses and LAE are fully developed. Changes in the Company’s estimates of these losses and LAE over time, also referred to as “development,” will occur and may be material. Favorable development is recognized when the Company decreases its estimate of previously reported losses and LAE and results in an increase in net income in the period recognized, whereas adverse development is recognized when the Company increases its estimate of previously reported losses and LAE and results in a decrease in net income. The Company recognized favorable development of $91.6 million, $92.1 million and $39.0 million before tax for the years ended December 31, 2006, 2005 and 2004, respectively.
Development by the Company’s business segments for the years ended December 31, 2006, 2005 and 2004, was:
| | | | | | | | | | | |
| | | FAVORABLE (ADVERSE) DEVELOPMENT |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 |
Kemper Auto and Home | | $ | 68.2 | | | $ | 65.4 | | | $ | 28.7 |
Unitrin Specialty | | | 8.9 | | | | 8.8 | | | | 1.4 |
Unitrin Direct | | | (4.5 | ) | | | 4.7 | | | | 2.1 |
Unitrin Business Insurance | | | 25.8 | | | | 14.5 | | | | 6.6 |
Life and Health Insurance | | | (6.8 | ) | | | (1.3 | ) | | | 0.2 |
| | | | | | | | | | | |
Total Favorable Development, Net | | $ | 91.6 | | | $ | 92.1 | | | $ | 39.0 |
| | | | | | | | | | | |
Development in the Company’s Kemper Auto and Home segment and Unitrin Business Insurance segment together comprised a substantial portion of the Company’s favorable development in 2006 and 2005. Additional information regarding this development follows.
Kemper Auto and Home Development
In June of 2002, the Company acquired the personal lines property and casualty insurance business of the Kemper Insurance Companies (“KIC”) in a renewal rights transaction. Pursuant to the agreements among the parties, KIC retained all liabilities for policies issued by KIC prior to the closing, while the Company is entitled to premiums written for substantially all personal lines property and casualty insurance policies issued or renewed after the closing and is liable for losses and LAE incurred thereon. Accordingly, the results for the Kemper Auto and Home segment for 2003 and 2002, including, but not limited to, the earned premiums and losses and LAE, are not necessarily indicative of a full year on a going-forward-basis. The Kemper Auto and Home segment did not complete a full calendar year underwriting cycle after the acquisition date until 2004. Accordingly, the Company’s results for 2002 and 2003 did not represent 100% of the acquired business. For example, for the 2002 calendar year, the Company’s share of earned premiums for the KIC personal lines business was approximately 20% of the entire KIC personal lines business. For the 2003 calendar year, the Company’s share of earned premiums was approximately 90% of the entire KIC personal lines business.
The Company’s actuaries use various generally accepted actuarial incurred and paid loss development methodologies to estimate unpaid losses and LAE. The key assumption in these estimation methodologies is that patterns observed in prior periods are indicative of how losses and LAE are expected to develop in the future and that such historical data can be used to predict and estimate ultimate losses and LAE. Initially, the Company’s actuaries had to rely solely on the historical data of KIC (the “KIC Data”) to predict how losses for business written by the Company after the acquisition would develop. As Kemper Auto and Home continued to renew policies, the paid loss and incurred loss data related to the Company’s share of the entire KIC personal lines business gradually increased. Immediately after the acquisition, the Company began accumulating incurred and paid loss and LAE data for its share of the KIC personal lines business (the “Unitrin Data”). In 2003 and throughout 2004, the Company’s actuaries began to review the Unitrin Data and began comparing development factors for it with the development factors for the KIC Data. These initial reviews indicated that the Unitrin Data was producing lower development factors than the factors produced by the KIC Data. However, the amount of Unitrin Data available for analysis was still limited, and the Company’s actuaries could not be confident that the observed changes in development were anything but random fluctuations and, therefore, placed less weight on the most recent development patterns.
Since the acquisition, the Company’s actuaries have gained increasing confidence that the development patterns from the Unitrin Data were
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CRITICAL ACCOUNTING ESTIMATES[CONTINUED]
Kemper Auto and Home Development [continued]
not only different from the KIC Data, but that these patterns were also sustainable. As the Company’s actuaries gave more weight, and continued to give more weight each quarter, to the improved development patterns from the Unitrin Data in the selection of their incremental development factors throughout 2004 and 2005 and into 2006, Kemper Auto and Home has recognized favorable development each quarter as appropriate.
The lower development factors for the Unitrin Data primarily resulted from improvements in the claim handling procedures on this book of business. In 2002, Kemper Auto and Home began to place special emphasis on reporting claims directly to the Company. Prior to that time, a policyholder’s agent usually was the primary contact to report a claim. In July of 2002, approximately one-third of all claims were reported directly to Kemper Auto and Home compared to approximately two-thirds at the end of both 2005 and 2006. Direct reporting of losses has enabled the Company not only to reduce claim cycle times, but also to better respond to and control loss costs. Kemper Auto and Home has also focused on reducing the number of days from when a loss is reported until the related claim is closed, while also controlling the overall loss and LAE costs. Specifically, Kemper Auto and Home has implemented several claims handling loss mitigation programs, including:
| | • | | Increased its utilization of alternative dispute resolution processes, such as mediation and arbitration, to facilitate settlements and reduce defense and legal costs; |
| | • | | Increased its in-house legal expertise to better manage the litigation processes and expenses, including managing the external lawyers with whom Kemper Auto and Home contracts to defend claims; and, |
| | • | | Increased its emphasis on attempting to settle third-party claims earlier in the claims process in an effort to reduce the ultimate claim and LAE payouts. |
In 2005, the personal lines claims function of the Company’s former Multi Lines Insurance (“MLI”) segment was combined into the Kemper Auto and Home segment’s claims function. In September 2005, Kemper Auto and Home converted all open MLI personal lines claims (the “MLI Data”) to its claims system and began including new claims from the MLI business in its claim system. These changes are likely to impact the development patterns for both the MLI Data and the Unitrin Data.
Although the Company’s actuaries were aware of, and gave consideration to, the changes in the Company’s claims handling processes, including the merging of the Kemper and MLI claims functions, it takes several years to ascertain whether such changes in claims handling will ultimately result in lower ultimate paid losses and LAE. Accordingly, the effects of the improvements and the changes in the claims handling processes have emerged and have been recognized over several quarterly periods as the Company’s actuaries have become more convinced that lower losses and LAE have in fact been realized. However, the Company cannot make any assurances that all such improvements and effects have fully emerged or will continue to emerge.
Unitrin Business Insurance Development
The Company attributes favorable development in its Unitrin Business Insurance segment primarily to changes in its claims handling processes and the re-underwriting of its underlying book of business over the past few years. In addition, favorable development for the year ended December 31, 2006 includes development of $2.2 million related to the favorable settlement of three specific claims.
Unitrin Business Insurance improved its claims handling by placing increased emphasis on earlier identification of the full value of a claim, especially case reserves for larger claims. As part of this effort, a large loss unit was created in its home office to handle all significant claims. In addition, Unitrin Business Insurance initiated several claims handling cost cutting measures, such as using third-party analytic software for legal expense and bodily injury review, outsourcing workers’ compensation bill review, utilizing preferred vendors for damage repair and pursuing subrogation more aggressively. The combined effects of these claims handling initiatives were case reserves in the earlier evaluation periods that more closely matched the ultimate payments.
Unitrin Business Insurance began aggressively re-underwriting its book of business in 2002 and substantially completed its re-underwriting activities in the first quarter of 2004. Emphasis was placed on removing highly volatile, unprofitable, and undesirable risks from Unitrin Business Insurance’s book of business, which resulted in a significant reduction in the number of policies in force. Improvements in the quality of the book reduced the number and severity of claims in more recent quarters, resulting in better-than-expected development of loss and LAE reserves.
Although the Company’s actuaries were aware of, and gave consideration to, the changes in the Company’s claims handling processes and the re-underwriting in estimating unpaid losses and LAE for Unitrin Business Insurance, it takes several years to ascertain whether such changes in claims handling and re-underwriting will ultimately result in lower ultimate paid losses and LAE. Accordingly, the improvements have emerged and have been recognized over several quarterly periods as the Company’s actuaries have become more convinced that lower losses and LAE have in fact been realized. Due to the long-tail nature of some of Unitrin Business Insurance’s liabilities, it may take 10 or more years to fully determine the impact of these actions. Accordingly, the Company cannot make any assurances that all such improvements have fully emerged or will continue to emerge.
Estimated Variability of Property and Casualty Insurance Reserves
The Company believes that its historical loss and LAE reserve development recognized to income illustrates the potential variability of the Company’s estimate of Property and Casualty Insurance Reserves. Based on development recorded in the Company’s financial statements
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Estimated Variability of Property and Casualty Insurance Reserves [continued]
through the application of its reserving methodologies over the past five years, the Company estimates that its Property and Casualty Insurance Reserves could vary from the amounts carried on the balance sheet as follows:
| | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | ESTIMATED VARIABILITY | |
Personal Lines | | $ | 799.7 | | ±14 | % |
Commercial Lines | | | 539.4 | | ±20 | % |
Unallocated Ceded Reserves | | | 93.5 | | NA | |
| | | | | | |
Total Property and Casualty Insurance Reserves | | $ | 1,432.6 | | ±15 | % |
| | | | | | |
The estimated variability shown above does not constitute a statistical range of actuarially determined probable outcomes, nor does it constitute a range of all possible outcomes. Rather, it is based solely on the Company’s historical experience over the last five full years, which may not necessarily be indicative of future variability due to a number of factors including, but not limited to, changes in claims handling, underwriting, mix of business by class and policy limit, growth in new lines of business or geographical areas, and the legal environment. The impact of changes in these factors is difficult to quantify and predict. Accordingly, the Company’s actuaries must exercise considerable professional judgment in making their actuarial indications in light of these factors. Reserves in the Company’s Kemper Auto and Home and Unitrin Business Insurance segments together account for nearly two-thirds of the Company’s reserves for property and casualty insurance losses and LAE. Accordingly, the indicated estimated variability is more likely to result from changes in these businesses.
In particular, the Company’s personal lines variability could differ due to the limited history available to the Company related to the Kemper Auto and Home segment and the Unitrin Direct segment. As more fully discussed earlier, the Company’s actuaries have observed improving loss development factors for the Unitrin Data compared with the KIC Data. While over time the Company’s actuaries have been placing more and more confidence in the Unitrin Data, they are still influenced by the KIC Data. If these favorable development patterns continue to emerge favorably compared to the KIC Data, the Company believes that it is reasonable that favorable development could continue to emerge and could be material. If on the other hand, the effects of the changes in claims handling are temporary or do not emerge or even reverse in later development periods, the Company believes that it is reasonable that adverse development could emerge and could be material. Accordingly, until the Unitrin Data is fully developed, the Company’s actuaries cannot be certain that the favorable development trends that appear to be resulting from changes in claims handling will continue in subsequent reporting periods or whether such trends could reverse.
Although development will emerge in all of Unitrin’s personal lines’ product lines, development in Kemper Auto and Home’s personal automobile insurance product line could have the most significant impact. To further illustrate the sensitivity of Kemper Auto and Home’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries estimated the impact of decreases in the cumulative development factors used in the incurred loss development methodology. For the newest quarterly evaluation period, the Company assumed an average decrease of 10.3% in the cumulative development factor, gradually declining to an average decrease of 2.8% over the next 8 older evaluation quarters, gradually declining to 0.3% over the next 15 older evaluation quarters and then gradually declining to 0% thereafter. Assuming that Kemper Auto and Home’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed decreases in the cumulative development factors, the Company estimates that Kemper Auto and Home’s automobile insurance loss and LAE reserves would have decreased by $64.1 million at December 31, 2006 for all accident years combined.
To further illustrate the sensitivity of Kemper Auto and Home’s reserves for automobile insurance losses and LAE to changes in the cumulative development factors, the Company’s actuaries also estimated the impact of increases in the cumulative development factors used in the incurred loss development methodology. For the newest quarterly evaluation period, the Company assumed an average increase of 10.3% in the cumulative development factor, gradually declining to an average increase of 2.8% over the next 8 older evaluation quarters, gradually declining to 0.3% over the next 15 older evaluation quarters and then gradually declining to 0% thereafter. Assuming that Kemper Auto and Home’s automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and such assumed increases in the cumulative development factors, the Company estimates that Kemper Auto and Home’s automobile insurance loss and LAE reserves would have increased by $64.1 million at December 31, 2006 for all accident years combined.
The Company’s commercial lines include certain long-tail liabilities, which are more difficult to predict. Accordingly, the Company believes that estimated variability for its commercial lines could be greater than for its personal lines. The Company’s Unitrin Business Insurance segment has made certain changes in its claims handling processes and re-underwrote its underlying book of business over the past several
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Estimated Variability of Property and Casualty Insurance Reserves [continued]
years. The Company has recognized favorable development in its Unitrin Business Insurance segment over the past three years due primarily to the effects of these changes. If favorable development patterns continue to emerge as a result of these changes, the Company believes that it is reasonable that additional favorable development could continue to emerge in future periods and could be material. If on the other hand, the effects of these changes are temporary or even reverse in later development periods, the Company believes that it is reasonable that unfavorable development could emerge in future periods and could be material. Due to the long-tail nature of some of Unitrin Business Insurance’s liabilities, it may take 10 or more years to fully determine the impact of these actions.
Although development will emerge in all of Unitrin’s commercial product lines, development in Unitrin Business Insurance’s product lines, in particular its commercial property and liability and workers’ compensation product lines, could have the most significant impact. To further illustrate the sensitivity of the Company’s reserves for losses and LAE to changes in the cumulative development factors for these product lines, the Company’s actuaries estimated the impact of decreases in the cumulative development factors used in the incurred loss development methodology. For the newest quarterly evaluation period, the Company assumed an average decrease of 23.4% in the cumulative development factor, gradually declining to an average decrease of 6.9% over the next 25 older evaluation quarters, gradually declining to an average decrease of 1.5% over the next 25 older evaluation quarters and then gradually declining to 0% thereafter for commercial property and liability insurance, excluding certain construction defect and asbestos losses and LAE; and an average decrease of 33.1% in the cumulative development factor, gradually declining to an average decrease of 2.4% over the next 30 older evaluation quarters, gradually declining to an average decrease of 0.6% over the next 35 older evaluation quarters and then gradually declining to 0% thereafter for workers’ compensation. Assuming that Unitrin Business Insurance’s loss and LAE reserves were based solely on the incurred loss development methodology and such assumed decreases in the cumulative development factors, the Company estimates that Unitrin Business Insurance’s loss and LAE reserves would have decreased by $54.1 million at December 31, 2006 for these product lines and accident years combined.
To further illustrate the sensitivity of these product lines’ reserves for losses and LAE to changes in the cumulative development factors, the Company’s actuaries also estimated the impact of increases in the cumulative development factors used in the incurred loss development methodology. For the newest quarterly evaluation period, the Company assumed an average increase of 23.4% in the cumulative development factor, gradually declining to an average increase 6.9% over the next 25 older evaluation quarters, gradually declining to an average increase of 1.5% over the next 25 older evaluation quarters and then gradually declining to 0% thereafter for commercial property and liability insurance, excluding certain construction defect and asbestos losses and LAE; and an average increase of 33.1% in the cumulative development factor, gradually declining to an average increase of 2.4% over the next 30 older evaluation quarters, gradually declining to an average increase of 0.6% over the next 35 older evaluation quarters and then gradually declining to 0% thereafter for workers’ compensation. Assuming that Unitrin Business Insurance’s loss and LAE reserves were based solely on the incurred loss development methodology and such assumed increases in the cumulative development factors, the Company estimates that Unitrin Business Insurance’s loss and LAE reserves would have increased by $54.1 million at December 31, 2006 for these product lines and accident years combined.
In addition to the factors described above, other factors may also impact loss reserve development in future periods. These factors include governmental actions, including court decisions interpreting existing laws, regulations or policy provisions, developments related to insurance policy claims and coverage issues, adverse or favorable outcomes in pending claims litigation, the number and severity of insurance claims, the impact of inflation on insurance claims and the impact of residual market assessments. Although the Company’s actuaries do not make specific numerical assumptions about these factors, changes in these factors from past patterns will impact historical loss development factors and in turn future loss reserve development. Significant positive changes in one or more factors will lead to positive future loss reserve development, which could result in the actual loss developing closer to, or even below, the lower end of the Company’s estimated reserve variability. Significant negative changes in one or more factors will lead to negative loss reserve development, which could result in the actual loss developing closer to, or even above, the higher end of the Company’s estimated reserve variability. Accordingly, due to these factors and the other factors enumerated throughout this Management’s Discussion and Analysis of Operations and Financial Condition and the inherent limitations of the loss reserving methodologies, the estimated and illustrated reserve variability may not necessarily be indicative of the Company’s future reserve variability, which possibly could ultimately be greater than the estimated and illustrated variability. In addition, as previously noted, development will emerge in all of Unitrin’s product lines over time. Accordingly, the Company’s future reserve variability possibly could ultimately be greater than the illustrated variability.
Unallocated Ceded Reserves are reinsured by an insurance subsidiary of SCOR (see Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). The Company does not anticipate that any variability of these reserves will have a financial impact on the Company’s reported results of operations or liquidity and, accordingly, has not estimated any potential variability to these reserves. The Company does not allocate these reserves to its business segments.
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CRITICAL ACCOUNTING ESTIMATES[CONTINUED]
Estimated Variability of Property and Casualty Insurance Reserves [continued]
The Unitrin Business Insurance segment has exposure to construction defect losses through general liability and commercial multiperil coverages it provided to contractors. Construction defect claims arise from allegedly defective work performed in the construction of buildings and the alleged resulting loss of economic value of those structures. The majority of the Unitrin Business Insurance segment’s construction defect losses is concentrated in a limited number of western states, including California, and was primarily written by the Company’s Valley Insurance Company and Valley Property & Casualty Insurance Company subsidiaries (the “Valley Companies”). The Company acquired the Valley Companies in 1999, at which time the Valley Companies substantially limited their exposure to contractors on a going-forward basis in the western United States. As a result, the Company is tracking construction defect activity throughout the United States to forecast any emerging trends. There can be no assurance that such a trend will not emerge in non-western states in which the Company may have significant general liability insurance risks. The process of estimating reserves for these claims is particularly difficult due to the potentially long period of time between the loss date and the date the loss is actually reported, changes in the regulatory and legal environment and involvement of multiple plaintiffs, defendants and insurers.
Loss and LAE reserves for the Valley Companies’ construction defect losses were $28.1 million and $32.4 million at December 31, 2006 and 2005, respectively. Claim activity for the Valley Companies’ construction defect claims in the western United States for the years ended December 31, 2006, 2005 and 2004, were:
| | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
Number of Claims: | | | | | | | | | | | | |
Pending at Beginning of Year | | | 470 | | | | 647 | | | | 642 | |
Reported During the Year | | | 248 | | | | 338 | | | | 299 | |
Closed During the Year | | | (328 | ) | | | (515 | ) | | | (294 | ) |
| | | | | | | | | | | | |
Pending at End of Year | | | 390 | | | | 470 | | | | 647 | |
| | | | | | | | | | | | |
Cumulative Amount Paid for Claims Closed During the Year (in millions) | | $ | 8.6 | | | $ | 9.9 | | | $ | 8.1 | |
| | | | | | | | | | | | |
Average Cumulative Amount Paid per Claim Closed During the Year (in thousands) | | $ | 26.2 | | | $ | 19.1 | | | $ | 27.6 | |
| | | | | | | | | | | | |
The Company considers a claim to be closed when the Company has satisfied its obligation to the claimant. The “Cumulative Amount Paid for Claims Closed During the Year” and the “Average Cumulative Amount Paid per Claim Closed During the Year” for the year ended December 31, 2004, includes subrogation and reinsurance recoveries of $1.5 million, received in 2005.
The Company’s commercial lines business is focused on the small commercial market. The Company has typically not written policies insuring large manufacturers. Accordingly, the Company’s exposure to asbestos and environmental losses is limited. Total asbestos and environmental reserves in the Unitrin Business Insurance segment were $18 million and $19 million at December 31, 2006 and 2005, respectively.
Additional information pertaining to the estimation of and development of the Company’s Property and Casualty Insurance Reserves for Losses and LAE is contained in Item 1 of Part I of the Company’s 2006 Annual Report on Form 10-K under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
Reserve for Loan Losses
The Reserve for Loan Losses is estimated using the Company’s estimate of ultimate charge-offs and recoveries of loans based on past experience adjusted for current economic conditions. Such charge-offs and recoveries emerge over a period of years. Accordingly, the Company’s actual ultimate net charge-off could differ from the Company’s estimate due to a variety of factors including, but not limited to, future economic conditions, the timing of charge-offs and recoveries, the value of collateral and changes in the overall credit quality of the loan portfolio. Actual net charge-off patterns may also differ materially from historical net charge-off patterns if there is a change in collection practices, the mix of loans or the credit quality of borrowers. For example, net charge-off patterns may differ in the Consumer Finance segment’s expansion states from the Company’s historical experience. A 100–basis point increase in the Company’s estimated ultimate rate of net charge-off would increase the Company’s Reserve for Loan Losses at December 31, 2006, by $24.8 million.
Goodwill Recoverability
The process of determining whether or not an asset, such as Goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Such projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. In evaluating the recoverability of Goodwill, the Company performs a discounted cash flow analysis of the Company’s reporting units. The discounted cash value may be
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CRITICAL ACCOUNTING ESTIMATES[CONTINUED]
Goodwill Recoverability [continued]
different from the fair value that would result from an actual transaction between a willing buyer and a willing seller. Such analyses are particularly sensitive to changes in discount rates and investment rates. Changes to these rates might result in material changes in the valuation and determination of the recoverability of Goodwill. For example, an increase in the interest rate used to discount cash flows will decrease the discounted cash value. There is likely to be a similar, but not necessarily as large as, increase in the investment rate used to project the cash flows resulting from investment income earned on the Company’s investments. Accordingly, an increase in the investment rate would increase the discounted cash value.
Postretirement Obligations
The process of estimating the Company’s postretirement benefit obligations and postretirement benefit costs is inherently uncertain and the actual cost of benefits may vary materially from the estimates recorded. These liabilities are particularly volatile due to their long-term nature and are based on several assumptions. The main assumptions used in the valuation of the Company’s postretirement pension benefit obligations are:
| | a) | Estimated mortality of the employees and retirees eligible for benefits; |
| | b) | Estimated expected long-term rates of returns on investments; |
| | c) | Estimated compensation increases; |
| | d) | Estimated employee turnover; and |
| | e) | Estimated rate used to discount the ultimate estimated liability to a present value. |
The main assumptions used in the valuation of the Company’s postretirement medical benefit obligations are:
| | a) | Estimated mortality of the employees and retirees eligible for benefits; |
| | b) | Estimated morbidity of the employees and retirees eligible for benefits; |
| | c) | Estimated medical cost trend rates; and |
| | d) | Estimated discount rate. |
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a one–percentage point decrease in the Company’s estimated discount rate would increase the pension obligation and the postretirement medical benefit obligation at December 31, 2006, by $54.7 million and $3.1 million, respectively, while a one–percentage point increase in the rate would decrease the pension obligation and the postretirement medical benefit obligation at December 31, 2006, by $43.9 million and $2.5 million, respectively. A one–percentage point increase in the Company’s estimated health care cost trend rate for each year would increase the postretirement medical benefit obligation at December 31, 2006, by $3.2 million. A one–percentage point decrease in the Company’s estimated health care cost trend rate for each year would decrease the postretirement medical benefit obligation at December 31, 2006, by $2.8 million. A one–percentage point decrease in the Company’s estimated long-term rate of return on plan assets would increase the pension expense for the year ended December 31, 2006, by $3.2 million, while a one–percentage point increase in the rate would decrease pension expense by $3.2 million for the same period.
CATASTROPHES
Total catastrophe losses and LAE (including development), net of reinsurance recoveries, were $59.8 million, $94.5 million and $35.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. Catastrophes and storms are inherent risks of the property and casualty insurance business. These catastrophic events and natural disasters include hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds and winter storms. Such events result in insured losses that are, and will continue to be, a material factor in the results of operations and financial position of the Company’s property and casualty insurance companies. Further, because the level of these insured losses occurring in any one year cannot be accurately predicted, these losses may contribute to material year-to-year fluctuations in the results of the operations and financial position of these companies. Specific types of catastrophic events are more likely to occur at certain times within the year than others. This factor adds an element of seasonality to property and casualty insurance claims. The Company has adopted the industry-wide catastrophe classifications of storms and other events promulgated by Insurance Services Office, Inc. (“ISO”) to track and report losses related to catastrophes. ISO classifies a disaster as a catastrophe when the event causes $25.0 million or more in direct losses to property and affects a significant number of policyholders and insurers. ISO-classified catastrophes are assigned a unique serial number recognized throughout the insurance industry. The segment discussions that follow utilize ISO’s definition of catastrophes.
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification and reinsurance. The Company maintains three separate catastrophe reinsurance programs for its property and casualty insurance
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CATASTROPHES[CONTINUED]
businesses. Coverage for each reinsurance program is provided in three layers. The annual program covering the Kemper Auto and Home segment provides, effective July 1, 2006, the following reinsurance coverage:
| | | |
KEMPER AUTO AND HOME RANGE OF CATASTROPHE LOSSES AND LAE | | PERCENTAGE REINSURED | |
Less than or equal to $40 million | | 0 | % |
Greater than $40 million, but less than or equal to $70 million | | 65 | % |
Greater than $70 million, but less than or equal to $150 million | | 88 | % |
Greater than $150 million, but less than or equal to $250 million | | 80 | % |
Kemper Auto and Home’s current annual program is substantially different from its prior annual program, effective from July 1, 2005 to June 30, 2006, which provided reinsurance coverage of 100% of reinsured catastrophe losses of $160 million above retention of $20 million. The aggregate annual premium, excluding reinstatement premium, for Kemper Auto and Home’s current annual program is $19.5 million, compared to an annual cost of $11.1 million, excluding reinstatement premium, for its prior annual program.
The annual program covering the Company’s Unitrin Direct, Unitrin Specialty and Unitrin Business Insurance segments provides, effective January 1, 2006, reinsurance coverage of 100% of reinsured catastrophe losses of $36 million above retention of $4 million. In 2005, the annual program covering these segments also provided reinsurance coverage of 100% of reinsured catastrophe losses of $36 million above retention of $4 million. The aggregate annual premium, excluding reinstatement premium, for the 2006 annual program covering these segments is $1.9 million, compared to an annual cost of $1.8 million, excluding reinstatement premium, for the 2005 annual program.
The annual program covering the property insurance operations of the Company’s Life and Health Insurance segment provides, effective January 1, 2006, reinsurance coverage of 100% of reinsured catastrophe losses of $90 million above retention of $10 million. In 2005, the annual program covering this segment provided reinsurance coverage of 100% of reinsured catastrophe losses of $52 million above retention of $8 million. The aggregate annual premium, excluding reinstatement premium, for the 2006 annual program covering this segment is $5.8 million, compared to an annual cost of $2.7 million, excluding reinstatement premium, for the 2005 annual program.
In addition, in the event that the Company’s incurred catastrophe losses and LAE covered by any of its three catastrophe reinsurance programs exceed the retention for that particular program, each of the programs requires one reinstatement of such coverage. In such an instance, the Company is required to pay a reinstatement premium to the reinsurers to reinstate the full amount of reinsurance available under such program. The reinstatement premium is a percentage of the original premium based on the ratio of the losses exceeding the Company’s retention to the reinsurers’ coverage limit. In addition to these programs, the Kemper Auto and Home segment and the Life and Health Insurance segment purchase reinsurance from the Florida Hurricane Catastrophe Fund (the “FHCF”) for hurricane losses in the state of Florida at retentions lower than those described above.
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CATASTROPHES[CONTINUED]
Catastrophe reinsurance premiums for the Company’s reinsurance programs and the FHCF reduced earned premiums for the years ended December 31, 2006, 2005 and 2004, by the following:
| | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | 2005 | | 2004 |
Kemper Auto and Home: | | | | | | | | | |
Ceded Reinsurance Premiums for Initial Catastrophe Coverage | | $ | 15.4 | | $ | 10.8 | | $ | 9.5 |
Ceded Reinsurance Premiums to Reinstate Catastrophe Coverage | | | 0.3 | | | 3.1 | | | — |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | | 15.7 | | | 13.9 | | | 9.5 |
| | | | | | | | | |
Unitrin Specialty: | | | | | | | | | |
Ceded Reinsurance Premiums for Initial Catastrophe Coverage | | | 0.2 | | | 0.2 | | | 0.2 |
Ceded Reinsurance Premiums to Reinstate Catastrophe Coverage | | | — | | | — | | | — |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | | 0.2 | | | 0.2 | | | 0.2 |
| | | | | | | | | |
Unitrin Direct: | | | | | | | | | |
Ceded Reinsurance Premiums for Initial Catastrophe Coverage | | | 0.5 | | | 0.4 | | | 0.4 |
Ceded Reinsurance Premiums to Reinstate Catastrophe Coverage | | | — | | | — | | | — |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | | 0.5 | | | 0.4 | | | 0.4 |
| | | | | | | | | |
Unitrin Business Insurance: | | | | | | | | | |
Ceded Reinsurance Premiums for Initial Catastrophe Coverage | | | 1.2 | | | 1.2 | | | 1.4 |
Ceded Reinsurance Premiums to Reinstate Catastrophe Coverage | | | — | | | 0.1 | | | — |
| | | | | | | | | |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | | 1.2 | | | 1.3 | | | 1.4 |
Life and Health Insurance: | | | | | | | | | |
Ceded Reinsurance Premiums for Initial Catastrophe Coverage | | | 5.9 | | | 2.8 | | | 2.8 |
Ceded Reinsurance Premiums to Reinstate Catastrophe Coverage | | | 0.2 | | | 2.4 | | | — |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | | 6.1 | | | 5.2 | | | 2.8 |
| | | | | | | | | |
Total Ceded Catastrophe Reinsurance Premiums | | $ | 23.7 | | $ | 21.0 | | $ | 14.3 |
| | | | | | | | | |
The Company was required to reinstate catastrophe reinsurance coverage in 2005 following Hurricanes Katrina and Rita (see discussion below). Reinsured losses from Hurricane Katrina were higher than initially anticipated in 2005. Accordingly, the Company was required to reinstate additional catastrophe reinsurance coverage and recorded additional reinstatement premiums in 2006.
Total catastrophe losses and LAE (including development), net of reinsurance recoveries, were $59.8 million, $94.5 million and $35.9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Three major hurricanes that significantly impacted the Company (Katrina, Rita and Wilma) made landfall in the United States in 2005. A summary of the Company’s losses and LAE, net of reinsurance recoveries, from Hurricanes Katrina, Rita and Wilma initially recorded in the Company’s Consolidated Statement of Income for the year ended December 31, 2005, by business segment were:
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | KATRINA | | RITA | | WILMA | | TOTAL |
Kemper Auto and Home | | $ | 20.2 | | $ | 20.0 | | $ | 2.7 | | $ | 42.9 |
Unitrin Specialty | | | 2.1 | | | 0.3 | | | — | | | 2.4 |
Unitrin Direct | | | 0.1 | | | — | | | 2.1 | | | 2.2 |
Unitrin Business Insurance | | | 1.9 | | | 3.7 | | | — | | | 5.6 |
Life and Health Insurance | | | 8.4 | | | 8.0 | | | 1.1 | | | 17.5 |
| | | | | | | | | | | | |
Total Loss and LAE, Net of Reinsurance | | $ | 32.7 | | $ | 32.0 | | $ | 5.9 | | $ | 70.6 |
| | | | | | | | | | | | |
The Company’s losses and LAE from Hurricane Katrina included $0.6 million of losses and LAE in Florida. These losses in Florida occurred too early to be aggregated with losses and LAE in the other Gulf states under the Company’s reinsurance programs. The Life and Health Insurance segment’s estimated losses and LAE from Hurricane Wilma for the year ended December 31, 2005, are net of recoveries of $2.6 million from the FHCF. The Kemper Auto and Home segment’s estimated losses and LAE from Hurricane Wilma for the year ended December 31, 2005, are net of recoveries of $1.5 million from the FHCF.
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CATASTROPHES [CONTINUED]
During 2006, the Company recognized adverse development of $5.0 million, net of reinsurance recoveries, due primarily to increases in the Company’s estimates of both direct losses and indirect residual market losses for these hurricanes. During the first quarter of 2006, the Company significantly increased its estimate of losses and LAE, before reinsurance recoveries, for Hurricane Katrina due primarily to an $11.5 million increase in the estimate of assessed indirect losses from the Mississippi Windstorm Underwriting Association residual market. In the second quarter of 2006, the Company increased its estimate of losses and LAE, before reinsurance recoveries, for Hurricane Katrina due primarily to a $3.9 million increase in the Company’s estimate of direct losses in its Life and Health Insurance segment. In addition, the Company significantly increased its estimate of losses and LAE, before reinsurance recoveries, in 2006 for Hurricane Rita due primarily to an increase in the estimate of direct losses in the Company’s Life and Health Insurance segment. The increase in the Company’s estimate of losses and LAE from Hurricane Rita was offset entirely by reinsurance recoveries and, accordingly, had no impact on the Company’s reported losses and LAE, net of reinsurance, or on net income for the year ended December 31, 2006.
The Company’s estimates for Hurricanes Katrina, Rita and Wilma include estimates for both direct losses and LAE and indirect losses from residual market assessments. The process of estimating and establishing reserves for catastrophe losses is inherently uncertain and the actual ultimate cost of a claim, net of actual reinsurance recoveries, may vary materially from the estimated amount reserved. The Company’s estimates of direct catastrophe losses are generally based on inspections by claims adjusters and historical loss development experience for areas that have not been inspected or for claims that have not yet been reported. The Company’s estimates of direct catastrophe losses are based on the coverages provided by its insurance policies. The Company’s homeowners insurance policies do not provide coverage for losses caused by floods, but generally provide coverage for physical damage caused by wind or wind-driven rain. Accordingly, the Company’s estimates of direct losses for homeowners insurance do not include losses caused by flood. Depending on the policy, automobile insurance may provide coverage for losses caused by flood. Estimates of the number of and severity of claims ultimately reported are influenced by many variables including, but not limited to, repair or reconstruction costs and determination of cause of loss, that are difficult to quantify and will influence the final amount of claim settlements. All these factors, coupled with the impact of the availability of labor and material on costs, require significant judgment in the reserve setting process. A change in any one or more of these factors is likely to result in an ultimate net claim cost different from the estimated reserve. The Company’s estimates of indirect losses from residual market assessments are based on a variety of factors including, but not limited to, actual or estimated assessments provided by or received from the assessing entity, insurance industry estimates of losses, and estimates of the Company’s market share in the assessable states. Actual assessments may differ materially from these estimated amounts.
The Company currently estimates that, as a result of Hurricane Katrina’s landfall in Louisiana, Mississippi and Alabama, its Life and Health Insurance segment’s incurred losses and LAE, before reinsurance recoveries, exceeds the aggregate of its initial retention of $8 million and reinsurance coverage of $52 million by $4.4 million. The excess was recognized as adverse development for the year ended December 31, 2006. The process of estimating and establishing reserves for both direct losses and LAE and indirect residual market losses is inherently uncertain and the actual ultimate cost of losses and LAE, before reinsurance recoveries, may vary from the estimated amount reserved. Any further development of direct and indirect losses and LAE from Hurricane Katrina in the Life and Health Insurance segment would have an impact on net income.
The Company currently estimates that, as a result of Hurricane Rita’s landfall in Texas and Louisiana, its Life and Health Insurance subsidiaries, together with Capitol County Mutual Fire Insurance Company (“Capitol”) (see Note 19, “Other Reinsurance,” to the Consolidated Financial Statements), incurred losses and LAE of $52.3 million, before reinsurance recoveries, or $44.3 million of losses and LAE in excess of its retention of $8 million.
The Company currently estimates that, as a result of Hurricane Katrina’s landfall in Louisiana, Mississippi and Alabama, its Kemper Auto and Home segment incurred losses and LAE of $43.4 million, before reinsurance recoveries, or $23.4 million of losses and LAE in excess of its retention of $20 million.
The Company currently estimates that, as a result of Hurricane Rita’s landfall in Texas and Louisiana, its Kemper Auto and Home segment incurred losses and LAE of $19.4 million, or $0.6 million below its initial retention of $20 million.
The Company currently estimates that, as a result of Hurricane Katrina’s landfall in Louisiana, Mississippi and Alabama, the Unitrin Direct, Unitrin Specialty and Unitrin Business Insurance segments together incurred losses and LAE of $4.8 million, before reinsurance recoveries, or $0.8 million of losses and LAE in excess of their retention of $4 million.
The Company currently estimates that, as a result of Hurricane Rita’s landfall in Texas and Louisiana, the Unitrin Direct, Unitrin Specialty and Unitrin Business Insurance segments together incurred losses and LAE of $4.5 million, before reinsurance recoveries, or $0.5 million of losses and LAE in excess of their retention of $4 million.
During 2004, four hurricanes (Charley, Frances, Ivan and Jeanne) made landfall in several states along the Gulf Coast and the eastern United States. All four hurricanes made landfall in the state of Florida, the first time in over 100 years that four hurricanes have made landfall in the same state in the same hurricane season.
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CATASTROPHES[CONTINUED]
A summary of the Company’s estimated catastrophe losses and LAE before tax from these hurricanes, net of estimated recoveries from the FHCF, in 2004, follows:
| | | | | | | | | | | | | | | |
DOLLARS IN MILLIONS | | CHARLEY | | FRANCES | | IVAN | | JEANNE | | TOTAL |
Kemper Auto and Home | | $ | 3.0 | | $ | 3.8 | | $ | 4.1 | | $ | 1.6 | | $ | 12.5 |
Unitrin Specialty | | | — | | | — | | | — | | | — | | | — |
Unitrin Direct | | | 0.6 | | | 0.4 | | | 0.4 | | | 0.3 | | | 1.7 |
Unitrin Business Insurance | | | — | | | — | | | 0.1 | | | — | | | 0.1 |
Life and Health Insurance | | | 1.2 | | | 1.3 | | | 2.1 | | | 1.9 | | | 6.5 |
| | | | | | | | | | | | | | | |
Total Loss and LAE, Net of Reinsurance | | $ | 4.8 | | $ | 5.5 | | $ | 6.7 | | $ | 3.8 | | $ | 20.8 |
| | | | | | | | | | | | | | | |
The Life and Health Insurance segment’s estimated losses and LAE for the year ended December 31, 2004, are net of recoveries of $2.4 million from the FHCF. The Kemper Auto and Home segment’s estimated losses and LAE for the year ended December 31, 2004, are net of recoveries of $1.2 million from the FHCF.
KEMPER AUTO AND HOME
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 | |
Earned Premiums: | | | | | | | | | | | | |
Automobile | | $ | 611.6 | | | $ | 623.2 | | | $ | 636.2 | |
Homeowners | | | 284.7 | | | | 275.2 | | | | 264.4 | |
Other Personal | | | 48.3 | | | | 47.3 | | | | 45.2 | |
| | | | | | | | | | | | |
Total Earned Premiums | | | 944.6 | | | | 945.7 | | | | 945.8 | |
Net Investment Income | | | 49.1 | | | | 48.1 | | | | 39.6 | |
Other Income | | | 0.4 | | | | 0.6 | | | | 7.0 | |
| | | | | | | | | | | | |
Total Revenues | | | 994.1 | | | | 994.4 | | | | 992.4 | |
| | | | | | | | | | | | |
Incurred Losses and LAE | | | 586.2 | | | | 625.9 | | | | 639.0 | |
Insurance Expenses | | | 275.8 | | | | 289.1 | | | | 276.9 | |
| | | | | | | | | | | | |
Operating Profit | | | 132.1 | | | | 79.4 | | | | 76.5 | |
Income Tax Expense | | | 37.6 | | | | 19.4 | | | | 20.3 | |
| | | | | | | | | | | | |
Net Income | | $ | 94.5 | | | $ | 60.0 | | | $ | 56.2 | |
| | | | | | | | | | | | |
| | | |
RATIO BASED ON EARNED PREMIUMS | | | | | | | | | | | | |
Incurred Loss and LAE Ratio (excluding Catastrophes) | | | 57.4 | % | | | 59.5 | % | | | 65.0 | % |
Incurred Catastrophe Loss and LAE Ratio | | | 4.7 | | | | 6.7 | | | | 2.6 | |
| | | | | | | | | | | | |
Total Incurred Loss and LAE Ratio | | | 62.1 | | | | 66.2 | | | | 67.6 | |
Incurred Expense Ratio | | | 29.2 | | | | 30.6 | | | | 29.3 | |
| | | | | | | | | | | | |
Combined Ratio | | | 91.3 | % | | | 96.8 | % | | | 96.9 | % |
| | | | | | | | | | | | |
| | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | DEC. 31, 2005 |
Insurance Reserves: | | | | | | |
Personal Automobile | | $ | 399.9 | | $ | 414.9 |
Homeowners | | | 106.6 | | | 111.3 |
Other | | | 27.6 | | | 27.4 |
| | | | | | |
Insurance Reserves | | $ | 534.1 | | $ | 553.6 |
| | | | | | |
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KEMPER AUTO AND HOME[CONTINUED]
| | | | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | | DEC. 31, 2005 | |
Loss Reserves: | | | | | | | | |
Case | | $ | 238.6 | | | $ | 220.3 | |
Incurred but Not Reported | | | 200.8 | | | | 230.1 | |
| | | | | | | | |
Total Loss Reserves | | | 439.4 | | | | 450.4 | |
LAE Reserves | | | 94.7 | | | | 103.2 | |
| | | | | | | | |
Total Insurance Reserves | | $ | 534.1 | | | $ | 553.6 | |
| | | | | | | | |
FOR THE YEAR ENDED | | | | | | | | |
Favorable Loss and LAE Reserve Development, Net (excluding Catastrophes) | | $ | 67.3 | | | $ | 62.6 | |
Favorable Catastrophe Loss and LAE Reserve Development, Net | | | 0.9 | | | | 2.8 | |
| | | | | | | | |
Total Favorable Loss and LAE Reserve Development, Net | | $ | 68.2 | | | $ | 65.4 | |
| | | | | | | | |
Loss and LAE Reserve Development as a Percentage of Insurance Reserves at Beginning of Year | | | 12.3 | % | | | 13.0 | % |
| | | | | | | | |
2006 Compared with 2005
Earned Premiums in the Kemper Auto and Home segment decreased by $1.1 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower volume of insurance, partially offset by higher insurance premium rates. The cost of catastrophe reinsurance coverage, which reduced total earned premiums, was $15.7 million for the year ended December 31, 2006, including an additional charge of $0.3 million to reinstate reinsurance coverage due primarily to higher reinsured losses from Hurricane Katrina than previously anticipated. The cost of catastrophe reinsurance coverage was $13.9 million for the year ended December 31, 2005, which included a charge of $3.1 million to reinstate reinsurance coverage following Hurricanes Katrina and Rita (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”). Excluding the effects of the charges to reinstate reinsurance coverage, the cost of catastrophe reinsurance increased for the year ended December 31, 2006, compared to the same period in 2005, due primarily to the higher cost of the new catastrophe reinsurance program which became effective on July 1, 2006. Automobile insurance earned premiums decreased by $11.6 million due primarily to lower volume, partially offset by higher insurance premium rates. Earned premiums on homeowners insurance increased by $9.5 million due primarily to higher insurance premium rates. Other personal insurance earned premiums increased by $1.0 million due primarily to higher insurance premium rates, partially offset by lower volume. Net Investment Income increased by $1.0 million due primarily to higher yields on investments.
Operating Profit in the Kemper Auto and Home segment increased by $52.7 million for the year ended December 31, 2006, compared to the same period in 2005. Operating Profit increased due primarily to lower non-catastrophe incurred losses and LAE, lower catastrophe losses and LAE, net of reinsurance recoveries, and lower insurance expenses. Loss and LAE reserve development (which recognizes changes in estimates of prior year reserves in the current period) had a favorable effect of $68.2 million for the year ended December 31, 2006, compared to a favorable effect of $65.4 million in 2005. Favorable loss and LAE reserve development on automobile insurance was $49.1 million for the year ended December 31, 2006, compared to $43.7 million in 2005. Favorable loss and LAE reserve development on homeowners insurance was $14.7 million for the year ended December 31, 2006, compared to $19.0 million in 2005. Favorable loss and LAE reserve development on other personal insurance was $4.4 million for the year ended December 31, 2006, compared to $2.7 million in 2005. Non-catastrophe losses and LAE as a percentage of earned premiums decreased in part due to the effect of placing greater weight on the emerging loss development trends in the current accident year actuarial indications (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Critical Accounting Estimates”). Catastrophe losses and LAE (including development), net of reinsurance recoveries, were $44.2 million for the year ended December 31, 2006, compared to $63.1 million in 2005. Catastrophe losses and LAE, net of reinsurance recoveries, in 2005 included losses and LAE from Hurricanes Katrina and Rita (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”).
Insurance Expenses decreased by $13.3 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower restructuring expenses. Restructuring expenses were insignificant in 2006, compared to $6.4 million for the year ended December 31, 2005.
Net Income in the Kemper Auto and Home segment increased by $34.5 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to the changes in Operating Profit. The Kemper Auto and Home segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt
M-14
KEMPER AUTO AND HOME[CONTINUED]
2006 Compared with 2005 [continued]
investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $25.6 million for the year ended December 31, 2006, compared to $24.1 million for the same period in 2005.
2005 Compared with 2004
Earned Premiums in the Kemper Auto and Home segment decreased by $0.1 million for the year ended December 31, 2005, compared to the same period in 2004. Automobile insurance earned premiums decreased by $13.0 million due primarily to lower volume of insurance from assigned risk and involuntary market pools, which decreased by $9.0 million. Automobile insurance earned premiums in 2004 also included income of $2.4 million due to a decrease in the Kemper Auto and Home segment’s estimate of its North Carolina premium rate rollback. Homeowners insurance earned premiums increased by $10.8 million due to higher premium rates and higher volume, partially offset by higher catastrophe reinsurance premiums. Catastrophe reinsurance premiums reduced total earned premiums in the Kemper Auto and Home segment by $13.9 million in 2005, compared to $9.5 million in 2004. Catastrophe reinsurance premiums in 2005 include $3.1 million to reinstate catastrophe reinsurance coverage following Hurricanes Katrina and Rita.
Other Income decreased by $6.4 million for the year ended December 31, 2005, compared to the same period in 2004, due to the continuing run-off of policies and related claims administered for KIC (the “KIC Run-off”). Other Income in 2004 also included income from certain service fee adjustments in connection with the KIC Settlement, as further described below. Net Investment Income increased by $8.5 million due to higher levels of investments and to higher yields on investments.
Operating Profit in the Kemper Auto and Home segment increased by $2.9 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to lower incurred losses and LAE as a percentage of earned premiums and the higher net investment income, partially offset by higher insurance expenses. Incurred loss and LAE as a percentage of earned premiums in the Kemper Auto and Home segment decreased due primarily to higher favorable loss and LAE reserve development partially offset by higher losses and LAE from catastrophes. The Kemper Auto and Home segment recognized favorable loss and LAE reserve development of $65.4 million in 2005, compared to favorable development of $28.7 million in 2004. Catastrophe losses and LAE (including development), net of reinsurance, were $63.1 million in 2005, compared to $24.1 million in 2004. Catastrophe losses and LAE in 2005 included $42.9 million, net of reinsurance, from Hurricanes Katrina, Rita and Wilma. Insurance expenses increased by $12.2 million, due primarily to certain restructuring costs and higher amortization of deferred policy acquisition costs.
In 2004, the Company and KIC agreed to settle and extinguish certain liabilities and obligations arising from the Company’s acquisition of certain businesses from KIC (the “KIC Settlement”). The Company recorded a consolidated charge of $14.9 million before tax, including a performance bonus of $18.4 million partially offset by certain service fee adjustments, in connection with the KIC Settlement. The performance bonus is included in Insurance Expenses and the service fee adjustments are included in Other Income in the Consolidated Statements of Income. For management reporting purposes, the Company does not allocate the performance bonus to the Kemper Auto and Home segment, and accordingly, such expense is included in Other Expense, Net. The net impact of the KIC Settlement included in the Kemper Auto and Home segment in 2004 was a gain of $3.5 million before tax.
Net Income in the Kemper Auto and Home segment increased by $3.8 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to the change in operating results. The Kemper Auto and Home segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income. Tax-exempt investment income was $24.1 million in 2005, compared to $19.6 million in 2004.
M-15
UNITRIN SPECIALTY
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 | |
Earned Premiums: | | | | | | | | | | | | |
Personal Automobile | | $ | 326.1 | | | $ | 331.9 | | | $ | 376.6 | |
Commercial Automobile | | | 118.3 | | | | 121.3 | | | | 109.9 | |
Other | | | — | | | | — | | | | 0.3 | |
| | | | | | | | | | | | |
Total Earned Premiums | | | 444.4 | | | | 453.2 | | | | 486.8 | |
Net Investment Income | | | 21.8 | | | | 20.6 | | | | 18.0 | |
| | | | | | | | | | | | |
Total Revenues | | | 466.2 | | | | 473.8 | | | | 504.8 | |
Incurred Losses and LAE | | | 335.6 | | | | 335.1 | | | | 356.4 | |
Insurance Expenses | | | 92.0 | | | | 96.0 | | | | 103.6 | |
| | | | | | | | | | | | |
Operating Profit | | | 38.6 | | | | 42.7 | | | | 44.8 | |
Income Tax Expense | | | 9.6 | | | | 11.4 | | | | 12.9 | |
| | | | | | | | | | | | |
Net Income | | $ | 29.0 | | | $ | 31.3 | | | $ | 31.9 | |
| | | | | | | | | | | | |
RATIO BASED ON EARNED PREMIUMS | | | | | | | | | | | | |
Incurred Loss and LAE Ratio (excluding Catastrophes) | | | 75.3 | % | | | 73.1 | % | | | 73.1 | % |
Incurred Catastrophe Loss and LAE Ratio | | | 0.2 | | | | 0.8 | | | | 0.1 | |
| | | | | | | | | | | | |
Total Incurred Loss and LAE Ratio | | �� | 75.5 | | | | 73.9 | | | | 73.2 | |
Incurred Expense Ratio | | | 20.7 | | | | 21.2 | | | | 21.3 | |
| | | | | | | | | | | | |
Combined Ratio | | | 96.2 | % | | | 95.1 | % | | | 94.5 | % |
| | | | | | | | | | | | |
| | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | DEC. 31, 2005 |
Insurance Reserves: | | | | | | |
Personal Automobile | | $ | 151.9 | | $ | 161.7 |
Commercial Automobile | | | 124.5 | | | 116.5 |
Other | | | 17.0 | | | 17.6 |
| | | | | | |
Insurance Reserves | | $ | 293.4 | | $ | 295.8 |
| | | | | | |
| | | | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | | DEC. 31, 2005 | |
Loss Reserves: | | | | | | | | |
Case | | $ | 162.4 | | | $ | 153.2 | |
Incurred but Not Reported | | | 77.9 | | | | 84.5 | |
| | | | | | | | |
Total Loss Reserves | | | 240.3 | | | | 237.7 | |
LAE Reserves | | | 53.1 | | | | 58.1 | |
| | | | | | | | |
Total Insurance Reserves | | $ | 293.4 | | | $ | 295.8 | |
| | | | | | | | |
FOR THE YEAR ENDED | | | | | | | | |
Favorable Loss and LAE Reserve Development, Net (excluding Catastrophes) | | $ | 8.4 | | | $ | 8.8 | |
Favorable Catastrophe Loss and LAE Reserve Development, Net | | | 0.5 | | | | — | |
| | | | | | | | |
Total Favorable Loss and LAE Reserve Development, Net | | $ | 8.9 | | | $ | 8.8 | |
| | | | | | | | |
Loss and LAE Reserve Development as a Percentage of Insurance Reserves at Beginning of Year | | | 3.0 | % | | | 3.3 | % |
| | | | | | | | |
M-16
UNITRIN SPECIALTY[CONTINUED]
2006 Compared with 2005
Earned Premiums in the Unitrin Specialty segment decreased by $8.8 million for the year ended December 31, 2006, compared to the same period in 2005. Personal automobile insurance earned premiums decreased by $5.8 million due primarily to lower personal automobile insurance premium rates and Unitrin Specialty’s decision to exit its motorcycle insurance business, partially offset by higher volume of personal automobile insurance. The Unitrin Specialty segment continues to experience increased competition from traditional non-standard risk, as well as standard risk, automobile insurance companies. The Unitrin Specialty segment primarily competes for personal automobile insurance customers by changing personal automobile insurance rates, subject to regulatory approval, by changing payment options and by changing its computer applications to make it easier for agents to transact business with Unitrin Specialty. In the second quarter of 2005, the Unitrin Specialty segment began implementing rate reductions in certain states where profitability was above its target level. In 2006, the Unitrin Specialty segment continued to roll out enhancements to its web-based applications by adding functionality that made them more accessible and easier for agents to use. Personal automobile earned premiums for the year ended December 31, 2005 included $6.1 million of motorcycle insurance premiums. Unitrin Specialty exited this line of business during 2005. Commercial automobile insurance earned premiums decreased by $3.0 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower volume of commercial automobile insurance and increased competition. Net Investment Income increased by $1.2 million due primarily to higher levels of investments.
Operating Profit in the Unitrin Specialty segment decreased by $4.1 million for the year ended December 31, 2006, compared to the same period in 2005. Incurred losses and LAE as a percentage of earned premiums increased due primarily to the lower personal automobile insurance premium rates, partially offset by lower catastrophe losses and LAE, net of reinsurance recoveries. Catastrophe losses and LAE (including development), net of reinsurance recoveries, were $0.8 million for the year ended December 31, 2006 compared to $3.4 million for the same period in 2005. Catastrophe losses and LAE, net of reinsurance recoveries, in 2005 included losses and LAE from Hurricanes Katrina and Rita (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”). Loss and LAE reserve development (which recognizes changes in estimates of prior year loss and LAE reserves in the current period) had a favorable effect of $8.9 million for the year ended December 31, 2006, compared to a favorable effect of $8.8 million for the same period in 2005.
Net Income in the Unitrin Specialty segment decreased by $2.3 million for the year ended December 31, 2006, compared to the same period in 2005. The Unitrin Specialty segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.4 million and $10.3 million for the years ended December 31, 2006 and 2005, respectively.
2005 Compared with 2004
Earned Premiums in the Unitrin Specialty segment decreased by $33.6 million for the year ended December 31, 2005, compared to the same period in 2004. Personal automobile earned premiums decreased by $44.7 million due to lower volume and lower premium rates. Personal automobile premiums also decreased due to Unitrin Specialty’s decision to exit its motorcycle insurance business, which is included in the Unitrin Specialty segment’s personal automobile insurance line. Motorcycle earned premiums were $6.1 million in 2005, compared to $16.3 million in 2004. Commercial automobile insurance earned premiums increased by $11.4 million due primarily to higher volume. Net Investment Income increased by $2.6 million due to higher levels of investments and higher yields on investments.
Operating Profit in the Unitrin Specialty segment decreased by $2.1 million for the year ended December 31, 2005, compared to the same period in 2004. Operating profit from personal automobile insurance decreased by $9.2 million due primarily to the lower premium volume and higher losses and LAE as a percentage of earned premiums. Personal automobile insurance losses and LAE increased as a percentage of earned premiums due primarily to higher losses and LAE, net of reinsurance, from catastrophes and higher severity of losses, partially offset by the effect of loss and LAE reserve development. Operating profit from commercial automobile insurance increased by $6.5 million due primarily to higher investment income, lower losses and LAE as a percentage of earned premiums, and the higher premium volume. Operating profit from other insurance, which is comprised primarily of business from certain reinsurance pools that are in run-off, increased by $0.5 million due primarily to effects of loss and LAE reserve development.
Loss and LAE reserve development had a favorable effect of $8.8 million for the year ended December 31, 2005, compared to a favorable effect of $1.4 million for the same period in 2004. Catastrophe losses and LAE, net of reinsurance, in the Unitrin Specialty segment were $3.4 million in 2005, compared to $0.3 million for the same period in 2004. Catastrophe losses and LAE, net of reinsurance, in the Unitrin Specialty segment from Hurricanes Katrina and Rita were $2.4 million in 2005 (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”).
Net Income in the Unitrin Specialty segment decreased by $0.6 million for the year ended December 31, 2005, compared to the same period in 2004. The Unitrin Specialty segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income. Tax-exempt investment income in the Unitrin Specialty segment was $10.3 million and $8.4 million for the years ended December 31, 2005 and 2004, respectively.
M-17
UNITRIN DIRECT
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 | |
Earned Premiums | | $ | 225.9 | | | $ | 221.3 | | | $ | 188.6 | |
Net Investment Income | | | 9.0 | | | | 8.6 | | | | 6.9 | |
Other Income | | | 0.4 | | | | 0.2 | | | | — | |
| | | | | | | | | | | | |
Total Revenues | | | 235.3 | | | | 230.1 | | | | 195.5 | |
Incurred Losses and LAE | | | 182.3 | | | | 173.4 | | | | 149.8 | |
Insurance Expenses | | | 63.1 | | | | 55.2 | | | | 50.8 | |
| | | | | | | | | | | | |
Operating Profit (Loss) | | | (10.1 | ) | | | 1.5 | | | | (5.1 | ) |
Income Tax Benefit | | | 5.2 | | | | 1.1 | | | | 3.5 | |
| | | | | | | | | | | | |
Net Income (Loss) | | $ | (4.9 | ) | | $ | 2.6 | | | $ | (1.6 | ) |
| | | | | | | | | | | | |
RATIO BASED ON EARNED PREMIUMS | | | | | | | | | | | | |
Incurred Loss and LAE Ratio (excluding Catastrophes) | | | 80.2 | % | | | 77.2 | % | | | 78.3 | % |
Incurred Catastrophe Loss and LAE Ratio | | | 0.5 | | | | 1.2 | | | | 1.1 | |
| | | | | | | | | | | | |
Total Incurred Loss and LAE Ratio | | | 80.7 | | | | 78.4 | | | | 79.4 | |
Incurred Expense Ratio | | | 27.9 | | | | 24.9 | | | | 26.9 | |
| | | | | | | | | | | | |
Combined Ratio | | | 108.6 | % | | | 103.3 | % | | | 106.3 | % |
| | | | | | | | | | | | |
| | | | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | | DEC. 31, 2005 | |
Loss Reserves: | | | | | | | | |
Case | | $ | 71.4 | | | $ | 70.2 | |
Incurred but Not Reported | | | 16.8 | | | | 12.2 | |
| | | | | | | | |
Total Loss Reserves | | | 88.2 | | | | 82.4 | |
LAE Reserves | | | 18.6 | | | | 17.0 | |
| | | | | | | | |
Total Insurance Reserves | | $ | 106.8 | | | $ | 99.4 | |
| | | | | | | | |
FOR THE YEAR ENDED | | | | | | | | |
Favorable (Adverse) Loss and LAE Reserve Development, Net | | $ | (4.5 | ) | | $ | 4.7 | |
| | | | | | | | |
Loss and LAE Reserve Development as a Percentage of Insurance Reserves at Beginning of Year | | | (4.5 | )% | | | 5.0 | % |
| | | | | | | | |
M-18
UNITRIN DIRECT[CONTINUED]
2006 Compared with 2005
Earned Premiums in the Unitrin Direct segment increased by $4.6 million for the year ended December 31, 2006, compared to the same period in 2005, due to higher premium rates, partially offset by lower volume. Unitrin Direct reduced its writings of new and renewal business in certain states during 2005 while implementing certain product changes and rate increases. Earned premiums in these states decreased by $17.2 million in 2006. Growth in targeted states did not completely offset the decline in premium volume in the states where writings were reduced. Unitrin Direct has begun to allocate a larger portion of its marketing budget to television and internet advertising. Unitrin Direct began writing premiums in four new states during 2006 and estimates that it currently writes premiums in states comprising 74% of the U.S. personal automobile insurance market. Unitrin Direct anticipates entering six new states, comprising an estimated additional 9% of the U.S. personal automobile insurance market, in 2007.
The Unitrin Direct segment reported an Operating Loss of $10.1 million for the year ended December 31, 2006, compared to an Operating Profit of $1.5 million for the same period in 2005. Operating results decreased due primarily to the unfavorable effects of loss and LAE reserve development (which recognizes changes in estimates of prior year reserves in the current period) and higher marketing and other policy acquisition expenses, partially offset by lower catastrophe losses and LAE. Unitrin Direct recognized adverse loss and LAE reserve development of $4.5 million in 2006, compared to favorable loss and LAE reserve development of $4.7 million in 2005. Marketing and other policy acquisition expenses as a percentage of earned premiums, increased from 8.0% in 2005 to 10.6% in 2006, due primarily to increased spending on television and web advertising. Direct marketing initially results in higher expenses as a percentage of earned premiums because up-front marketing costs, to the extent they are not deferrable, are expensed as incurred. Unitrin Direct plans to accelerate its growth with increased direct marketing in both new and existing states. Accordingly, these direct marketing initiatives are expected to result in operating losses in the Unitrin Direct segment for the next several years. Catastrophe losses and LAE (including development), net of reinsurance recoveries, were $1.1 million for the year ended December 31, 2006, compared to $2.6 million for the same period in 2005. Catastrophe losses and LAE, net of reinsurance recoveries, in 2005 included losses and LAE from Hurricanes Katrina and Wilma (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”).
Unitrin Direct reported a Net Loss of $4.9 million for the year ended December 31, 2006, compared to Net Income of $2.6 million for the same period in 2005. Unitrin Direct’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $4.7 million in 2006, compared to $4.3 million in 2005.
2005 Compared with 2004
Earned Premiums in the Unitrin Direct segment increased by $32.7 million, for the year ended December 31, 2005, compared to the same period in 2004, due to higher volume and higher premium rates. Net Investment Income increased by $1.7 million due to higher levels of investments and, to a lesser extent, higher yields on investments.
Operating Profit in the Unitrin Direct segment was $1.5 million for the year ended December 31, 2005, compared to an Operating loss of $5.1 million for the same period in 2004. Operating results improved due to lower insurance expenses as a percentage of earned premiums, lower losses and LAE as a percentage of earned premiums and higher net investment income. Insurance expenses as a percentage of earned premiums decreased due primarily to improved economies of scale. Incurred losses and LAE decreased as a percentage of earned premiums due primarily to the favorable effects of loss and LAE reserve development. Net loss and LAE reserve development had a favorable effect of $4.7 million in 2005, compared to a favorable effect of $2.1 million in 2004. Unitrin Direct reported catastrophe losses and LAE of $2.6 million, primarily due to Hurricane Wilma, in 2005, compared to $2.1 million, primarily due to Hurricanes Charley, Frances, Ivan and Jeanne, in 2004.
Unitrin Direct reported Net Income of $2.6 million for the year ended December 31, 2005, compared to a Net Loss of $1.6 million in 2004. Unitrin Direct’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income. Tax-exempt investment income was $4.3 million in 2005, compared to $3.8 million for the same period in 2004.
M-19
UNITRIN BUSINESS INSURANCE
On January 1, 2005, the Company launched its new stand-alone commercial lines business unit—Unitrin Business Insurance. The Unitrin Business Insurance segment includes the commercial lines operations and certain commercial reinsurance programs of the former Multi Lines Insurance segment. During 2005, Unitrin Business Insurance re-engineered certain business processes as it began transforming the structure that remained from the former Multi Lines Insurance segment into a structure more suitable and scalable to its future commercial lines insurance strategy. During 2005, Unitrin Business Insurance implemented new policy administration, billing and claims systems, redesigned its insurance products and made filings for over 5,000 policy rate, rule and form changes with various states. In addition, Unitrin Business Insurance began to close its full service regional offices, significantly reduced its employee workforce and outsourced certain policy administration functions, while retaining control over product development, pricing, underwriting and claims. At the end of 2005, all existing claims had been migrated to the new claims system and approximately 60% of Unitrin Business Insurance’s policies had been migrated to the new policy administration system. During 2006, Unitrin Business Insurance completed the migration and completed the closure of three of its full service regional offices and scaled back a fourth office. Unitrin Business Insurance incurred certain redundant system and personnel costs in 2006 and 2005. Restructuring costs recognized in Unitrin Business Insurance were $0.8 million and $3.3 million for the years ended December 31, 2006 and 2005, respectively. Although the new, scalable structure better matches the current size of the Unitrin Business Insurance segment, the segment will likely not reach adequate economies of scale for several years.
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 | |
Earned Premiums: | | | | | | | | | | | | |
Commercial Automobile | | $ | 58.6 | | | $ | 62.6 | | | $ | 66.7 | |
Commercial Property and Liability | | | 84.9 | | | | 83.7 | | | | 84.2 | |
Workers’ Compensation | | | 20.4 | | | | 21.6 | | | | 21.6 | |
Commercial Reinsurance Program | | | 24.3 | | | | 22.7 | | | | 23.5 | |
| | | | | | | | | | | | |
Total Earned Premiums | | | 188.2 | | | | 190.6 | | | | 196.0 | |
Net Investment Income | | | 28.2 | | | | 28.2 | | | | 25.7 | |
Other Income | | | 1.9 | | | | — | | | | — | |
| | | | | | | | | | | | |
Total Revenues | | | 218.3 | | | | 218.8 | | | | 221.7 | |
Incurred Losses and LAE | | | 108.8 | | | | 116.6 | | | | 126.1 | |
Insurance Expenses | | | 94.0 | | | | 85.9 | | | | 76.5 | |
| | | | | | | | | | | | |
Operating Profit | | | 15.5 | | | | 16.3 | | | | 19.1 | |
Income Tax Expense | | | 0.4 | | | | 0.7 | | | | 1.6 | |
| | | | | | | | | | | | |
Net Income | | $ | 15.1 | | | $ | 15.6 | | | $ | 17.5 | |
| | | | | | | | | | | | |
RATIO BASED ON EARNED PREMIUMS | | | | | | | | | | | | |
Incurred Loss and LAE Ratio (excluding Catastrophes) | | | 56.3 | % | | | 58.5 | % | | | 63.5 | % |
Incurred Catastrophe Loss and LAE Ratio | | | 1.5 | | | | 2.7 | | | | 0.8 | |
| | | | | | | | | | | | |
Total Incurred Loss and LAE Ratio | | | 57.8 | | | | 61.2 | | | | 64.3 | |
Incurred Expense Ratio | | | 49.9 | | | | 45.1 | | | | 39.0 | |
| | | | | | | | | | | | |
Combined Ratio | | | 107.7 | % | | | 106.3 | % | | | 103.3 | % |
| | | | | | | | | | | | |
| | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | DEC. 31, 2005 |
Insurance Reserves: | | | | | | |
Commercial Automobile | | $ | 69.9 | | $ | 79.4 |
Commercial Property and Liability | | | 207.7 | | | 216.4 |
Workers’ Compensation | | | 84.2 | | | 94.7 |
Commercial Reinsurance Program | | | 36.1 | | | 29.2 |
| | | | | | |
Insurance Reserves | | $ | 397.9 | | $ | 419.7 |
| | | | | | |
M-20
UNITRIN BUSINESS INSURANCE [CONTINUED]
| | | | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | | DEC. 31, 2005 | |
Loss Reserves: | | | | | | | | |
Case | | $ | 138.0 | | | $ | 140.7 | |
Incurred but Not Reported | | | 168.7 | | | | 182.6 | |
| | | | | | | | |
Total Loss Reserves | | | 306.7 | | | | 323.3 | |
LAE Reserves | | | 91.2 | | | | 96.4 | |
| | | | | | | | |
Total Insurance Reserves | | $ | 397.9 | | | $ | 419.7 | |
| | | | | | | | |
FOR THE YEAR ENDED | | | | | | | | |
Favorable Loss and LAE Reserve Development, Net (excluding Catastrophe losses) | | $ | 26.1 | | | $ | 13.1 | |
Favorable (Adverse) Catastrophe Loss and LAE Reserve Development, Net | | | (0.3 | ) | | | 1.4 | |
| | | | | | | | |
Total Favorable Loss and LAE Reserve Development, Net | | $ | 25.8 | | | $ | 14.5 | |
| | | | | | | | |
Loss and LAE Reserve Development as a Percentage of Insurance Reserves, Net at Beginning of Year | | | 6.1 | % | | | 3.2 | % |
| | | | | | | | |
2006 Compared with 2005
Earned Premiums in the Unitrin Business Insurance segment decreased by $2.4 million for the year ended December 31, 2006, compared to the same period in 2005, due to lower insurance premium rates, partially offset by higher volume of insurance. The Unitrin Business Insurance segment has reduced insurance rates across most product lines due to increased competition in its markets, while at the same time increasing the volume of insurance by focusing on larger accounts written through its account executive distribution network. Business written by the Unitrin Business Insurance segment increased in the second half of 2006, but at a slower rate of growth than previously anticipated, due primarily to increased competition and several open account executive positions. Nearly all of the account executive positions were filled at December 31, 2006. Accordingly, the Unitrin Business Insurance segment expects business written by its account executive distribution network to increase in 2007.
The Unitrin Business Insurance segment’s commercial reinsurance program consists of certain business written and administered by First NonProfit Insurance Company (“FNP”). FNP specializes in providing various forms of commercial insurance to charitable and other nonprofit organizations. The Unitrin Business Insurance segment intends to exit this commercial reinsurance business in 2007. See Note 19, “Other Reinsurance,” to the Consolidated Financial Statements for additional information about this reinsurance arrangement. Excluding the impact of the exit from the commercial reinsurance business, the Unitrin Business Insurance segment expects earned premiums to remain relatively flat in 2007, due primarily to increased competition, lower insurance premium rates and the impact of efforts to reduce exposure to natural disasters, offset by the impact of a more fully staffed account executive distribution network.
Other Income in the Unitrin Business Insurance segment resulted primarily from a gain on the sale of a regional office building in 2006.
Operating Profit in the Unitrin Business Insurance segment decreased by $0.8 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to higher insurance expenses, partially the result of system migration initiatives and increased marketing efforts, partially offset by lower incurred losses and LAE and the gain recognized on the sale of the regional office building. Incurred losses and LAE decreased due primarily to higher favorable loss and LAE reserve development (which recognizes changes in estimates of prior year reserves in the current period) and lower catastrophe losses and LAE, partially offset by an abnormal number of large fire losses in 2006. Incurred losses and LAE also increased due to the higher volume of larger general liability insurance accounts, which typically have higher expected losses and LAE as a percentage of earned premiums than certain of Unitrin Business Insurance’s other product lines. Losses and LAE on general liability insurance typically are reported and settled over a longer period of time than some of Unitrin Business Insurance’s other product lines. Accordingly, the higher losses and LAE typically are offset to some extent by additional investment income during the settlement period. Loss and LAE reserve development, including development of catastrophe losses and LAE, was $25.8 million favorable in 2006, compared to $14.5 million favorable in 2005. Catastrophe losses and LAE (including development), net of reinsurance recoveries, were $2.9 million in 2006, compared to $5.2 million in 2005, including $5.6 million, net of reinsurance, for Hurricanes Katrina and Rita (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”).
Net Income in the Unitrin Business Insurance segment decreased by $0.5 million for the year ended December 31, 2006, compared to the same period in 2005. The Unitrin Business Insurance segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and other tax deductions. Tax-exempt investment income in the Unitrin Business Insurance segment was $14.7 million and $14.2 million for the years ended December 31, 2006 and 2005, respectively.
M-21
UNITRIN BUSINESS INSURANCE[CONTINUED]
2005 Compared with 2004
Earned Premiums in the Unitrin Business Insurance segment decreased by $5.4 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to lower volume of commercial automobile insurance and commercial property and liability insurance. Net Investment Income in the Unitrin Business Insurance segment increased by $2.5 million, due to higher yields on investments and higher levels of investments.
Operating Profit in the Unitrin Business Insurance segment decreased by $2.8 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to higher insurance expenses, partially the result of certain restructuring and system migration initiatives, and higher catastrophe losses, net of reinsurance, partially offset by lower non-catastrophe incurred losses and LAE and the higher net investment income. Incurred losses and LAE, excluding catastrophes, decreased due primarily to the favorable effects of loss and LAE reserve development. Loss and LAE reserve development, including development of catastrophe loss and LAE, was $14.5 million favorable for 2005, compared to $6.6 million favorable for 2004. Catastrophe losses and LAE were $5.2 million in 2005, including $5.6 million, net of reinsurance, for Hurricanes Katrina and Rita. Catastrophe losses and LAE, net of reinsurance, were $1.5 million for 2004.
Net Income in the Unitrin Business Insurance segment decreased by $1.9 million for the year ended December 31, 2005, compared to the same period in 2004. The Unitrin Business Insurance segment’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and other tax deductions. Tax-exempt investment income in the Unitrin Business Insurance segment was $14.2 million and $13.0 million for the years ended December 31, 2005 and 2004, respectively. Net Income for the year ended December 31, 2004 included other tax deductions of $2.2 million, with no such other tax deductions in 2005.
LIFE AND HEALTH INSURANCE
| | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | 2005 | | 2004 |
Earned Premiums: | | | | | | | | | |
Life | | $ | 400.7 | | $ | 401.3 | | $ | 401.7 |
Accident and Health | | | 158.3 | | | 160.5 | | | 161.3 |
Property | | | 116.6 | | | 105.7 | | | 105.0 |
| | | | | | | | | |
Total Earned Premiums | | | 675.6 | | | 667.5 | | | 668.0 |
Net Investment Income | | | 178.3 | | | 157.1 | | | 150.0 |
Other Income | | | 11.2 | | | 6.2 | | | 3.6 |
| | | | | | | | | |
Total Revenues | | | 865.1 | | | 830.8 | | | 821.6 |
Policyholders’ Benefits and Incurred Losses and LAE | | | 404.5 | | | 414.3 | | | 396.9 |
Insurance Expenses | | | 308.2 | | | 324.8 | | | 327.4 |
| | | | | | | | | |
Operating Profit | | | 152.4 | | | 91.7 | | | 97.3 |
Income Tax Expense | | | 52.9 | | | 31.7 | | | 34.3 |
| | | | | | | | | |
Net Income | | $ | 99.5 | | $ | 60.0 | | $ | 63.0 |
| | | | | | | | | |
| | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | DEC. 31, 2005 |
Insurance Reserves: | | | | | | |
Life | | $ | 2,386.6 | | $ | 2,317.1 |
Accident and Health | | | 99.5 | | | 87.8 |
Property | | | 6.9 | | | 31.2 |
| | | | | | |
Insurance Reserves | | $ | 2,493.0 | | $ | 2,436.1 |
| | | | | | |
M-22
LIFE AND HEALTH INSURANCE[CONTINUED]
2006 Compared with 2005
Earned Premiums in the Life and Health Insurance segment increased by $8.1 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to certain quota share reinsurance transactions with Capitol and its wholly owned subsidiary, Old Reliable Casualty Company (“ORCC”). Capitol is a mutual insurance company which is owned by its policyholders (see Note 19, “Other Reinsurance,” to the Consolidated Financial Statements). Some of the Life and Health Insurance segment’s career agents sell property insurance products for Capitol and ORCC. Effective January 1, 2006, the Company entered into a quota share reinsurance agreement with ORCC whereby the Company assumes 100% of the business written by ORCC. Prior to 2006, the Company did not assume business from ORCC. In the third quarter of 2005, the Company increased the share of business it assumed from Capitol to 100%. Prior to this change, the Company had assumed 95% of the business written by Capitol. The Company estimates that earned premiums increased by $12.7 million in 2006 due to the impact of these quota share reinsurance transactions.
Excluding the impact of the quota share reinsurance transactions described above, Earned Premiums in the Life and Health Insurance segment decreased by $4.6 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower earned premiums on accident and health insurance and lower earned premiums on property insurance. Earned premiums on accident and health insurance decreased by $2.2 million in 2006, as lower volume of accident and health insurance, primarily on limited benefit medical and Medicare supplement products, contributed $8.2 million to the decrease in accident and health insurance earned premiums, while higher insurance premium rates on those same products accounted for an increase of $6.0 million. In the fourth quarter of 2006, the Company’s subsidiary, Reserve National Insurance Company (“Reserve National”), entered into a reinsurance agreement whereby it assumes 100% of certain accident and health insurance business. The Company estimates that accident and health insurance earned premiums will increase by $4.4 million in 2007 due to the assumption. Excluding the impact of the quota share reinsurance transactions described above, earned premiums on property insurance decreased due to lower volume related to the Life and Health Insurance segment’s decision to reduce its coastal exposures and an increase in the cost of catastrophe reinsurance. Beginning January 1, 2006, the Life and Health Insurance segment began reducing its exposures to natural disasters by ceasing to write new property insurance business in most coastal areas of the Gulf and southeastern United States. The affected areas comprise approximately 20% of the Life and Health Insurance segment’s property insurance business. The Life and Health Insurance segment estimates that Earned Premiums reported in 2006 decreased approximately $1.0 million as a result of reducing its coastal exposures. The Life and Health Insurance segment estimates that Earned Premiums will decrease by approximately $2.0 million in 2007 related to its continued reduction of its coastal exposures. The cost of catastrophe reinsurance coverage was $6.1 million in 2006, including a charge of $0.2 million to reinstate reinsurance due to higher reinsured losses from Hurricane Katrina than previously anticipated. The cost of catastrophe reinsurance coverage was $5.2 million in 2005, including a charge of $2.4 million to reinstate reinsurance coverage following Hurricane Katrina. Excluding the effects of the charges to reinstate reinsurance coverage, the cost of catastrophe reinsurance increased in 2006 due primarily to the higher cost of the Life and Health Insurance segment’s catastrophe reinsurance program which became effective on January 1, 2006 (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”). Earned premiums on life insurance decreased by $0.6 million in 2006 due primarily to lower volume.
Net Investment Income increased by $21.2 million for the year ended December 31, 2006, compared to the same period in 2005, due to higher yields on investments and higher levels of investments.
Other Income for the year ended December 31, 2006, includes a gain of $10.0 million, net of a remaining deferred gain of $2.2 million, recognized on the sale and leaseback of Reserve National’s home office building and a gain of $1.0 million recognized on the sale of the Career Agency Group’s Louisiana office building. The deferred gain is being amortized over the three-year term of the leaseback. During 2006, the Career Agency Group completed the consolidation of its Louisiana regional office operations into its St. Louis home office. Other Income for the year ended December 31, 2005, includes a gain of $2.4 million recognized on the sale of the Career Agency Group’s home office building. Other Income in 2005 also includes service fees charged for certain administrative services provided by the Career Agency Group to ORCC, prior to the effective date of the 100% quota share agreement described above.
Operating Profit in the Life and Health Insurance segment increased by $60.7 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to the higher Net Investment Income discussed above, lower insurance expenses and lower catastrophe losses and LAE (including development) on property insurance and the higher other income. Insurance expenses in 2005 included a charge of $6.0 million to write off deferred policy acquisition costs (“DPAC”) attributed to certain policies that lapsed following Hurricane Katrina. Excluding the charge to write off DPAC in 2005, insurance expenses decreased by $10.6 million in 2006 due primarily to lower commissions. Commissions decreased in 2006 due in part to the initial impact on accrued benefits from certain changes in the Life and Health Insurance segment’s compensation plans. Catastrophe losses and LAE (including development), net of reinsurance recoveries, on property insurance sold by the Life and Health Insurance segment’s career agents were $10.8 million and $20.2 million in 2006 and 2005, respectively (see Management’s Discussion and Analysis of Results of Operations and Financial Condition, “Catastrophes”). Catastrophe losses and LAE, net
M-23
LIFE AND HEALTH INSURANCE[CONTINUED]
2006 Compared with 2005 [continued]
of reinsurance, in 2006 included adverse development of $4.4 million, net of reinsurance recoveries, from Hurricane Katrina. Catastrophe losses and LAE, net of reinsurance, in 2005 included $17.5 million from Hurricanes Katrina, Rita and Wilma. Property insurance reserves decreased by $24.3 million in 2006 due primarily to payment of claims related to Hurricanes Katrina and Rita.
Net Income in the Life and Health Insurance segment increased by $39.5 million due primarily to the higher Operating Profit.
2005 Compared with 2004
Earned Premiums in the Life and Health Insurance segment decreased by $0.5 million for the year ended December 31, 2005, compared to the same period in 2004. The Life and Health Insurance segment estimates that earned premiums on life insurance and property insurance decreased by $4.6 million and $0.7 million, respectively, due to the effects of policies that lapsed due to hurricanes (seeHurricanes Katrina, Rita and Wilmabelow). Earned premiums in property insurance also included a reduction of $2.4 million to reinstate catastrophe reinsurance coverage following Hurricane Katrina. Excluding the effects of hurricanes, earned premiums on life insurance increased by $4.2 million due primarily to higher volume. Excluding the effects of hurricanes, earned premiums on property insurance sold by the Life and Health Insurance segment’s career agents increased by $3.8 million due almost entirely to increased premium volume prior to Hurricanes Katrina and Rita. Earned premiums on accident and health insurance decreased by $0.8 million. Lower volume of accident and health insurance, primarily on limited benefit medical and Medicare supplement products, accounted for a decrease of $6.8 million in accident and health insurance earned premiums, while higher premium rates on those same products accounted for an increase of $6.0 million. Other Income increased by $2.6 million, due primarily to a gain recognized on the sale of the Career Agency Companies’ home office. Net Investment Income in the Life and Health Insurance segment increased by $7.1 million due primarily to higher levels of investments and, to a lesser extent, higher yields.
Operating Profit in the Life and Health Insurance segment decreased by $5.6 million for the year ended December 31, 2005, compared to the same period in 2004. Catastrophe losses and LAE (including development), net of reinsurance, on property insurance sold by the Life and Health Insurance segment’s career agents were $20.2 million and $7.9 million in 2005 and 2004, respectively. Catastrophe losses and LAE, net of reinsurance, in 2005 included $17.5 million from Hurricanes Katrina, Rita and Wilma. Catastrophe losses and LAE, net of reinsurance, in 2004 included $6.5 million from Hurricanes Charley, Frances, Ivan and Jeanne. Policyholders’ benefits in 2005 included income of $4.4 million before tax attributed to the change in reserves on the lapsed policies following Hurricane Katrina. Policyholders’ benefits for 2004 included a charge of $5.4 million due to a change in the actuarial estimate of reserves resulting from the conversion of certain business to a new computer system. Excluding the impact of these changes in reserves for policyholders’ benefits, life and health insurance policyholders’ benefits increased due primarily to higher mortality and morbidity. Insurance expenses decreased by $2.6 million due primarily to lower salaries and fringe benefits, partially offset by a charge of $6.0 million to write off DPAC attributed to the lapsed policies following Hurricane Katrina. Salary and fringe benefits decreased partially as a result of the Company’s efforts to consolidate back office operations.
Net Income in the Life and Health Insurance segment decreased by $3.0 million due primarily to the lower Operating Profit.
Hurricanes Katrina, Rita and Wilma
The Life and Health Insurance segment derives approximately 50% of its life insurance earned premiums and 75% of its property insurance earned premiums (the Life and Health Insurance segment’s career agents also sell property insurance to their customers) from business in the states of Louisiana, Mississippi, Texas and Florida. In 2005, Hurricanes Katrina, Rita and Wilma each made landfall in one or more of these states and impacted the Life and Health Insurance segment’s results in several ways. In 2005, the Life and Health Insurance segment recorded catastrophe loss and LAE, net of reinsurance recoveries, of $17.5 million as a result of these hurricanes and recorded reinstatement premiums of $2.4 million.
Following Hurricanes Katrina and Rita, the Life and Health Insurance segment implemented state-mandated and certain voluntary moratoriums on the lapsing of insurance policies, including life insurance policies, due to the non-payment of premiums. The moratoriums on lapsing of insurance policies due to non-payment of premiums had expired by the end of 2005. Accordingly, the Life and Health Insurance segment lapsed such policies in accordance with the terms of the insurance policies. Prior to the expiration of the moratoriums and lapsing of the policies, the Life and Health Insurance segment offered a deferred payment program to affected life insurance policyholders to assist them in paying premiums. The Life and Health Insurance segment estimates that the lapsed policies represented approximately $5.3 million of the Life and Health Insurance segment’s earned premiums on an annual basis, of which $4.6 million related to life insurance and $0.7 million related to property insurance. The Life and Health Insurance segment’s results in 2005 include a charge of $1.6 million before tax to write off DPAC, net of related insurance reserves of $4.4 million, associated with the lapsed policies.
M-24
CONSUMER FINANCE
| | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | 2005 | | 2004 |
Interest, Loan Fees and Earned Discounts | | $ | 237.3 | | $ | 210.5 | | $ | 192.9 |
Net Investment Income | | | 3.9 | | | 3.7 | | | 4.3 |
Other Revenues | | | 7.7 | | | 7.1 | | | 5.6 |
| | | | | | | | | |
Total Revenues | | | 248.9 | | | 221.3 | | | 202.8 |
Provision for Loan Losses | | | 62.4 | | | 47.4 | | | 45.8 |
Interest Expense on Certificates of Deposits | | | 49.8 | | | 37.9 | | | 32.7 |
General and Administrative Expenses | | | 91.9 | | | 83.1 | | | 77.2 |
| | | | | | | | | |
Operating Profit | | | 44.8 | | | 52.9 | | | 47.1 |
Income Tax Expense | | | 18.7 | | | 22.1 | | | 19.7 |
| | | | | | | | | |
Net Income | | $ | 26.1 | | $ | 30.8 | | $ | 27.4 |
| | | | | | | | | |
Consumer Finance Loan Originations | | $ | 806.9 | | $ | 767.1 | | $ | 639.1 |
| | | | | | | | | |
| | | | | | | | |
DOLLARS IN MILLIONS | | DEC. 31, 2006 | | | DEC. 31, 2005 | |
Percentage of Consumer Finance Receivables Past Due: | | | | | | | | |
Less than 30 Days | | | 26.7 | % | | | 23.9 | % |
30 Days to 59 Days Past Due | | | 8.6 | | | | 8.3 | |
60 Days to 89 Days Past Due | | | 3.0 | | | | 2.9 | |
90 Days and Greater Past Due | | | 1.3 | | | | 1.2 | |
| | | | | | | | |
Total Past Due | | | 39.6 | % | | | 36.3 | % |
| | | | | | | | |
Ratio of Reserve for Loan Losses to Gross Consumer Finance Receivables | | | 5.3 | % | | | 5.3 | % |
| | | | | | | | |
Weighted-Average Yield on Certificates of Deposits | | | 4.7 | % | | | 4.0 | % |
| | | | | | | | |
FOR THE YEAR ENDED | | | | | | | | |
Reserve for Loan Losses—At Beginning of Year | | $ | 62.6 | | | $ | 56.6 | |
Provision for Loan Losses | | | 62.4 | | | | 47.4 | |
Net Charge-off: | | | | | | | | |
Consumer Finance Receivables Charged-off | | | (105.6 | ) | | | (82.5 | ) |
Consumer Finance Receivables Recovered | | | 49.4 | | | | 41.1 | |
| | | | | | | | |
Net Charge-off | | | (56.2 | ) | | | (41.4 | ) |
| | | | | | | | |
Reserve for Loan Losses—At End of Year | | $ | 68.8 | | | $ | 62.6 | |
| | | | | | | | |
2006 Compared with 2005
Interest, Loan Fees and Earned Discounts in the Consumer Finance segment increased by $26.8 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to higher levels of loans outstanding, partially offset by lower interest rates.
Operating Profit in the Consumer Finance segment decreased by $8.1 million for the year ended December 31, 2006, compared to the same period in 2005. Provision for Loan Losses increased by $15.0 million in 2006, as a result of a higher level of loans outstanding and higher net charge-off. Interest Expense on Certificates of Deposits increased by $11.9 million in 2006, due primarily to higher interest rates on Certificates of Deposits and higher levels of deposits. General and Administrative Expenses, as a percentage of Interest, Loan Fees and Earned Discounts, decreased from 39.5% for the year ended December 31, 2005, to 38.7% for the year ended December 31, 2006, due primarily to higher levels of loans outstanding. Net Income in the Consumer Finance segment decreased by $4.7 million in 2006 due primarily to the lower Operating Profit. The Consumer Finance segment’s effective tax rate differs from the Federal statutory tax rate due primarily to state income taxes.
M-25
CONSUMER FINANCE[CONTINUED]
2005 Compared with 2004
Interest, Loan Fees and Earned Discounts in the Consumer Finance segment increased by $17.6 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to higher levels of loans outstanding, partially offset by lower interest rates. Net Investment Income in the Consumer Finance segment decreased by $0.6 million for the year ended December 31, 2005, compared to the same period in 2004, due to lower levels of investments.
Operating Profit in the Consumer Finance segment increased by $5.8 million for the year ended December 31, 2005, compared to the same period in 2004. Provision for Loan Losses increased by $1.6 million for the year ended December 31, 2005, compared to the same period in 2004, as a result of a higher level of loans outstanding, partially offset by a change in the Company’s estimate of the rate of ultimate loan losses as a result of higher recoveries and lower charge-offs for loans originated in previous years. Interest Expense on Certificates of Deposits increased by $5.2 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to higher interest rates on Certificates of Deposits and higher levels of deposits. General and Administrative Expenses, as a percentage of Interest, Loan Fees and Earned Discounts, decreased from 40.0% for the year ended December 31, 2004, to 39.5% for the year ended December 31, 2005, due primarily to the higher levels of loans outstanding. Net Income in the Consumer Finance segment increased by $3.4 million for the year ended December 31, 2005, due primarily to the higher Operating Profit. The Consumer Finance segment’s effective tax rate differs from the Federal statutory tax rate due primarily to state income taxes.
INVESTEE
The Company accounts for its investment in the common stock of Intermec under the equity method of accounting. Intermec is listed on the New York Stock Exchange (NYSE symbol: IN) and is subject to the reporting requirements of the federal securities laws. Intermec is held for investment purposes. The fair value of the Company’s Investment in Investee was $307.2 million at December 31, 2006, compared to an asset carrying value of $92.7 million under the equity method of accounting.
At December 31, 2006, the Company owned 20.4% of Intermec’s common stock. Intermec has described itself as a leader in global supply chain solutions and in the design, development, manufacture and integration of wired and wireless automated data collection, mobile computing systems, bar code printers, label media and Intellitag® RFID (radio frequency identification). Intermec’s products and services are used by customers in many industries to improve productivity, quality and responsiveness of business operations, from supply chain management and enterprise resource planning to field sales and service. Intermec’s products and services are sold globally to a diverse set of customers in markets such as manufacturing, warehousing, direct store delivery, retail, consumer goods, field services, government, security, healthcare, transportation and logistics.
The Company accounts for its Investment in Investee under the equity method of accounting using the most recent and sufficiently timely publicly available financial reports and other publicly available information, which generally results in a three-month-delay basis (see Note 2, “Summary of Accounting Policies,” to the Company’s Consolidated Financial Statements). Equity in Net Income of Investee was $9.2 million, $5.3 million and $3.6 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Prior to the periods presented in the Company’s Consolidated Financial Statements, the Company determined that a decline in the fair value of its investment in Intermec was other than temporary under applicable accounting standards. Accordingly, the Company reduced the carrying value of its investment in Intermec to its then current estimated realizable value and allocated the reduction to the Company’s proportionate share of Intermec’s non-current assets. Accordingly, the Company’s reported equity in the net income of Intermec differs from the Company’s proportionate share of Intermec’s reported results to the extent that such results include depreciation, amortization or other charges related to such non-current assets. During the first quarter of 2005, the Company estimated that Intermec had subsequently fully recognized in its financial statements the amortization, depreciation or write-downs of such non-current assets. Accordingly, for periods beginning after the first quarter of 2005, Equity in Net Income of Investee equals the Company’s proportionate share of Intermec’s results. The fair value of the Company’s investment in Intermec subsequently recovered such that the fair value exceeded the carrying value of the Company’s investment in Intermec by $214.5 million and $347.4 million at December 31, 2006 and 2005, respectively. In accordance with applicable accounting standards, such excess is not recorded in the Company’s Consolidated Financial Statements.
INVESTMENT RESULTS
Net Investment Income was $305.1 million, $282.1 million and $261.2 million in 2006, 2005 and 2004, respectively. Net Investment Income increased by $23.0 million in 2006, compared to the same period in 2005, due to higher investment yields and, to a lesser extent, higher levels of investments. Net Investment Income increased by $20.9 million in 2005, compared to the same period in 2004, due primarily to higher levels of fixed maturity and short-term investments and, to a lesser extent, higher investment yields.
M-26
INVESTMENT RESULTS[CONTINUED]
The components of Net Realized Investment Gains for the years ended December 31, 2006, 2005 and 2004, were:
| | | | | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | | 2005 | | | 2004 | |
Fixed Maturities: | | | | | | | | | | | | |
Gains on Dispositions | | $ | 5.0 | | | $ | 2.7 | | | $ | 1.8 | |
Losses on Dispositions | | | (4.4 | ) | | | (1.7 | ) | | | (0.6 | ) |
Losses from Write-downs | | | — | | | | (2.4 | ) | | | (0.1 | ) |
Northrop Common Stock: | | | | | | | | | | | | |
Gains on Dispositions | | | 5.6 | | | | 4.0 | | | | 43.2 | |
Other Equity Securities: | | | | | | | | | | | | |
Gains on Dispositions | | | 23.2 | | | | 25.8 | | | | 39.0 | |
Losses on Dispositions | | | (1.1 | ) | | | (3.0 | ) | | | (0.9 | ) |
Losses from Write-downs | | | (2.8 | ) | | | (7.9 | ) | | | (5.8 | ) |
Real Estate: | | | | | | | | | | | | |
Gains on Dispositions | | | 0.9 | | | | 39.4 | | | | 1.9 | |
Losses from Write-downs | | | (0.1 | ) | | | — | | | | — | |
Other Investments: | | | | | | | | | | | | |
Gains on Dispositions | | | 0.6 | | | | 0.4 | | | | 0.4 | |
Losses on Dispositions | | | (0.4 | ) | | | (0.4 | ) | | | (0.4 | ) |
| | | | | | | | | | | | |
Net Realized Investment Gains | | $ | 26.5 | | | $ | 56.9 | | | $ | 78.5 | |
| | | | | | | | | | | | |
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in the fair value of an investment is other than temporary. Losses arising from other than temporary declines in fair value are reported in the Consolidated Statements of Income in the period that the decline was determined to be other than temporary.
Net Realized Investment Gains for the years ended December 31, 2006, 2005 and 2004, include pretax losses of $2.8 million, $10.3 million and $5.9 million, respectively, from other than temporary declines in the fair values of investments. The Company cannot anticipate when or if similar investment losses may occur in the future.
CORPORATE INVESTMENTS
The Company considers the management of certain investments, including Northrop Grumman Corporation (“Northrop”) preferred and common stock, Baker Hughes common stock and its investee, Intermec, to be a corporate responsibility and excludes income from these investments from its Operating Segments. Dividend income from these Corporate Investments for the years ended December 31, 2006, 2005 and 2004, was:
| | | | | | | | | |
DOLLARS IN MILLIONS | | 2006 | | 2005 | | 2004 |
Northrop Preferred Stock | | $ | 9.3 | | $ | 12.4 | | $ | 12.4 |
Northrop Common Stock | | | 8.6 | | | 8.0 | | | 8.7 |
Baker Hughes Common Stock | | | 0.3 | | | 0.5 | | | 0.8 |
| | | | | | | | | |
Total Unallocated Dividend Income | | $ | 18.2 | | $ | 20.9 | | $ | 21.9 |
| | | | | | | | | |
Dividend income from the Company’s investment in Northrop preferred stock decreased for the year ended December 31, 2006, compared to the same period in 2005, due to the timing of the ex-dividend date. Dividend income from the Company’s investment in Northrop common stock increased for the year ended December 31, 2006, compared to the same period in 2005, due primarily to an increase in the dividend rate.
Dividend income from the Company’s investments in Northrop common stock and Baker Hughes common stock has decreased for the year ended December 31, 2005, compared to the same period in 2004, due to sales of a portion of the Company’s investment in these companies (see discussion above under heading “Investment Results”).
M-27
CORPORATE INVESTMENTS[CONTINUED]
The changes in fair values of Unitrin’s Corporate Investments for the year ended December 31, 2006, were:
| | | | | | | | | | | | | | |
DOLLARS IN MILLIONS | | FAIR VALUE
DEC. 31, 2005 | | DISPOSITIONS | | | HOLDING GAIN
(LOSS) ARISING
DURING PERIOD | | | FAIR VALUE
DEC. 31, 2006 |
Equity Securities: | | | | | | | | | | | | | | |
Northrop Preferred Stock | | $ | 225.7 | | $ | — | | | $ | 10.3 | | | $ | 236.0 |
Northrop Common Stock | | | 460.7 | | | (17.5 | ) | | | 57.1 | | | | 500.3 |
Baker Hughes Common Stock | | | 48.7 | | | (18.8 | ) | | | 11.2 | | | | 41.1 |
Investee: | | | | | | | | | | | | | | |
Intermec Common Stock | | | 427.8 | | | — | | | | (120.6 | ) | | | 307.2 |
| | | | | | | | | | | | | | |
Total Corporate Investments | | $ | 1,162.9 | | $ | (36.3 | ) | | $ | (42.0 | ) | | $ | 1,084.6 |
| | | | | | | | | | | | | | |
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2006, there were approximately 6.5 million shares of the Company’s outstanding common stock that could be repurchased under the Company’s outstanding repurchase authorization. Common stock may be repurchased in the open market or in privately negotiated transactions from time to time subject to market conditions and other factors. The Company repurchased and retired 2,006,500 shares of its common stock in 2006 at a cost of $89.9 million. The Company repurchased and retired 1,043,200 shares of its common stock in 2005 at a cost of $48.9 million. The Company has repurchased and retired approximately 57.7 million shares of its common stock in open market transactions at an aggregate cost of approximately $1.6 billion since 1990.
On June 24, 2005, the Company entered into a five-year, $325 million, unsecured, revolving credit agreement, expiring June 30, 2010, with a group of financial institutions. The agreement provides for fixed and floating rate advances for periods up to one year at various interest rates. The agreement also contains various financial covenants, including limits on total debt to total capitalization and minimum risk-based capital ratios for the Company’s largest insurance subsidiaries. The proceeds from advances under the revolving credit facility may be used for general corporate purposes. The new revolving credit agreement replaced the Company’s former $360 million revolving credit agreement which would have expired on August 30, 2005, but was terminated as of June 24, 2005. The Company had no outstanding advances under its unsecured, revolving credit agreement at December 31, 2006, or December 31, 2005. Undrawn letters of credit issued pursuant to the unsecured, revolving credit agreement were $13.1 million and $13.4 million at December 31, 2006, and December 31, 2005, respectively. Accordingly, the amounts available for future borrowing were $311.9 million and $311.6 million at December 31, 2006 and 2005, respectively.
The Company issued $200 million of its 4.875% senior notes due November 1, 2010 (the “4.875% Senior Notes”) in 2003, at an effective yield of 5.04%. The 4.875% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Company’s option at specified redemption prices. Interest expense under the 4.875% Senior Notes was $10.0 million for each of the years ended December 31, 2006, 2005 and 2004.
The Company issued $300 million of its 5.75% senior notes due July 1, 2007 (the “5.75% Senior Notes”), in 2002, for an effective yield of 5.99%. The 5.75% Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at the Company’s option at specified redemption prices. Interest expense under the 5.75% Senior Notes was $18.0 million, $17.9 million and $17.9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
In August 2005, the Company filed a universal shelf registration statement with the Securities and Exchange Commission for the future sale of up to an aggregate of $300 million of debt securities, common stock, preferred stock and other securities. The Company’s present intention is to utilize the shelf to refinance its $300 million 5.75% Senior Notes closer to their maturity.
The Company does not anticipate making significant changes to its capital structure during 2007. The Company’s management believes that it has sufficient resources to maintain the payment of dividends to its shareholders at its present level. Sources available for future shareholder dividend payments, the payment of interest on Unitrin’s senior notes and the repurchases of the Company’s common stock include the receipt of dividends from Unitrin’s operating subsidiaries, the receipt of dividends from its investments in Northrop, borrowings under the Company’s revolving credit agreement, and monetization of a portion of the Unitrin parent company’s Northrop holdings. Various state insurance laws restrict the ability of the Company’s insurance subsidiaries to pay dividends without regulatory approval. Such laws generally restrict the amount of dividends paid in an annual period to the greater of statutory net income from the previous year or 10% of statutory capital and surplus. Certain risk-based capital regulations also
M-28
LIQUIDITY AND CAPITAL RESOURCES[CONTINUED]
have the effect of limiting the amount of dividends that may be paid by the Company’s consumer finance subsidiary, Fireside Bank. In 2007, the Company estimates that its subsidiaries would be able to pay $324 million in dividends to the Company without prior regulatory approval. During 2006, six of Unitrin’s subsidiaries (Trinity, Union National, United Insurance Company of America (“United”), Fireside Securities Corporation (“Fireside”), The Reliable Life Insurance Company (“Reliable”) and Southern States General Agency (“Southern States”)) paid cash dividends totaling $115.0 million, $60.0 million, $17.9 million, $16.3 million, $12.1 million and $0.5 million, respectively, to Unitrin. The Unitrin parent company directly held investments in Northrop preferred and common stock with a market value totaling $330.0 million at December 31, 2006. In addition to the Unitrin parent company’s holdings of Northrop preferred and common stock, Trinity held investments in Northrop common stock with a market value of $406.3 million at December 31, 2006. During 2006, the Unitrin parent company and Trinity sold a portion of their Northrop common stock, generating gross proceeds of $12.7 million and $4.8 million, respectively.
During the first two quarters of 2005, Trinity paid dividends to the Unitrin Parent Company, which included a portion of its shares of Northrop common stock with a market value of approximately $50 million. During the fourth quarter of 2005, the Unitrin Parent Company sold a portion of its shares of Northrop common stock in the open market, generating gross proceeds of approximately $15 million. The Unitrin parent company directly held investments in Northrop preferred and common stock with a market value totaling $322 million at December 31, 2005. In addition to the Unitrin parent company’s holdings of Northrop preferred and common stock, Trinity held investments in Northrop common stock with a market value of $365 million at December 31, 2005.
During the fourth quarter of 2005, United, a subsidiary of the Unitrin Parent Company, sold its subsidiary, Reliable to the Unitrin Parent Company for $174.0 million in cash. Reliable in turn then paid a $40.0 million cash dividend to the Unitrin Parent Company. United also paid a $140.0 million cash dividend to the Unitrin Parent Company. United also distributed its subsidiary, Union National, to the Unitrin Parent Company. Also during the fourth quarter of 2005, three of Unitrin’s other subsidiaries, Trinity, Fireside and Southern States paid cash dividends of $30.0 million, $4.5 million and $0.5 million, respectively, to the Unitrin Parent Company. During the first three quarters of 2005, United, Trinity and Fireside paid cash dividends of $45.0 million, $26.0 million and $13.5 million, respectively, to the Unitrin Parent Company.
The primary sources of funds for the Company’s insurance subsidiaries are premiums and investment income. The primary uses of funds are the payment of policyholder benefits under life insurance contracts and claims under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses and the purchase of investments. Generally, there is a time lag between when premiums are collected and when policyholder benefits and insurance claims are paid. Accordingly, during periods of growth, insurance companies typically experience positive operating cash flows and are able to invest a portion of their operating cash flows to fund future policyholder benefits and claims. During periods in which premium revenues decline, insurance companies may experience negative cash flow from operations and may need to sell investments to fund payments to policyholders and claimants. In addition, if the Company’s property and casualty insurance subsidiaries experience several significant catastrophic events over a relatively short period of time, investments may have to be sold in advance of their maturity dates to fund payments, which could either result in investment gains or losses. Management believes that its insurance subsidiaries maintain adequate levels of liquidity and surplus capacity to manage the risks inherent with any differences between the duration of their liabilities and invested assets and to provide adequate liquidity in the event that its property and casualty insurance subsidiaries experience several catastrophic events over a relatively short period of time.
The primary sources of funds for Fireside Bank are customer deposits, repayments of consumer loans, interest on consumer loans and investment income. The primary uses of funds for Fireside Bank are loans made to consumers, repayment of customer deposits, interest paid to depositors and general expenses.
Net Cash Provided by Operating Activities decreased by $70.3 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to cash outflows related to the payment of insurance claims that were expensed and reserved for in prior years.
Net Cash Provided by Operating Activities increased by $78.5 million for the year ended December 31, 2005, compared to 2004, due primarily to changes in income taxes and in other receivables. Income Taxes paid were $64.3 million in 2005, compared to $254.2 million in 2004. Income Taxes paid decreased due to income taxes paid in the first half of 2004 related to sales of investments in the second half of 2003. In 2004, White Mountains Insurance Group paid a negotiated settlement amount to the Company to settle a certain matter related to the Company’s 1999 acquisition of Valley Group, Inc.
Net Cash Used by Investing Activities is largely dependent on Net Cash Provided by Operating Activities and cash flow from Financing Activities. Net Cash Used by Investing Activities decreased by $333.3 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower levels of cash from Financing and Operating Activities. In addition, the Company significantly increased its cash on hand in 2006 as a result of certain premium tax planning strategies while the Company significantly reduced its cash on hand in 2005 and invested such excess. Net Cash Used by Investing Activities increased by $211.0 million for the year ended December 31, 2005, compared to 2004, due primarily to the corresponding changes in Net Cash from Operating Activities and Net Cash Provided by Financing Activities.
Net Cash Provided by Financing Activities decreased by $112.0 million for the year ended December 31, 2006, compared to the same period in 2005. Cash from certificates of deposits issued, net of withdrawals,
M-29
LIQUIDITY AND CAPITAL RESOURCES[CONTINUED]
decreased by $63.5 million in 2006 compared to the same period in 2005. In addition, the Company used $89.9 million of cash in 2006 to repurchase shares of its common stock, compared to $48.9 million of cash used to repurchase shares of its common stock in the same period in 2005.
Net Cash Provided by Financing Activities increased by $78.5 million for the year ended December 31, 2005, compared to 2004. Certificates of deposits issued, net of withdrawals, increased by $144.7 million to fund the growth in Consumer Finance Receivables. Common stock repurchases totaled $48.9 million in 2005. The Company did not repurchase any of its common stock in 2004.
Unitrin and its subsidiaries have not formed special purpose entities or similar structured financing vehicles to access capital and/or manage risk or for any other purpose. The Company’s retained earnings includes $55.6 million and $47.8 million representing the undistributed equity in net income of investee at December 31, 2006 and 2005, respectively.
OFF–BALANCE SHEET ARRANGEMENTS
The Company has no material obligations under a guarantee contract meeting the characteristics identified in paragraph 3 of Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 45,Guarantor’s Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others. The Company has no material retained or contingent interests in assets transferred to an unconsolidated entity. The Company has no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. The Company has no obligations, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, the Company, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with, the Company. Accordingly, the Company has no material off–balance sheet arrangements.
CONTRACTUAL OBLIGATIONS
Estimated cash disbursements pertaining to the Company’s contractual obligations at December 31, 2006, are as follows:
| | | | | | | | | | | | | | | |
DOLLARS IN MILLIONS | | JAN. 1, 2007
TO DEC. 31, 2007 | | JAN. 1, 2008
TO
DEC. 31, 2009 | | JAN. 1, 2010
TO DEC. 31, 2011 | | AFTER
DEC. 31, 2011 | | TOTAL |
Long Term Debt Obligations | | $ | 300.1 | | $ | 0.2 | | $ | 200.2 | | $ | 5.6 | | $ | 506.1 |
Certificates of Deposits | | | 479.5 | | | 341.3 | | | 326.4 | | | 15.5 | | | 1,162.7 |
Operating Lease Obligations | | | 27.6 | | | 43.7 | | | 28.1 | | | 35.4 | | | 134.8 |
Purchase Obligations | | | 22.2 | | | 32.4 | | | 20.7 | | | — | | | 75.3 |
Life and Health Insurance Policy Benefits | | | 264.4 | | | 349.3 | | | 326.2 | | | 4,746.6 | | | 5,686.5 |
Property and Casualty Insurance Reserves | | | 660.6 | | | 499.1 | | | 167.3 | | | 105.6 | | | 1,432.6 |
Other Contractual Obligations Reflected in Long Term Liabilities on the Consolidated Balance Sheet under GAAP | | | 75.7 | | | 69.6 | | | 33.2 | | | 1.2 | | | 179.7 |
| | | | | | | | | | | | | | | |
Total Contractual Obligations | | $ | 1,830.1 | | $ | 1,335.6 | | $ | 1,102.1 | | $ | 4,909.9 | | $ | 9,177.7 |
| | | | | | | | | | | | | | | |
Amounts included in Life and Health Insurance Policy Benefits within the contractual obligations table above reflect estimated cash payments to be made to policyholders and beneficiaries. Such cash outflows are based on the Company’s current assumptions for mortality, morbidity and policy lapse, but are undiscounted with respect to interest. Policies must remain in force for the policyholder or beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. The Company estimates that future cash inflows would total approximately $3.9 billion using the same assumptions used to estimate the cash outflows.
The Company’s Life insurance reserves in the Company’s Consolidated Balance Sheet are generally based on the historical assumptions for mortality and policy lapse and are on a discounted basis. Accordingly, the sum of the amounts presented above for Life and Health Insurance Policy Benefits significantly exceeds the amount of Life and Health Insurance Reserves reported on the Company’s Consolidated Balance Sheet at December 31, 2006.
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $207 million at December 31, 2006. The funding of such investment commitments are dependent upon a number of factors, the timing of which is indeterminate.
Other Contractual Obligations Reflected in Long Term Liabilities on the Consolidated Balance Sheet under GAAP primarily consist of interest obligations related to Long Term Debt Obligations and Certificates of Deposits.
M-30
INTEREST AND OTHER EXPENSES
Interest and Other Expenses was $62.5 million, $64.0 million and $57.4 million in 2006, 2005 and 2004, respectively. Interest expense, excluding interest on a mortgage note payable included in real estate investment expense, was $28.5 million, $28.4 million and $28.3 million in 2006, 2005 and 2004, respectively. Other Corporate Expenses were $34.0 million, $35.6 million and $29.1 million in 2006, 2005 and 2004, respectively.
Other Corporate Expenses decreased by $1.6 million for the year ended December 31, 2006, compared to the same period in 2005, due primarily to lower compensation and employee benefit costs. Other Corporate Expenses increased by $6.5 million for the year ended December 31, 2005, compared to the same period in 2004, due primarily to higher compensation and employee benefit costs.
INCOME TAXES
The Company’s effective income tax rate differs from the Federal statutory income tax rate due primarily to the effects of certain tax adjustments described below, tax-exempt investment income and dividends received deductions, partially offset by state income taxes. Tax-exempt investment income and dividends received deductions were $69.5 million, $68.3 million and $60.0 million in 2006, 2005 and 2004, respectively. State income taxes were $5.7 million, $6.0 million and $5.8 million in 2006, 2005 and 2004, respectively.
During 2005, a benefit of approximately $14 million was recorded primarily for Federal income tax adjustments related to the tax years ended December 31, 2002 and December 31, 2001. During the fourth quarter of 2005, the Company received notification from the Department of the Treasury that the Joint Committee on Taxation (the “JCT”) had completed its review of the Internal Revenue Service’s (the “IRS”) report regarding these years and took no exception with the IRS’ report. Based on the notification from the JCT, the Company expects no further examination of these years by the IRS.
During 2004, an income tax benefit of $0.9 million was recorded for Federal income tax adjustments related to the tax year that ended on December 31, 2000. During 2004, the statute of limitations expired for the tax year that ended on December 31, 2000.
ACCOUNTING CHANGES
In December 2004, FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment. SFAS No. 123(R) replaces SFAS No. 123,Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees. SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. The Company has adopted SFAS No. 123(R) using the modified prospective method effective January 1, 2006. Under the modified prospective method, companies record prospectively the compensation cost for new and modified awards, on or after the date of adoption, over the requisite service period of such awards. In addition, companies record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining requisite service period of such awards. The Company previously adopted SFAS No. 123 in 2003.
Accordingly, the incremental effect of adoption of SFAS No. 123(R) was insignificant.
In November 2005, the FASB issued FASB Staff Position (“FSP”) FAS 123(R)-3,Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. FSP FAS 123(R)-3 provides an alternative transition method for establishing the beginning balance of the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R) (the “APIC Pool”). The Company has elected to adopt the alternative transition method provided in FSP FAS 123(R)-3 for establishing the beginning balance of the APIC Pool. This method consists of a computational component that establishes a beginning balance of the APIC Pool related to employee compensation and a simplified method to determine the subsequent impact on the APIC Pool of employee awards that are fully vested and outstanding upon the adoption of SFAS No. 123(R). The impact on the APIC Pool of partially vested awards was insignificant.
M-31
ACCOUNTING CHANGES[CONTINUED]
In June 2006, the FASB issued FIN 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.FIN 48 clarifies the accounting for uncertainty in income taxes recognized under SFAS No. 109,Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on various related matters such as derecognition, interest and penalties, and disclosure. FIN 48 is effective with the Company’s fiscal year beginning January 1, 2007. The Company expects that the financial impact, if any, of applying the provisions of FIN 48 to all tax positions will not be material upon the initial adoption of FIN 48.
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Early application is encouraged, provided that the reporting entity has not yet issued financial statements for an interim period within that fiscal year. The Company estimates that the initial application of SFAS No. 157 will not be material.
In September 2006, the FASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 amends SFAS No. 87,Employers’ Accounting for Pensions, SFAS No. 88,Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and Termination Benefits, SFAS No. 106,Employers’ Accounting for Postretirement Benefits Other Than Pensions, and SFAS No. 132(R),Employers’ Disclosure about Pensions and Other Postretirement Benefits. SFAS No. 158 requires the recognition of the funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in the statement of financial position and the recognition of changes in the funded status through comprehensive income in the year in which such changes occur. The Company adopted the recognition provisions of SFAS No. 158 and initially applied them to the funded status of its defined benefit postretirement plans as of December 31, 2006. The initial recognition of the funded status of its defined benefit postretirement plans resulted in a decrease in Shareholders’ Equity of $7.3 million, which was net of a tax benefit of $5.5 million. The Company accounts for its investment in its investee, Intermec, under the equity method of accounting on a three-month-delay basis. As of September 30, 2006, the date of Intermec’s most recent publicly available financial statements, Intermec had not yet determined the impact of SFAS No. 158 on its financial statements. Accordingly, the Company cannot determine the impact that Intermec’s adoption of SFAS No. 158 will ultimately have on the Company’s financial statements. However, had Intermec been required to apply the provisions of SFAS No. 158 to the accounting for Intermec’s defined benefit postretirement plans at December 31, 2005, the Company estimates it would have recognized a decrease of approximately $8 million to the Company’s Shareholders’ Equity for its share of the impact from Intermec’s adoption of FSAB No. 158.
SFAS No. 158 also requires that the funded status of a plan be measured as of the date of the year-end statement of financial position, with limited exceptions. The Company currently measures its funded status as of the date of the Company’s fiscal year-end statement of financial position. Accordingly, the Company’s adoption of the measurement provisions of SFAS No. 158 will have no impact on the Company’s Consolidated Financial Statements. Intermec, however, does not measure its funded status as of the date of its year-end statement of financial position. The Company estimates that the impact of Intermec’s adoption of the measurement provisions will not be material to the Company.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative Information About Market Risk
The Company’s consolidated balance sheet includes five types of financial instruments subject to the material market risk disclosures required by the Securities and Exchange Commission (“SEC”):
| | 1) | Investments in Fixed Maturities; |
| | 2) | Investments in Equity Securities; |
| | 3) | Consumer Finance Receivables; |
| | 4) | Certificates of Deposits; and |
Investments in Fixed Maturities, Consumer Finance Receivables, Certificates of Deposits and Notes Payable are subject to material interest rate risk. The Company’s Investments in Equity Securities include common and preferred stocks and, accordingly, are subject to material equity price risk and interest rate risk, respectively.
For purposes of this disclosure, market risk sensitive financial instruments are divided into two categories: financial instruments acquired for trading purposes and financial instruments acquired for purposes other than trading. The Company’s market risk sensitive financial instruments are generally classified as held for purposes other than trading. The Company has no significant holdings of financial instruments acquired for trading purposes. The Company has no significant holdings of derivatives.
The Company measures its sensitivity to market risk by evaluating the change in its financial assets and liabilities relative to fluctuations in interest rates and equity prices. The evaluation is made using instantaneous changes in interest rates and equity prices on a static balance sheet to determine the effect such changes would have on the Company’s market value at risk and the resulting pretax effect on Shareholders’ Equity. The changes chosen reflect the Company’s view of adverse changes which are
M-32
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK[CONTINUED]
Quantitative Information About Market Risk [continued]
reasonably possible over a one-year period. The selection of the changes chosen should not be construed as the Company’s prediction of future market events, but rather an illustration of the impact of such events.
For the interest rate sensitivity analysis presented below, the Company assumed an adverse and instantaneous increase of 100–basis points in the yield curve at December 31, 2006 and 2005, respectively, for Investments in Fixed Maturities. Such 100–basis point increase in the yield curve may not necessarily result in a corresponding 100–basis point increase in the interest rate for all investments in fixed maturities. For example, a 100–basis point increase in the yield curve for risk-free, taxable investments in fixed maturities may not result in a 100–basis point increase for tax-exempt investments in fixed maturities. For Investments in Fixed Maturities, the Company also anticipated changes in cash flows due to changes in the likelihood that investments would be called or prepaid prior to their contractual maturity. All other variables were held constant. For preferred stock equity securities and Consumer Finance Receivables, the Company assumed an adverse and instantaneous increase of 100–basis points in market interest rates from their levels at December 31, 2006 and 2005, respectively. All other variables were held constant. For Certificates of Deposits and Notes Payable, the Company assumed an adverse and instantaneous decrease of 100–basis points in market interest rates from their levels at December 31, 2006 and 2005, respectively. All other variables were held constant. The Company measured equity price sensitivity assuming an adverse and instantaneous 10% decrease in the Standard and Poor’s Stock Index (the “S&P 500”) from its levels at December 31, 2006 and 2005, with all other variables held constant. The Company’s investments in common stock equity securities were correlated with the S&P 500 using the portfolio’s weighted-average beta of 0.58 and 0.46 at December 31, 2006 and 2005, respectively. The portfolio’s weighted-average beta was calculated using each security’s beta for the five-year periods ended December 31, 2006 and 2005, respectively, and weighted on the fair value of such securities at December 31, 2006 and 2005, respectively. Beta measures a stock’s relative volatility in relation to the rest of the stock market, with the S&P 500 having a beta coefficient of 1.00.
The estimated adverse effects on the market value of the Company’s financial instruments at December 31, 2006, using these assumptions were:
| | | | | | | | | | | | | | | |
| | | | | PRO FORMA INCREASE (DECREASE) | |
DOLLARS IN MILLIONS | | FAIR VALUE | | INTEREST
RATE RISK | | | EQUITY
PRICE RISK | | | TOTAL
MARKET RISK | |
ASSETS | | | | | | | | | | | | | | | |
Investments in Fixed Maturities | | $ | 3,832.9 | | $ | (260.5 | ) | | $ | — | | | $ | (260.5 | ) |
Investments in Equity Securities | | | 1,305.6 | | | (2.5 | ) | | | (72.8 | ) | | | (75.3 | ) |
Consumer Finance Receivables | | | 1,231.4 | | | (16.4 | ) | | | — | | | | (16.4 | ) |
LIABILITIES | | | | | | | | | | | | | | | |
Certificates of Deposits | | $ | 1,154.6 | | $ | 22.4 | | | $ | — | | | $ | 22.4 | |
Notes Payable | | | 501.3 | | | 8.3 | | | | — | | | | 8.3 | |
The estimated adverse effects on the market value of the Company’s financial instruments at December 31, 2005, using these assumptions were:
| | | | | | | | | | | | | | | |
| | | | | PRO FORMA INCREASE (DECREASE) | |
DOLLARS IN MILLIONS | | FAIR
VALUE | | INTEREST
RATE RISK | | | EQUITY
PRICE RISK | | | TOTAL
MARKET RISK | |
ASSETS | | | | | | | | | | | | | | | |
Investments in Fixed Maturities | | $ | 4,086.6 | | $ | (301.8 | ) | | $ | — | | | $ | (301.8 | ) |
Investments in Equity Securities | | | 1,098.9 | | | (4.4 | ) | | | (47.1 | ) | | | (51.5 | ) |
Consumer Finance Receivables | | | 1,112.5 | | | (14.8 | ) | | | — | | | | (14.8 | ) |
LIABILITIES | | | | | | | | | | | | | | | |
Certificates of Deposits | | $ | 1,070.9 | | $ | 18.6 | | | $ | — | | | $ | 18.6 | |
Notes Payable | | | 504.3 | | | 12.9 | | | | — | | | | 12.9 | |
M-33
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK[CONTINUED]
Quantitative Information About Market Risk [continued]
The market risk sensitivity analysis assumes that the composition of the Company’s interest rate sensitive assets and liabilities, including, but not limited to, credit quality, and equity price sensitive assets existing at the beginning of the period remains constant over the period being measured. It also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the time to maturity. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Also, any future correlation, either in the near term or the long term, between the Company’s common stock equity securities portfolio and the S&P 500 may differ from the historical correlation as represented by the weighted-average historical beta of the common stock equity securities portfolio. Accordingly, the market risk sensitivity analysis may not be indicative of, is not intended to provide, and does not provide, a precise forecast of the effect of changes of market rates on the Company’s income or shareholders’ equity. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates or equity prices.
To the extent that any adverse 100–basis point change occurs in increments over a period of time instead of instantaneously, the adverse impact on fair values would be partially mitigated because some of the underlying financial instruments would have matured. For example, proceeds from any maturing assets could be reinvested and any new liabilities would be incurred at the then current interest rates.
Qualitative Information About Market Risk
Market risk is a broad term related to economic losses due to adverse changes in the fair value of a financial instrument and is inherent to all financial instruments. SEC disclosure rules focus on only one element of market risk—price risk. Price risk relates to changes in the level of prices due to changes in interest rates, equity prices, foreign exchange rates or other factors that relate to market volatility of the rate, index, or price underlying the financial instrument. The Company’s primary market risk exposures are to changes in interest rates and certain exposures to changes in equity prices.
The Company manages its interest rate exposures with respect to Investments in Fixed Maturities by investing primarily in investment-grade securities of moderate effective duration. The interest rate risks with respect to the fair value of Consumer Finance Receivables should be partially offset by the impact of interest rate movements on Certificates of Deposits which are issued to fund its receivables.
At December 31, 2006 and 2005, $736.3 million and $686.4 million, respectively, of the Company’s Investments in Equity Securities, which exclude the Company’s Investment in Investee, was concentrated in the preferred and common stock of Northrop. Northrop stated in its 2005 Annual Report on Form 10-K that it “provides technologically advanced innovative products, services and solutions in information and services, aerospace, electronics and shipbuilding.” Additionally, Northrop stated that “as a prime contractor, principal subcontractor, partner or preferred supplier,” it “participates in many high-priority defense and non-defense technology programs in the United States and abroad.” Accordingly, the Company’s Investments in Equity Securities is sensitive to the nature of Northrop’s industry segments.
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CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Management’s Discussion and Analysis of Results of Operations and Financial Condition, Quantitative and Qualitative Disclosures About Market Risk and the accompanying Consolidated Financial Statements (including the notes thereto) may contain or incorporate by reference information that includes or is based upon forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements give expectations or forecasts of future events. The reader can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as “believe(s),”“goal(s),” “target(s),” “estimate(s),” “anticipate(s),” “forecast(s),” “project(s),” “plan(s),” “intend(s),” “expect(s),” “might,” “may” and other words and terms of similar meaning in connection with a discussion of future operating or financial performance. Forward-looking statements, in particular, include statements relating to future actions, prospective services or products, future performance or results of current and anticipated services or products, sales efforts, expenses, the outcome of contingencies such as legal proceedings, trends in operations and financial results.
Any or all forward-looking statements may turn out to be wrong, and, accordingly, readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this Annual Report. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining the Company’s actual future results. These statements are based on current expectations and the current economic environment. They involve a number of risks and uncertainties that are difficult to predict. These statements are not guarantees of future performance; actual results could differ materially from those expressed or implied in the forward-looking statements.
Among the general factors that could cause actual results to differ materially from estimated results are:
| | • | | Changes in general economic conditions, including performance of financial markets, interest rates, unemployment rates and fluctuating values of particular investments held by the Company and its subsidiaries; |
| | • | | Heightened competition, including, with respect to pricing, entry of new competitors and the development of new products by new and existing competitors; |
| | • | | The number and severity of insurance claims (including those associated with catastrophe losses) and their impact on the adequacy of loss reserves; |
| | • | | The impact of inflation on insurance claims, including, but not limited to, the effects attributed to scarcity of resources available to rebuild damaged structures, including labor and materials and the amount of salvage value recovered for damaged property; |
| | • | | Orders, interpretations or other actions by regulators that impact the reporting, adjustment and payment of claims; |
| | • | | Changes in the pricing or availability of reinsurance; |
| | • | | Changes in the financial condition of reinsurers and amounts recoverable therefrom; |
| | • | | Changes in industry trends and significant industry developments; |
| | • | | Regulatory approval of insurance rates, policy forms, license applications and similar matters; |
| | • | | Developments related to insurance policy claims and coverage issues including, but not limited to, interpretations or decisions by courts or regulators that may govern or influence insurance policy coverage issues arising with respect to losses incurred in connection with hurricanes and other catastrophes; |
| | • | | Governmental actions, including new laws or regulations or court decisions interpreting existing laws and regulations or policy provisions; |
| | • | | Adverse outcomes in litigation or other legal and regulatory proceedings involving the Company or its subsidiaries; |
| | • | | Regulatory, accounting or tax changes that may affect the cost of, or demand for, the Company’s products or services; |
| | • | | The impact of residual market assessments and assessments for insurance industry insolvencies; |
| | • | | Changes in distribution channels, methods or costs resulting from changes in laws or regulations, lawsuits or market forces; |
| | • | | Changes in ratings by credit rating agencies including A.M. Best Co., Inc.; |
| | • | | The level of success and costs expended in realizing economies of scale and implementing significant business consolidations and technology initiatives; |
| | • | | Increased costs and risks related to data security; |
| | • | | Absolute and relative performance of the Company’s products or services; and |
| | • | | Other risks and uncertainties described from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”). |
No assurances can be given that the results contemplated in any forward-looking statements will be achieved or will be achieved in any particular timetable. The Company assumes no obligation to publicly correct or update any forward-looking statements as a result of events or developments subsequent to the date of this Annual Report. The reader is advised, however, to consult any further disclosures the Company makes on related subjects in filings made with the SEC.
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