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EX-10.3 - Amtrust Financial Services, Inc.v190886_ex10-3.htm
EX-31.2 - Amtrust Financial Services, Inc.v190886_ex31-2.htm
EX-32.1 - Amtrust Financial Services, Inc.v190886_ex32-1.htm
EX-10.6 - Amtrust Financial Services, Inc.v190886_ex10-6.htm
EX-10.5 - Amtrust Financial Services, Inc.v190886_ex10-5.htm
EX-31.1 - Amtrust Financial Services, Inc.v190886_ex31-1.htm
EX-32.2 - Amtrust Financial Services, Inc.v190886_ex32-2.htm
EX-10.4 - Amtrust Financial Services, Inc.v190886_ex10-4.htm
EX-10.2 - Amtrust Financial Services, Inc.v190886_ex10-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________________ to ___________________

Commission file no. 001-33143

AmTrust Financial Services, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
04-3106389
(State or other jurisdiction of
 
(IRS Employer Identification No.)
incorporation or organization)
   
     
59 Maiden Lane, 6th  Floor, New York, New York
 
10038
(Address of principal executive offices)
  
(Zip Code)

(212) 220-7120
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   x   No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   ¨ No   ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act:

Large accelerated filer    ¨
Accelerated filer    x
   
Non-accelerated filer    ¨
Smaller reporting company    ¨
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act). Yes   ¨   No   x

As of August 2, 2010, the Registrant had one class of Common Stock ($.01 par value), of which 59,464,977 shares were issued and outstanding.

 
 

 

INDEX

       
 Page 
PART I
 
FINANCIAL INFORMATION
   
         
Item 1.
 
Unaudited Financial Statements:
   
         
   
Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009 (audited)
 
3
         
   
Condensed Consolidated Statements of Income
 
4
   
— Three and six months ended June 30, 2010 and 2009
   
         
   
Condensed Consolidated Statements of Cash Flows
 
5
   
— Three and six months ended June 30, 2010 and 2009
   
         
   
 
Notes to Condensed Consolidated Financial Statements
 
6
         
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
29
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
51
         
Item 4.
 
Controls and Procedures
 
53
         
PART II
 
OTHER INFORMATION
   
         
Item 1.
 
Legal Proceedings
 
53
         
Item 1A.
 
Risk Factors
 
53
         
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
53
         
Item 3.
 
Defaults Upon Senior Securities
 
53
         
Item 4.
 
(Removed and Reserved)
 
53
         
Item 5.
 
Other Information
 
53
         
Item 6.
 
Exhibits
 
54
         
 
  
Signatures
  
55

 
2

 

PART 1 - FINANCIAL INFORMATION
  
Item 1. Financial Statements

AMTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except par value)

   
June 30,
2010
   
December 31,
2009
 
   
(Unaudited)
       
ASSETS
           
Investments:
           
Fixed maturities, available-for-sale, at market value (amortized cost $1,047,827; $1,080,914)
 
$
1,063,472
   
$
1,085,362
 
Equity securities, available-for-sale, at market value (cost $54,553; $60,639)
   
45,937
     
50,355
 
Short-term investments
   
990
     
31,265
 
Equity investment in unconsolidated subsidiaries – related party
   
74,359
     
1,288
 
Other investments
   
13,323
     
12,746
 
Total investments
   
1,198,081
     
1,181,016
 
Cash and cash equivalents
   
316,409
     
233,810
 
Accrued interest and dividends
   
6,326
     
7,617
 
Premiums receivable, net
   
654,780
     
495,871
 
Note receivable – related party
   
23,822
     
23,224
 
Reinsurance recoverable
   
360,564
     
349,695
 
Reinsurance recoverable – related party
   
335,973
     
293,626
 
Prepaid reinsurance premium
   
166,477
     
148,425
 
Prepaid reinsurance premium – related party
   
279,983
     
262,128
 
Prepaid expenses and other assets
   
97,027
     
85,108
 
Federal income tax receivable
   
     
364
 
Deferred policy acquisition costs
   
222,519
     
180,179
 
Deferred income taxes
   
     
7,615
 
Property and equipment, net
   
14,916
     
15,858
 
Goodwill
   
59,764
     
53,156
 
Intangible assets
   
65,941
     
62,672
 
  
 
$
3,802,582
   
$
3,400,364
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities:
               
Loss and loss expense reserves
 
$
1,154,615
   
$
1,091,944
 
Unearned premiums
   
960,432
     
871,779
 
Ceded reinsurance premiums payable
   
144,501
     
75,032
 
Ceded reinsurance premium payable – related party
   
93,390
     
86,165
 
Reinsurance payable on paid losses
   
2,819
     
1,238
 
Funds held under reinsurance treaties
   
620
     
690
 
Securities sold but not yet purchased, at market
   
70,328
     
16,315
 
Securities sold under agreements to repurchase, at contract value
   
238,252
     
172,774
 
Accrued expenses and other current liabilities
   
165,797
     
180,325
 
Deferred tax liability
   
4,194
     
 
Federal tax payable
   
9,762
     
 
Derivatives liabilities
   
220
     
1,893
 
Note payable on collateral loan – related party
   
167,975
     
167,975
 
Non interest bearing note payable – net of unamortized discount of $922; $1,372
   
14,078
     
21,128
 
Term loan
   
13,333
     
20,000
 
Junior subordinated debt
   
123,714
     
123,714
 
Total liabilities
   
3,164,030
     
2,830,972
 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, $.01 par value; 100,000 shares authorized, 84,280 and 84,179 issued in 2010 and 2009, respectively; 59,464 and 59,314 outstanding in 2010 and 2009, respectively
   
843
     
842
 
Preferred stock, $.01 par value; 10,000 shares authorized
   
     
 
Additional paid-in capital
   
546,015
     
543,977
 
Treasury stock at cost; 24,816 and 24,866 shares in 2010 and 2009, respectively
   
(300,278
)
   
(300,889
)
Accumulated other comprehensive loss
   
(11,716
)
   
(17,020
)
Retained earnings
   
403,688
     
342,482
 
Total stockholders’ equity
   
638,552
     
569,392
 
  
 
$
3,802,582
   
$
3,400,364
 
 
See accompanying notes to unaudited condensed consolidated statements. 

 
3

 

AmTrust Financial Services, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(in thousands, except per share data)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues:
                       
Premium income:
                       
Net written premium
 
$
196,394
   
$
137,120
   
$
385,808
   
$
273,299
 
Change in unearned premium
   
(133
)
   
(317
)
   
(41,447
)
   
(4,073
)
Net earned premium
   
196,261
     
136,803
     
344,361
     
269,226
 
Ceding commission – primarily related party
   
32,958
     
32,278
     
65,206
     
59,869
 
Service and fee income
   
6,241
     
5,711
     
11,539
     
11,282
 
Service and fee income – related party
   
2,880
     
1,896
     
5,548
     
3,779
 
Net investment income
   
14,686
     
13,799
     
28,285
     
27,790
 
Net realized loss on investments
   
(6,544
)
   
(7,709
)
   
(4,759
)
   
(16,947
)
Total revenues
   
246,482
     
182,778
     
450,180
     
354,999
 
Expenses:
                               
Loss and loss adjustment expense
   
121,510
     
76,585
     
211,331
     
151,500
 
Acquisition costs and other underwriting expenses
   
79,579
     
64,587
     
140,925
     
122,741
 
Other
   
9,336
     
5,774
     
15,570
     
10,968
 
Total expenses
   
210,425
     
146,946
     
367,826
     
285,209
 
Income before other income (expense), income taxes and equity in earnings (loss) of unconsolidated subsidiaries
   
36,057
     
35,832
     
82,354
     
69,790
 
Other income (expenses):
                               
Foreign currency gain
   
755
     
611
     
38
     
644
 
Interest expense
   
(3,063
)
   
(4,007
)
   
(6,635
)
   
(8,178
)
Total other expenses
   
(2,308
)
   
(3,396
)
   
(6,597
)
   
(7,534
)
Income before income taxes and equity in earnings (loss) of unconsolidated subsidiaries
   
33,749
     
32,436
     
75,757
     
62,256
 
Provision for income taxes
   
8,839
     
5,448
     
24,007
     
10,704
 
Income before equity in earnings (loss) of unconsolidated subsidiaries
   
24,910
     
26,988
     
51,750
     
51,552
 
Equity in earnings (loss) of unconsolidated subsidiaries – related party
   
5,913
     
(217
   
17,773
     
(619
Net Income
   
30,823
     
26,771
     
69,523
     
50,933
 
                                 
Earnings per common share:
                               
Basic earnings per common share
 
$
0.52
   
$
0.45
   
$
1.17
   
$
0.86
 
Diluted earnings per common share
 
$
0.51
   
$
0.45
   
$
1.15
   
$
0.85
 
Dividends declared per common share
 
$
0.07
   
$
0.06
   
$
0.14
   
$
0.11
 
 
Net realized loss on investments:
                       
Total other-than-temporary impairment losses
 
$
(12,007
)
 
$
(10,786
)
 
$
(17,145
)
 
$
(12,213
)
Portion of loss recognized in other comprehensive income
   
     
     
     
 
Net impairment losses recognized in earnings
   
(12,007
)
   
(10,786
)
   
(17,145
)
   
(12,213
)
Other net realized gain (loss) on investments
   
5,463
     
3,077
     
12,386
     
(4,734
)
Net realized investment loss
 
$
(6,544
)
 
$
(7,709
)
 
$
(4,759
)
 
$
(16,947
)
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4

 

AmTrust Financial Services, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 
   
Six Months Ended June 30,
 
(in thousands)
 
2010
   
2009
 
Cash flows from operating activities:
           
Net income from continuing operations
 
$
69,523
   
$
50,933
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
7,945
     
4,415
 
Equity earnings and gain on investment in unconsolidated subsidiaries
   
(17,773
)
   
-
 
Realized loss (gain) on marketable securities
   
(12,386
   
4,734
 
Non-cash write-down of marketable securities
   
17,145
     
12,213
 
Discount on notes payable
   
450
     
596
 
Stock compensation expense
   
1,860
     
1,812
 
Bad debt expense
   
3,510
     
1,951
 
Foreign currency (gain)
   
(38
)
   
(644
)
Changes in assets - (increase) decrease:
               
Premium and notes receivable
   
(162,419
   
33,890
 
Reinsurance recoverable
   
(10,869
   
18,004
 
Reinsurance recoverable – related party
   
(42,347
)
   
(44,775
)
Deferred policy acquisition costs, net
   
(42,340
)
   
(33,516
)
Prepaid reinsurance premiums
   
(18,052
)
   
(7,149
)
Prepaid reinsurance premiums – related party
   
(17,855
   
7,659
 
Prepaid expenses and other assets
   
(739
   
9,850
 
Deferred tax asset
   
(4,170
   
27,117
 
Changes in liabilities - increase (decrease):
               
Reinsurance premium payable
   
69,469
     
(9,294
Reinsurance premium payable – related party
   
25,011
     
(13,283
)
Loss and loss expense reserve
   
62,671
     
43,587
 
Unearned premiums
   
88,653
     
7,927
 
Funds held under reinsurance treaties
   
(70
   
77
 
Accrued expenses and other current liabilities
   
(10,896
   
(3,270
Net cash provided by operating activities
   
6,283
 
   
112,834
 
Cash flows from investing activities:
               
Net sales (purchases) of securities with fixed maturities
   
95,734
     
36,935
 
Net (purchases) sales of equity securities
   
4,502
     
(4,615
)
Net sales of other investments
   
(577
   
441
 
Investment in ACAC
   
(53,055
)
   
-
 
Acquisition of subsidiaries, net of cash obtained
   
(3,553
   
-
 
Acquisition of renewal rights and goodwill
   
-
     
(910
)
Purchase of property and equipment
   
(1,677
)
   
(1,833
)
Net cash provided by investing activities
   
41,374
     
30,018
 
Cash flows from financing activities:
               
Repurchase agreements, net
   
65,478
     
(53,887
)
Term loan payment
   
(6,667
)
   
(6,666
)
Non-interest bearing note payment
   
(7,500
)
   
(7,500
)
Repurchase of common stock
   
-
     
(5,492
)
Stock option exercise
   
790
     
95
 
Dividends distributed on common stock
   
(7,713
)
   
(5,970
)
Net cash provided by (used in) financing activities
   
44,388
     
(79,420
)
Effect of exchange rate changes on cash
   
(9,446
   
2,387
 
Net increase in cash and cash equivalents
   
82,599
     
65,819
 
Cash and cash equivalents, beginning of the period
   
233,810
     
192,053
 
Cash and cash equivalents, end of the period
 
$
316,409
   
$
257,872
 
Supplemental Cash Flow Information:
               
Income tax payments
 
$
7,258
   
$
9,098
 
Interest payments on debt
   
8,434
     
8,296
 

See accompanying notes to unaudited condensed consolidated financial statements.

 
5

 

Notes to Unaudited Condensed Consolidated Financial Statements
(Unaudited)
(dollars in thousands, except share data)
 
1.
Basis of Reporting

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These interim statements should be read in conjunction with the financial statements and notes thereto included in the AmTrust Financial Services, Inc. (“AmTrust” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2009, previously filed with the Securities and Exchange Commission (“SEC”) on March 16, 2010. The balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
 
These interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements for the year ended December 31, 2009, included in the Company’s Form 10-K filed with the SEC.

All significant inter-company transactions and accounts have been eliminated in the consolidated financial statements. To facilitate period-to-period comparisons, certain reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation. There was no effect on net income from the change in presentation.

2.
Recent Accounting Pronouncements
 
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2010, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, that are of significance, or potential significance, to us.

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). This update requires additional disclosures about fair value measurements, including disclosure regarding the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for the transfers. For fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances which includes gains, losses, purchases, sales, issuances and settlements disclosed separately for the period is required. Additionally, fair value measurement disclosures will need disaggregation for each class of assets and liabilities. The requirements are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure about purchases, sales, issuances and settlements, which is effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted the guidance as of January 1, 2010 and the revised guidance did not have an impact on its results of operations, financial position or liquidity.

 
6

 
 
In June 2008, the FASB issued new guidance on determining whether instruments granted in share-based payment transactions are participating securities. The new guidance, which is now part of ASC 260, Earnings per Share, clarifies that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are to be included in the computation of earnings per share under the two-class method. This new guidance was effective for financial statements issued for fiscal years that began after December 15, 2008 and required all presented prior-period earnings per share data to be adjusted retrospectively. The Company issued participating securities during 2010 and therefore this guidance is applicable to the Company for the period ended June 30, 2010. The guidance did not have a material impact on the Company’s results of operations, financial position or liquidity.

Prospective Accounting Literature
 
The Emerging Issues Task Force (“EITF”) issued EITF Issue No. 09-G, Clarification of the Definition of Deferred Acquisition Costs (DAC) of Insurance Entities and intends to clarify the definition of what constitutes an acquisition cost and the types of acquisition costs capitalized by an insurance entity. In November 2009, the EITF reached a consensus-for-exposure that would limit the costs an entity can include in DAC to those that are “directly related to” the acquisition of new and renewal insurance contracts. The EITF clarified that the direct costs only include those that result in the successful acquisition of a policy and exclude all costs incurred for unsuccessful efforts, along with indirect costs. The consensus-for-exposure would require that an entity include only actual costs, not costs expected to be incurred, in DAC.
 
On March 18, 2010, the EITF affirmed the previous conclusions from the proposed consensus that indirect costs and costs of unsuccessful activities should not be included in capitalized acquisition costs. The EITF also agreed that advertising costs should be capitalized only when certain requirements are met. There were further questions on how accounting for advertising costs interacts with the DAC impairment model and further analysis was requested. A working group was formed to assist the staff in advising the EITF on the effective date and transition questions. They met in May 2010 and issued a report that was discussed at an EITF meeting on July 29, 2010. At that meeting, the EITF affirmed the previous conclusions from the proposed consensus. This literature has the potential to significantly impact the way insurance companies account for DAC, and therefore, could potentially have a significant impact on results of operations. It would result in the need to identify and recognize, as period costs, those amounts associated with unsuccessful acquisition efforts in addition to indirect costs. Amounts associated with successful acquisition efforts would continue to be capitalized and charged to expense in proportion to premium revenue recognized. As an example, under current guidance, underwriter salaries are capitalized and amortized over the period in which the associated premium written is earned as revenue. Under the proposed guidance, companies would be required to identify the portion of underwriter salaries that could be attributed to unsuccessful acquisition efforts and expense that amount in the current period. EITF Issue No. 09-G is effective for interim and annual periods beginning on or after December 15, 2011, with either prospective or retrospective application being permitted. The Company is currently evaluating the guidance for its impact on its results of operations, financial position and liquidity.

 
7

 

3.
Investments

(a) Available-for-Sale Securities

The original cost, estimated market value and gross unrealized appreciation and depreciation of available-for-sale securities as of June 30, 2010, are presented in the table below:
 
(Amounts in thousands)
 
Original or
amortized cost
   
Gross
unrealized
gains
   
Gross
unrealized
losses
   
Market
value
 
Preferred stock
 
$
5,621
   
$
   
$
(509
)
 
$
5,112
 
Common stock
   
48,932
     
3,067
     
(11,174
)
   
40,825
 
U.S. treasury securities
   
32,170
     
1,568
     
     
33,738
 
U.S. government agencies
   
41,506
     
750
     
     
42,256
 
Municipal bonds
   
32,844
     
1,263
     
(2
)
   
34,105
 
Corporate bonds and other bonds:
                               
Finance
   
423,248
     
9,265
     
(21,704
)
   
410,809
 
Industrial
   
49,414
     
2,889
     
(698
)
   
51,605
 
Utilities
   
25,006
     
1,210
     
(16
)
   
26,200
 
Commercial mortgage backed securities
   
2,102
     
93
     
-
     
2,195
 
Residential mortgage backed securities:
                               
Agency backed
   
430,619
     
20,224
     
-
     
450,843
 
Non-agency backed
   
7,985
     
596
     
(9
)
   
8,572
 
Asset-backed securities
   
2,933
     
216
     
-
     
3,149
 
   
$
1,102,380
   
$
41,141
   
$
(34,112
)
 
$
1,109,409
 

Proceeds from the sale of investments during the six months ended June 30, 2010 were approximately $369,726.
 
 (b) Investment Income

Net investment income for the three and six months ended June 30, 2010 and 2009 was derived from the following sources:

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(Amounts in thousands)
 
2010
   
2009
   
2010
   
2009
 
Fixed maturities
 
$
11,666
   
$
11,582
   
$
23,370
   
$
23,464
 
Equity securities
   
32
     
163
     
359
     
351
 
Cash and cash equivalents
   
1,910
     
1,768
     
2755
     
3,572
 
Note receivable - related party
   
1,204
     
821
     
2,049
     
1,633
 
     
14,812
     
14,334
     
28,533
     
29,020
 
Less: Investment expenses and interest expense on securities sold under agreement to repurchase
   
126
     
535
     
248
     
1,230
 
   
$
14,686
   
$
13,799
   
$
28,285
   
$
27,790
 

 
8

 

(c) Other-Than-Temporary Impairment
 
Other-than-temporary impairment (“OTTI”) charges of our fixed-maturities and equity securities for the three and six months ended June 30, 2010 and 2009 are presented in the table below:

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(Amounts in thousands)
 
2010
   
2009
   
2010
   
2009
 
Equity securities
 
$
1,467
   
$
8,761
   
$
6,605
   
$
10,188
 
Fixed maturities
   
10,540
     
2,025
     
10,540
     
2,025
 
   
$
12,007
   
$
10,786
   
$
17,145
   
$
12,213
 
  
The table below summarizes the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized loss position as of June 30, 2010:
 
   
Less Than 12 Months
   
12 Months or More
   
Total
 
(Amounts in  thousands)
 
Fair
Market
Value
   
Unrealized
Losses
   
No. of
Positions
Held
   
Fair
Market
Value
   
Unrealized
Losses
   
No. of
Positions
Held
   
Fair
Market
Value
   
Unrealized
Losses
 
                                                 
Common and preferred stock
 
$
21,198
   
$
(9,215
)
   
23
   
$
7,696
   
$
(2,468
)
   
87
   
$
28,894
   
$
(11,683
)
Municipal bonds
   
     
             
350
     
(2
)
   
1
     
350
     
(2
)
Corporate bonds:
                                                               
Finance
   
51,877
     
(1,230
)
   
13
     
172,249
     
(20,474
)
   
38
     
224,126
     
(21,704
)
Industrial
   
16,995
     
(698
)
   
3
     
     
     
1
     
16,995
     
(698
)
Utilities
   
     
     
     
2,065
     
(16
)
   
2
     
2,065
     
(16
)
Residential mortgage backed securities:
                                                               
Non-agency backed
   
     
     
     
22
     
(9
)
   
1
     
22
     
(9
)
Total temporarily impaired
 
$
90,070
   
$
(11,143
)
   
39
   
$
182,382
   
$
(22,969
)
   
130
   
$
272,452
   
$
(34,112
)

There are 169 securities at June 30, 2010 that account for the gross unrealized loss, none of which is deemed by the Company to be OTTI. Significant factors influencing the Company’s determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the length of time the security’s fair value has been below its amortized cost, the nature of the investment and management’s intent to sell these securities and it being more likely than not that the Company will not be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis.

(d) Derivatives

The following table presents the notional amounts by remaining maturity of the Company’s Interest Rate Swaps and Credit Default Swaps as of June 30, 2010:
 
 
 
Remaining Life of Notional Amount    (1)
 
(Amounts in thousands)
 
One Year
   
Two Through
Five Years
   
Six Through
Ten Years
   
After Ten
Years
   
Total
 
Interest rate swaps
  $     $ 13,333     $     $     $ 13,333  
Credit default swaps
          2,000                   2,000  
  
  $     $ 15,333     $     $     $ 15,333  

(1)
Notional amount is not representative of either market risk or credit risk and is not recorded in the consolidated balance sheet.

 
9

 

(e) Other
 
Securities sold but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price and, thereby, create a liability to purchase the security in the market at prevailing prices. The Company’s liability for securities to be delivered is measured at their fair value and as of June 30, 20010 was $69,288 for fixed maturity securities, which consisted of U.S. treasuries and corporate bonds, and $1,040 for equity securities. These transactions result in off-balance sheet risk, as the Company’s ultimate cost to satisfy the delivery of securities sold but not yet purchased, may exceed the amount reflected at June 30, 2010. Subject to certain limitations, all securities owned, to the extent required to cover the Company’s obligations to sell or repledge the securities to others, are pledged to the clearing broker.

The Company enters into repurchase agreements. The agreements are accounted for as collateralized borrowing transactions and are recorded at contract amounts. The Company receives cash or securities, that it invests or holds in short term or fixed income securities. As of June 30, 2010, there were $238,252 principal amount outstanding at interest rates between .30% and .35% per annum. Interest expense associated with these repurchase agreements for the three months ended June 30, 2010 and 2009 was $125 and $535, respectively, of which $136 was accrued as of June 30, 2010. Interest expense associated with the repurchase agreements for the six months ended June 30, 2010 and 2009 was $248 and $1,230, respectively. The Company has approximately $241,847 of collateral pledged in support of these agreements.

4.
Fair Value of Financial Instruments
 
The following table presents the level within the fair value hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of June 30, 2010:
 
(Amounts in thousands)
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
U.S. treasury securities
 
$
33,738
   
$
33,738
   
$
-
   
$
-
 
U.S. government agencies
   
42,256
     
-
     
42,256
     
-
 
Municipal bonds
   
34,105
     
-
     
34,105
     
-
 
Corporate bonds and other bonds:
                               
   Finance
   
410,809
     
-
     
410,809
     
-
 
   Industrial
   
51,605
     
-
     
51,605
     
-
 
   Utilities
   
26,200
     
-
     
26,200
     
-
 
Commercial mortgage backed securities
   
2,195
     
-
     
2,195
     
-
 
Residential mortgage backed securities:
                               
   Agency backed
   
450,843
     
-
     
450,843
     
-
 
   Non-agency backed
   
8,572
     
-
     
8,572
     
-
 
Asset-backed securities
   
3,149
     
-
     
3,149
     
-
 
Equity securities
   
45,937
     
45,937
     
-
     
-
 
Short term investment
   
990
     
990
                 
Other investments
   
13,323
     
-
     
-
     
13,323
 
   
$
1,123,722
   
$
80,665
   
$
1,029,734
   
$
13,323
 
Liabilities:
                               
Equity securities sold but not yet purchased, market
 
$
1,040
   
$
1,040
   
$
-
   
$
-
 
Fixed maturity securities sold but not yet purchased, market
   
69,288
     
52,328
     
16,960
     
-
 
Securities sold under agreements to repurchase, at contract value
   
238,252
     
-
     
238,252
     
-
 
Derivatives
   
220
     
-
     
-
     
220
 
  
 
$
308,800
   
$
53,368
   
$
255,212
   
$
220
 

The Company classifies its financial assets and liabilities in the fair value hierarchy based on the lowest level input that is significant to the fair value measurement. This classification requires judgment in assessing the market and pricing methodologies for a particular security. The fair value hierarchy includes the following three levels:

 
10

 

Level 1 – Valuations are based on unadjusted quoted market prices in active markets for identical financial assets or liabilities;

Level 2 – Valuations of financial assets and liabilities are based on prices obtained from third party pricing services, dealer quotations of the bid price using observable inputs, or through consensus pricing of a pricing service; and

Level 3 – Valuations are based on unobservable inputs for assets and liabilities where there is little or no market activity. Management’s assumptions are used in internal valuation pricing models to determine the fair value of financial assets or liabilities.

For additional discussion regarding techniques used to value the Company’s investment portfolio, refer to Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data” in its 2009 Form 10-K.

The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets for the three and six months ended June 30, 2010 and 2009:
 
(Amounts in thousands)
 
Assets
   
Liabilities
   
Total
 
Beginning balance as of April 1, 2010
 
$
14,019
   
 $
(353
)
 
$
13,666
 
Total net gains (losses) included in:
                       
Net income
   
-
     
133
     
133
 
Other comprehensive loss
   
(685
   
-
     
(685
Purchases and issuances
   
108
     
-
     
108
 
Sales and settlements
   
(119
   
-
     
(119
Net transfers into (out of) Level 3
   
-
     
-
     
-
 
Ending balance as of June 30, 2010
 
$
13,323
   
$
(220
)
 
$
13,103
 

(Amounts in thousands)
 
Assets
   
Liabilities
   
Total
 
Beginning balance as of January 1, 2010
 
$
12,746
   
 $
(1,893
)
 
$
10,853
 
Total net gains (losses) included in:
                       
Net income
   
277
     
133
     
410
 
Other comprehensive loss
   
296
     
-
     
296
 
Purchases and issuances
   
123
     
-
     
123
 
Sales and settlements
   
(119
   
1,540
     
1,421
 
Net transfers into (out of) Level 3
   
-
     
-
     
-
 
Ending balance as of June 30, 2010
 
$
13,323
   
$
(220
)
 
$
13,103
 

 
11

 

(Amounts in thousands)
 
Assets
   
Liabilities
   
Total
 
Beginning balance as of April 1, 2009
 
$
19,145
   
 $
(982
)
 
$
18,163
 
Total net gains (losses) included in:
                       
Net income
   
15
     
(139
   
(124
Other comprehensive loss
   
-
     
-
     
-
 
Purchases and issuances
   
-
     
-
     
-
 
Sales and settlements
   
(403
   
(1,199
 )
   
(1,602
Net transfers into (out of) Level 3
   
-
     
-
     
-
 
Ending balance as of June 30, 2009
 
$
18,757
   
$
(2,320
)
 
$
16,437
 

(Amounts in thousands)
 
Assets
   
Liabilities
   
Total
 
Beginning balance as of January 1, 2009
 
$
21,352
   
 $
(1,439
)
 
$
19,913
 
Total net gains (losses) included in:
                       
Net income
   
(39
   
(123
   
(162
Other comprehensive loss
   
-
     
-
     
-
 
Purchases and issuances
   
138
             
138
 
Sales and settlements
   
(2,694
   
(758
   
(3,452
Net transfers into (out of) Level 3
   
-
     
-
     
-
 
Ending balance as of June 30, 2009
 
$
18,757
   
$
(2,320
)
 
$
16,437
 

The Company had no transfers between levels during the three and six months ended June 30, 2010 and 2009.
 
The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:

Equity and Fixed Income Investments: Fair value disclosures for these investments are disclosed above in this note. The carrying values of cash, short term investments and investment income accrued approximate their fair values;

Premiums Receivable: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values due to the short term nature of the asset; and

Subordinated Debentures and Debt: The carrying values reported in the accompanying balance sheets for these financial instruments approximate fair value. Fair value was estimated using projected cash flows, discounted at rates currently being offered for similar notes.
 
5.
Debt

Junior Subordinated Debt

The Company has established four special purpose trusts for the purpose of issuing trust preferred securities. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts, were invested by the trusts in junior subordinated debentures issued by the Company. In accordance with FASB ASC 810-10-25, the Company does not consolidate such special purpose trusts, as the Company is not considered to be the primary beneficiary. The equity investment, totaling $3,714 as of June 30, 2010 on the Company’s consolidated balance sheet, represents the Company’s ownership of common securities issued by the trusts. The debentures require interest-only payments to be made on a quarterly basis, with principal due at maturity. The debentures contain covenants that restrict declaration of dividends on the Company’s common stock under certain circumstances, including default of payment. The Company incurred $2,605 of placement fees in connection with these issuances which is being amortized over thirty years.

 
12

 

The table below summarizes the Company’s trust preferred securities as of June 30, 2010:

   
Aggregate
                     
   
Liquidation
   
Aggregate
           
Per
 
   
Amount of
   
Liquidation
   
Aggregate
     
Annum
 
(Amounts in thousands)
 
Trust
   
Amount of
   
Principal
 
Stated
 
Interest
 
   
Preferred
   
Common
   
Amount
 
Maturity
 
Rate of
 
Name of Trust
 
Securities
   
Securities
   
of Notes
 
of Notes
 
Notes
 
AmTrust Capital Financing Trust I
 
$
25,000
   
$
774
   
$
25,774
 
3/17/2035
   
8.275
%(1)
AmTrust Capital Financing Trust II
   
25,000
     
774
     
25,774
 
6/15/2035
   
7.710
(1)
AmTrust Capital Financing Trust III
   
30,000
     
928
     
30,928
 
9/15/2036
   
8.830
(2)
AmTrust Capital Financing Trust IV
   
40,000
     
1,238
     
41,238
 
3/15/2037
   
7.930
(3)
Total trust preferred securities
 
$
120,000
   
$
3,714
   
$
123,714
           

(1)
The interest rate will change to three-month LIBOR plus 3.40% after the tenth anniversary in 2015.
(2)
The interest rate will change to LIBOR plus 3.30% after the fifth anniversary in 2011.
(3)
The interest rate will change to LIBOR plus 3.00% after the fifth anniversary in 2012.

The Company recorded $2,552 of interest expense for the three months ended June 30, 2010 and 2009 and $5,104 of interest expense for the six months ended June 30, 2010 and 2009, respectively, related to these trust preferred securities.

Term Loan
 
On June 3, 2008, the Company entered into a term loan with JP Morgan Chase Bank, N.A. in the aggregate amount of $40,000. The term of the loan is for a period of three years and requires quarterly principal payments of $3,333, which began on September 3, 2008 and end on June 3, 2011. As of June 30, 2010, the principal balance was $13,333. The loan carries a variable interest rate and is based on a Eurodollar rate plus an applicable margin. The Eurodollar rate is a periodic fixed rate equal to the London Interbank Offered Rate (“LIBOR”) plus a margin rate, which is 185 basis points. As of June 30, 2010 the interest rate was 2.1%. The Company recorded $211 and $385 of interest expense for the three months ended June 30, 2010 and 2009, respectively, and $463 and $842 of interest expense for the six months ended June 30, 2010 and 2009, respectively. The Company can prepay any amount without penalty upon prior notice. The term loan contains affirmative and negative covenants, including limitations on additional debt, limitations on investments and acquisitions outside the Company’s normal course of business. The loan requires the Company to maintain a debt to capital ratio of 0.35 to 1 or less. The Company incurred financing fees of $52 related to the agreement.
 
On June 4, 2008, the Company entered into a fixed rate interest swap agreement with a total notional amount of $40,000 to convert the term loan from a variable to a fixed rate. Under this agreement, the Company pays a fixed rate of 3.47% plus a margin of 185 basis points, or 5.32%, and receives a variable rate in return based on LIBOR plus a margin rate, which is 185 basis points. The variable rate is reset every three months, at which time the interest is settled and is recognized as adjustments to interest expense. The Company recorded interest expense of $33 and $164 for the three months ended June 30, 2010 and 2009, respectively, and $65 and $439 for the six months ended June 30, 2010 and 2009 related to this agreement.

Promissory Note
 
In connection with the stock and asset purchase agreement with a subsidiary of Unitrin, Inc. (“Unitrin”), the Company, on June 1, 2008, issued a promissory note to Unitrin in the amount of $30,000. The note is non-interest bearing and requires four annual principal payments of $7,500. The first two were paid in 2009 and 2010, respectively, and the remaining principal payments are due on June 1, 2011 and 2012. Upon entering into the promissory note, the Company calculated imputed interest of $3,155 based on interest rates available to the Company, which was 4.5%. Accordingly, the note’s carrying balance was adjusted to $26,845 at the acquisition. The note is required to be paid in full, immediately, under certain circumstances including a default of payment or change of control of the Company. The Company included $210 and $283 of amortized discount on the note in its results of operations for the three months ended June 30, 2010 and 2000, respectively and $450 and $596 for the six months ended June 30, 2010 and 2009, respectively. The note’s carrying value at June 30, 2010 was $14,078.

 
13

 

Line of Credit
 
On June 30, 2010, the Company extended the term of its unsecured $30,000 line of credit with JP Morgan Chase, N.A. to June 30, 2011. The line is used for collateral for letters of credit. Interest payments are required to be paid monthly on any unpaid principal and bears interest at a rate of LIBOR plus 150 basis points. As of June 30, 2010, there was no outstanding balance on the line of credit. At June 30, 2010, the Company had outstanding letters of credit in place for $25,495 that reduced the availability on the line of credit to $4,505.

Maturities of Debt
 
Maturities of the Company’s debt subsequent to June 30, 2010 are as follows:

(Amounts in thousands)
 
2010
   
2011
   
2012
   
2013
   
2014
   
Thereafter
 
Junior subordinated debt
 
$
   
$
   
$
   
$
   
$
   
$
123,714
 
Term loan
   
6,666
     
6,667
     
     
     
     
 
Promissory note
   
     
6,716
     
7,362
     
     
     
 
Total
 
$
6,666
   
$
13,383
   
$
7,362
   
$
   
$
   
$
123,714
 

6.
Acquisition Costs and Other Underwriting Expenses
 
The following table summarizes the components of acquisition costs and other underwriting expenses for the three and six months ended June 30, 2010 and 2009: