Attached files
file | filename |
---|---|
EXCEL - IDEA: XBRL DOCUMENT - PENN MILLERS HOLDING CORP | Financial_Report.xls |
EX-32.2 - EXHIBIT 32.2 - PENN MILLERS HOLDING CORP | c21148exv32w2.htm |
EX-32.1 - EXHIBIT 32.1 - PENN MILLERS HOLDING CORP | c21148exv32w1.htm |
EX-31.2 - EXHIBIT 31.2 - PENN MILLERS HOLDING CORP | c21148exv31w2.htm |
EX-31.1 - EXHIBIT 31.1 - PENN MILLERS HOLDING CORP | c21148exv31w1.htm |
EX-10.1 - EXHIBIT 10.1 - PENN MILLERS HOLDING CORP | c21148exv10w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 001-34496
PENN MILLERS HOLDING CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania (State or other jurisdiction of incorporation or organization) |
80-0482459 (I.R.S. Employer Identification No.) |
72 North Franklin Street, Wilkes-Barre, PA 18773
(Address of principal executive offices) (Zip Code)
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code: (800) 233-8347
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate 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 þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
At August 1, 2011, 5,080,252 shares of common stock, $0.01 par value, of Penn Millers Holding
Corporation were outstanding.
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
For the Quarter Ended June 30, 2011
INDEX
Page | ||||||||
Number | ||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
8 | ||||||||
28 | ||||||||
44 | ||||||||
45 | ||||||||
46 | ||||||||
46 | ||||||||
46 | ||||||||
46 | ||||||||
46 | ||||||||
46 | ||||||||
47 | ||||||||
Exhibit 10.1 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32.1 | ||||||||
Exhibit 32.2 | ||||||||
EX-101 INSTANCE DOCUMENT | ||||||||
EX-101 SCHEMA DOCUMENT | ||||||||
EX-101 CALCULATION LINKBASE DOCUMENT | ||||||||
EX-101 LABELS LINKBASE DOCUMENT | ||||||||
EX-101 PRESENTATION LINKBASE DOCUMENT | ||||||||
EX-101 DEFINITION LINKBASE DOCUMENT |
2
Table of Contents
Part I Financial Information
Item 1. | Financial Statements |
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
June 30, 2011 and December 31, 2010
(Dollars in thousands, except share data)
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
Assets |
||||||||
Investments: |
||||||||
Fixed maturities: |
||||||||
Available for sale, at fair value (amortized cost $156,970 in
2011 and $158,193 in 2010) |
$ | 162,096 | 162,771 | |||||
Equity Securities: |
||||||||
Available for sale, at fair value (cost $11,274 in 2011
and $10,885 in 2010) |
11,382 | 10,874 | ||||||
Cash and cash equivalents |
4,732 | 6,510 | ||||||
Premiums and fees receivable |
24,339 | 28,394 | ||||||
Reinsurance receivables and recoverables |
20,906 | 24,912 | ||||||
Deferred policy acquisition costs |
8,821 | 9,735 | ||||||
Prepaid reinsurance premiums |
3,737 | 4,320 | ||||||
Accrued investment income |
1,581 | 1,621 | ||||||
Property and equipment, net of accumulated depreciation |
3,145 | 3,323 | ||||||
Income taxes receivable |
783 | 1,253 | ||||||
Other |
3,001 | 1,008 | ||||||
Total assets |
$ | 244,523 | 254,721 | |||||
Liabilities and Shareholders Equity |
||||||||
Liabilities: |
||||||||
Losses and loss adjustment expense reserves |
$ | 106,630 | 109,973 | |||||
Unearned premiums |
38,254 | 42,807 | ||||||
Accounts payable and accrued expenses |
7,917 | 8,913 | ||||||
Total liabilities |
152,801 | 161,693 | ||||||
Shareholders equity: |
||||||||
Preferred stock, no par value, authorized 1,000,000; no shares
issued or outstanding |
| | ||||||
Common stock, $0.01 par value, authorized 10,000,000; issued
2011, 5,444,022 and 2010, 5,444,022; outstanding 2011,
4,524,415 shares and 2010, 4,462,131 shares |
54 | 54 | ||||||
Additional paid-in capital |
51,169 | 51,068 | ||||||
Accumulated other comprehensive income |
2,522 | 2,054 | ||||||
Retained earnings |
48,487 | 50,993 | ||||||
Unearned ESOP, 449,999 and 476,999 shares |
(4,500 | ) | (4,770 | ) | ||||
Treasury stock, at cost, 469,608 and 504,892 shares |
(6,010 | ) | (6,371 | ) | ||||
Total shareholders equity |
91,722 | 93,028 | ||||||
Total liabilities and shareholders equity |
$ | 244,523 | 254,721 | |||||
See accompanying notes to consolidated financial statements.
3
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
Three months ended June 30, 2011 and 2010
(Dollars in thousands, except share data)
2011 | 2010 | |||||||
Revenues: |
||||||||
Premiums earned |
$ | 16,808 | 16,679 | |||||
Investment income, net of investment expense |
1,404 | 1,452 | ||||||
Realized investment gains, net: |
||||||||
Total other-than-temporary impairment losses |
| | ||||||
Portion of loss recognized in other
comprehensive income |
| | ||||||
Other realized investment gains, net |
64 | 1,294 | ||||||
Total realized investment gains, net |
64 | 1,294 | ||||||
Other income |
70 | 88 | ||||||
Total revenues |
18,346 | 19,513 | ||||||
Losses and expenses: |
||||||||
Losses and loss adjustment expenses |
16,990 | 15,885 | ||||||
Amortization of deferred policy acquisition costs |
4,965 | 5,159 | ||||||
Underwriting and administrative expenses |
1,349 | 712 | ||||||
Interest expense |
1 | | ||||||
Other expense, net |
8 | 37 | ||||||
Total losses and expenses |
23,313 | 21,793 | ||||||
Loss before income taxes |
(4,967 | ) | (2,280 | ) | ||||
Income tax benefit |
(555 | ) | (1,005 | ) | ||||
Net loss |
$ | (4,412 | ) | (1,275 | ) | |||
Earnings per share (see note 14): |
||||||||
Basic net loss per common share |
$ | (0.98 | ) | (0.27 | ) | |||
Diluted net loss per common share |
$ | (0.98 | ) | (0.27 | ) | |||
See accompanying notes to consolidated financial statements.
4
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
Six months ended June 30, 2011 and 2010
(Dollars in thousands, except share data)
(Dollars in thousands, except share data)
2011 | 2010 | |||||||
Revenues: |
||||||||
Premiums earned |
$ | 33,722 | 33,735 | |||||
Investment income, net of investment expense |
2,845 | 3,024 | ||||||
Realized investment gains, net: |
||||||||
Total other-than-temporary impairment losses |
| | ||||||
Portion of loss recognized in other
comprehensive income |
| | ||||||
Other realized investment gains, net |
852 | 1,666 | ||||||
Total realized investment gains, net |
852 | 1,666 | ||||||
Other income |
156 | 180 | ||||||
Total revenues |
37,575 | 38,605 | ||||||
Losses and expenses: |
||||||||
Losses and loss adjustment expenses |
27,263 | 29,257 | ||||||
Amortization of deferred policy acquisition costs |
9,740 | 10,036 | ||||||
Underwriting and administrative expenses |
3,249 | 1,831 | ||||||
Interest expense |
16 | | ||||||
Other expense, net |
54 | 70 | ||||||
Total losses and expenses |
40,322 | 41,194 | ||||||
Loss before income taxes |
(2,747 | ) | (2,589 | ) | ||||
Income tax benefit |
(241 | ) | (1,072 | ) | ||||
Net loss |
$ | (2,506 | ) | (1,517 | ) | |||
Earnings per share (see note 14): |
||||||||
Basic net loss per common share |
$ | (0.56 | ) | (0.32 | ) | |||
Diluted net loss per common share |
$ | (0.56 | ) | (0.32 | ) | |||
See accompanying notes to consolidated financial statements.
5
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
Consolidated Statements of Shareholders Equity
(Unaudited)
Six months ended June 30, 2011 and 2010
(Dollars in thousands, except share data)
(Dollars in thousands, except share data)
Accumulated | ||||||||||||||||||||||||||||||||
Additional | Other | |||||||||||||||||||||||||||||||
Common Stock | Paid-In | Comprehensive | Retained | Unearned | Treasury | |||||||||||||||||||||||||||
Shares | Amount | Capital | Income | Earnings | ESOP | Stock | Total | |||||||||||||||||||||||||
Balance at December 31, 2009 |
5,444,022 | $ | 54 | 50,520 | 2,519 | 54,481 | (5,310 | ) | (2,216 | ) | 100,048 | |||||||||||||||||||||
Net loss |
(1,517 | ) | (1,517 | ) | ||||||||||||||||||||||||||||
Other comprehensive income, net of taxes: |
||||||||||||||||||||||||||||||||
Unrealized investment holding gain
arising during period, net of related
income tax expense of $539 |
1,046 | 1,046 | ||||||||||||||||||||||||||||||
Reclassification adjustment for realized
gains included in net loss, net of
related income tax expense of $566 |
(1,100 | ) | (1,100 | ) | ||||||||||||||||||||||||||||
Net unrealized investment loss |
(54 | ) | ||||||||||||||||||||||||||||||
Defined benefit pension plans, net of related
income tax expense of $19 |
37 | 37 | ||||||||||||||||||||||||||||||
Recognition of prior service costs related
to curtailment and settlement, net of
tax expense of $157 (see note 8) |
306 | 306 | ||||||||||||||||||||||||||||||
Comprehensive loss |
(1,228 | ) | ||||||||||||||||||||||||||||||
Stock-based compensation |
81 | 81 | ||||||||||||||||||||||||||||||
ESOP shares released |
70 | 270 | 340 | |||||||||||||||||||||||||||||
Treasury stock purchased, 287,131 shares |
(4,155 | ) | (4,155 | ) | ||||||||||||||||||||||||||||
Balance at June 30, 2010 |
5,444,022 | $ | 54 | 50,671 | 2,808 | 52,964 | (5,040 | ) | (6,371 | ) | 95,086 | |||||||||||||||||||||
Balance at December 31, 2010 |
5,444,022 | $ | 54 | 51,068 | 2,054 | 50,993 | (4,770 | ) | (6,371 | ) | 93,028 | |||||||||||||||||||||
Net loss |
(2,506 | ) | (2,506 | ) | ||||||||||||||||||||||||||||
Other comprehensive income, net of taxes: |
||||||||||||||||||||||||||||||||
Unrealized investment holding gain
arising during period, net of related
income tax expense of $516 |
1,002 | 1,002 | ||||||||||||||||||||||||||||||
Reclassification adjustment for realized
gains included in net loss, net of
related income tax expense of $290 |
(562 | ) | (562 | ) | ||||||||||||||||||||||||||||
Net unrealized investment gain |
440 | |||||||||||||||||||||||||||||||
Defined benefit pension plans, net of related
income tax expense of $14 |
28 | 28 | ||||||||||||||||||||||||||||||
Comprehensive loss |
(2,038 | ) | ||||||||||||||||||||||||||||||
Stock-based compensation |
321 | 321 | ||||||||||||||||||||||||||||||
ESOP shares released |
141 | 270 | 411 | |||||||||||||||||||||||||||||
Treasury stock reissued, 35,284 shares |
(361 | ) | 361 | | ||||||||||||||||||||||||||||
Balance at June 30, 2011 |
5,444,022 | $ | 54 | 51,169 | 2,522 | 48,487 | (4,500 | ) | (6,010 | ) | 91,722 | |||||||||||||||||||||
See accompanying notes to consolidated financial statements.
6
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
Six months ended June 30, 2011 and 2010
(Dollars in thousands)
2011 | 2010 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (2,506 | ) | (1,517 | ) | |||
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities: |
||||||||
Change in receivables, unearned premiums, and
prepaid reinsurance |
4,091 | (4,046 | ) | |||||
Change in losses and loss adjustment expense reserves |
(3,343 | ) | 9,530 | |||||
Change in accounts payable and accrued expenses |
(954 | ) | (1,980 | ) | ||||
Change in current income taxes |
470 | (1,877 | ) | |||||
Deferred income taxes |
(241 | ) | (186 | ) | ||||
Change in deferred acquisition costs |
914 | 549 | ||||||
Change in accrual and amortization of investment income |
561 | 589 | ||||||
Amortization and depreciation |
320 | 313 | ||||||
ESOP share allocation |
411 | 340 | ||||||
Amortization of stock-based compensation |
321 | 81 | ||||||
Realized investment gains, net |
(852 | ) | (1,666 | ) | ||||
Other, net |
(146 | ) | (80 | ) | ||||
Net cash (used in) provided by
operating activities |
(954 | ) | 50 | |||||
Cash flows from investing activities: |
||||||||
Available-for-sale investments: |
||||||||
Purchases of fixed maturity securities |
(23,197 | ) | (39,221 | ) | ||||
Purchases of equity securities |
(389 | ) | (11,084 | ) | ||||
Sales of fixed maturity securities |
21,407 | 29,602 | ||||||
Maturities of fixed maturity securities |
1,500 | 12,900 | ||||||
Proceeds from disposition of corporate owned life insurance policies |
| 2,682 | ||||||
Purchases of property and equipment, net |
(145 | ) | (63 | ) | ||||
Net cash used in investing activities |
(824 | ) | (5,184 | ) | ||||
Cash flows from financing activities: |
||||||||
Purchase of treasury stock |
| (4,155 | ) | |||||
Net cash used in financing activities |
| (4,155 | ) | |||||
Net decrease in cash |
(1,778 | ) | (9,289 | ) | ||||
Cash and cash equivalents at beginning of period |
6,510 | 20,220 | ||||||
Cash and cash equivalents at end of period |
$ | 4,732 | 10,931 | |||||
See accompanying notes to consolidated financial statements.
7
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(1) | Basis of Presentation |
The accompanying unaudited consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles (GAAP) for interim financial
information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of
the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the
information and notes required by GAAP for complete financial statements. Such information
reflects all adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations, and cash flows for the interim
periods. The results of operations for interim periods are not necessarily indicative of
results to be expected for the full year. All material intercompany balances and accounts have
been eliminated in consolidation. These financial statements should be read in conjunction
with the financial statements and notes for the year ended December 31, 2010 included in the
Companys 2010 Annual Report on Form 10-K.
(2) | Use of Estimates |
The preparation of consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the consolidated financial statements. These reported amounts
include the financial statement recognition of loss reserves, contingent liabilities, tax
valuation allowances, valuation of deferred policy acquisition costs, valuation of defined
benefit pension obligations and valuation of investments, including other-than-temporary
impairment of investments, and the disclosure of contingent assets and liabilities.
Managements estimates and assumptions also affect the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these estimates.
(3) | Concentration of Risk |
The Companys business is subject to concentration of risk with respect to geographic
concentration. Although the Companys operating subsidiaries are licensed collectively in 41
states, in-force premiums for two states, New Jersey and Pennsylvania, accounted for
approximately 18% of the Companys in-force premiums written as of June 30, 2011.
Consequently, changes in the New Jersey or Pennsylvania legal, regulatory, or economic
environment could adversely affect the Company.
(4) | Recent Accounting Standards |
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) 2011-05, Presentation of Comprehensive Income. This ASU improves the
comparability, consistency, and transparency of financial reporting and increases the
prominence of items reported in other comprehensive income. The updated guidance requires that
all nonowner changes in stockholders equity be presented either in a single continuous
statement of comprehensive income or in two separate but consecutive statements. In the
two-statement approach, the first statement should present total net income and its components
followed consecutively by a second statement that should present total other comprehensive
income, the components of other comprehensive income, and the total of comprehensive income.
The amendments in the ASU are effective for fiscal years, and interim periods within those
years, beginning after December 15, 2011 and should be applied retrospectively. Early
adoption is permitted, because compliance with the amendments is already permitted. The
updated guidance will result in a change in the presentation of the Companys financial
statements but will not have any impact on the Companys results of operations, financial
position or liquidity.
8
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements
and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU result in
common fair value measurement and disclosure requirements in GAAP and IFRSs. Consequently,
the amendments change the wording used to describe many of the requirements in GAAP for
measuring fair value and for disclosing information about fair value measurements. For many
of the requirements, the FASB does not intend for the amendments in this ASU to result in a
change in the application of the requirements of Topic 820. The amendments in the ASU are
effective for fiscal years, and interim periods within those years, beginning after December
15, 2011 and should be applied prospectively. Early adoption is not permitted. The Company
is currently evaluating the impact that the adoption of this ASU will have on its financial
statements and related disclosures.
In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring
or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force). This
ASU amends FASB Accounting Standards Codification (ASC) Topic 944, Financial Services
Insurance, to address which costs related to the acquisition of new or renewal insurance
contracts qualify for deferral. The ASU allows insurance entities to defer costs related to
the acquisition of new or renewal insurance contracts that are (1) incremental direct costs of
the contract transaction (i.e., would not have occurred without the contract transaction), (2)
a portion of the employees compensation and fringe benefits related to certain activities for
successful contract acquisitions, (3) other costs related directly to the insurers
acquisition activities in (2) that would not have been incurred had the acquisition contract
transaction not occurred, and (4) direct-response advertising costs as defined in ASC Subtopic
340-20, Other Assets and Deferred Costs Capitalized Advertising Costs. An insurance
entity would expense as incurred all other costs related to the acquisition of new or renewal
insurance contracts. The amendments in the ASU are effective for fiscal years, and interim
periods within those years, beginning after December 15, 2011, and can be applied either
prospectively or retrospectively. Early application is permitted at the beginning of an
entitys annual reporting period. The Company is currently evaluating the impact that the
adoption of this ASU will have on its financial position and results of operations.
All other standards and updates of those standards issued during the three months ended June
30, 2011 either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are
not applicable to the Company, or (iv) are not expected to have a significant impact on the
Company.
(5) | Fair Value Measurements |
The Companys estimates of fair value for financial assets and financial liabilities are based
on the framework established in the fair value accounting guidance, which is a part of ASC
820.
The fair value of a financial asset or financial liability is the amount at which the asset or
liability could be bought or sold in a current transaction between willing parties, that is,
other than in a forced or liquidated sale. In accordance with the guidance set forth by ASC
820, the Companys financial assets and financial liabilities measured at fair value are
categorized into three levels, based on the markets in which the assets and liabilities are
traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1 Unadjusted quoted market prices for identical assets or liabilities in active
markets that the Company has the ability to access.
9
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Level 2 Valuations based on observable inputs, other than quoted prices included in Level
1, for assets and liabilities traded in less active dealer or broker markets. Valuations are
based on identical or comparable assets and liabilities.
Level 3 Valuations for assets and liabilities that are derived from other valuation
methodologies, including option pricing models, discounted cash flow models, and similar
techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3
valuations incorporate certain assumptions and projections that are often unobservable in
determining the fair value assigned to such assets or liabilities.
Transfers between level categorizations may occur due to changes in the availability of
market observable inputs. Transfers in and out of level categorizations are reported as having
occurred at the beginning of the quarter in which the transfer occurred. There were no
transfers between level categorizations during the six months ended June 30, 2011 and 2010.
The table below presents the balances of assets and liabilities measured at fair value on
a recurring basis as of June 30, 2011 and December 31, 2010:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
June 30, 2011: |
||||||||||||||||
Fixed maturities, available for sale |
||||||||||||||||
U.S. treasuries |
$ | 798 | | | $ | 798 | ||||||||||
Agencies not backed by the full faith and
credit of the U.S. government |
| 14,964 | | 14,964 | ||||||||||||
State and political subdivisions |
| 43,572 | | 43,572 | ||||||||||||
Commercial mortgage-backed securities |
| 287 | | 287 | ||||||||||||
Residential mortgage-backed securities |
| 23,446 | | 23,446 | ||||||||||||
Corporate securities |
| 79,029 | | 79,029 | ||||||||||||
Total available for sale |
$ | 798 | 161,298 | | $ | 162,096 | ||||||||||
Equity securities |
||||||||||||||||
High-yield bond mutual fund |
$ | 11,382 | | | $ | 11,382 | ||||||||||
Total equities |
$ | 11,382 | | | $ | 11,382 | ||||||||||
Total assets |
$ | 12,180 | 161,298 | | $ | 173,478 | ||||||||||
10
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
December 31, 2010: |
||||||||||||||||
Fixed maturities, available for sale |
||||||||||||||||
U.S. Treasuries |
$ | 736 | | | $ | 736 | ||||||||||
Agencies not backed by the full faith and credit of the U.S. government |
| 14,458 | | 14,458 | ||||||||||||
State and political subdivisions |
| 44,559 | | 44,559 | ||||||||||||
Commercial mortgage-backed securities |
| 1,662 | | 1,662 | ||||||||||||
Residential mortgage-backed securities |
| 22,915 | | 22,915 | ||||||||||||
Corporate securities |
| 78,441 | | 78,441 | ||||||||||||
Total available for sale |
$ | 736 | 162,035 | | $ | 162,771 | ||||||||||
Equity securities |
||||||||||||||||
High-yield bond mutual fund |
$ | 10,874 | | | $ | 10,874 | ||||||||||
Total equities |
$ | 10,874 | | | $ | 10,874 | ||||||||||
Total assets |
$ | 11,610 | 162,035 | | $ | 173,645 | ||||||||||
The Company uses quoted values and other data provided by a nationally recognized
independent pricing service in its process for determining fair values of its investments. The
pricing service provides the Company one quote per instrument. Level 1 securities consist of
U.S. Treasury fixed maturity securities and publicly traded mutual funds. Level 2 securities
are comprised of available for sale fixed maturity securities whose fair value was determined
using observable market inputs. For fixed maturity securities that have quoted prices in
active markets, market quotations are provided. Fair values for securities for which quoted
market prices were unavailable were estimated based upon reference to observable inputs such
as benchmark interest rates, market comparables, and other relevant inputs. Investments
valued using these inputs include obligations of U.S. government agencies, obligations of
states and political subdivisions, commercial and residential mortgage-backed securities, and
corporate securities. Inputs into the fair value application that are utilized by asset class
include but are not limited to:
U.S. government agencies (depending on the specific market or program): broker quotes;
U.S. treasury market and floating rate indices; overall credit quality, including
assessments of market sectors and the level and variability of sources of payment; credit
support including collateral; the establishment of a risk adjusted credit spread over the
applicable risk free yield curve for discounted cash flow valuations; assessments of the
level of economic sensitivity;
States and political subdivisions: overall credit quality, including assessments of
market sectors and the level and variability of sources of payment such as general
obligation, revenue or lease; credit support such as insurance, state or local economic
and political base; prefunded and escrowed to maturity covenants;
Commercial mortgage-backed securities: overall credit quality, including assessments of
the level and variability of credit support and collateral type such as office, retail,
or lodging; predictability of cash flows for the deal structure; prevailing economic
market conditions;
11
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Residential mortgage-backed securities: estimates of prepayment speeds based upon
historical prepayment rate trends; underlying collateral interest rates; original
weighted average maturity; vintage year; borrower credit quality characteristics;
interest rate and yield curve forecasts; U.S. government support programs; tax policies;
and delinquency/default trends; and
Corporate securities: overall credit quality; the establishment of a risk adjusted credit
spread over the applicable risk free yield curve for discounted cash flow valuations;
assessments of the level of industry economic sensitivity; company financial policies;
indenture restrictive covenants; and/or security and collateral.
All unadjusted fair value estimates for fixed maturity securities are priced by the pricing
services as described above and are included in the amounts disclosed in Level 2. There have
been no changes to these valuation techniques.
Should the independent pricing service be unable to provide a fair value estimate, the
Company would attempt to obtain a non-binding fair value estimate, derived from observable
inputs, from a number of broker-dealers and review this estimate in conjunction with a fair
value estimate reported by an independent business news service or other sources. In instances
where only one broker-dealer provides a fair value for a fixed maturity security, the Company
uses that estimate. In instances where the Company is able to obtain fair value estimates from
more than one broker-dealer, the Company would review the range of estimates and would select
the most appropriate value based on the facts and circumstances. Should neither the
independent pricing service nor a broker-dealer provide a fair value estimate, the Company
would develop a fair value estimate based on cash flow analyses and other valuation techniques
that utilize certain unobservable inputs. Accordingly, the Company would classify such a
security as a Level 3 investment.
The fair value estimates of the Companys investments provided by the independent pricing
service at June 30, 2011 and December 31, 2010, were utilized, among other resources, in
reaching a conclusion as to the fair value of investments. As of June 30, 2011 and December
31, 2010, all of the Companys fixed maturity investments were priced using this one primary
service. Management reviews the reasonableness of the pricing provided by the independent
pricing service by employing various analytical procedures. The Company reviews all securities
to identify recent downgrades, significant changes in pricing, and pricing anomalies on
individual securities relative to other similar securities. This will include looking for
relative consistency across securities in various common blocks or sectors, durations, and
credit ratings. This review will also include all fixed maturity securities rated lower than
A by Moodys or Standard & Poors (S&P). If, after this review, management does not believe
the pricing for any security is a reasonable estimate of fair value, then it will seek to
resolve the discrepancy through discussions with the pricing service or its asset manager. The
classification within the fair value hierarchy as presented in ASC 820 is then confirmed based
on the final conclusions from the pricing review. The Company did not have any such
discrepancies at June 30, 2011 and December 31, 2010.
The fair value of other financial instruments, principally receivables, accounts
payable and accrued expenses, approximates their June 30, 2011 and December 31, 2010
carrying values.
12
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(6) | Investments |
The amortized cost and fair value of investments in fixed maturity and equity securities,
which are all available for sale, at June 30, 2011 and December 31, 2010, are as follows:
Gross | Gross | |||||||||||||||
Amortized | unrealized | unrealized | Estimated | |||||||||||||
cost | gains | losses | fair value | |||||||||||||
June 30, 2011: |
||||||||||||||||
U.S. Treasuries |
$ | 770 | 39 | 11 | $ | 798 | ||||||||||
Agencies not backed by the full
faith and credit of the
U.S. government |
14,621 | 343 | | 14,964 | ||||||||||||
State and political subdivisions |
41,731 | 1,854 | 13 | 43,572 | ||||||||||||
Commercial mortgage-backed securities |
284 | 3 | | 287 | ||||||||||||
Residential mortgage-backed securities |
22,775 | 717 | 46 | 23,446 | ||||||||||||
Corporate securities |
76,789 | 2,374 | 134 | 79,029 | ||||||||||||
Total fixed maturities |
$ | 156,970 | 5,330 | 204 | $ | 162,096 | ||||||||||
Total equity securities |
$ | 11,274 | 108 | | $ | 11,382 | ||||||||||
December 31, 2010: |
||||||||||||||||
U.S. Treasuries |
$ | 721 | 32 | 17 | $ | 736 | ||||||||||
Agencies not backed by the full
faith and credit of the
U.S. government |
14,111 | 347 | | 14,458 | ||||||||||||
State and political subdivisions |
43,224 | 1,564 | 229 | 44,559 | ||||||||||||
Commercial mortgage-backed securities |
1,589 | 73 | | 1,662 | ||||||||||||
Residential mortgage-backed securities |
22,223 | 758 | 66 | 22,915 | ||||||||||||
Corporate securities |
76,325 | 2,325 | 209 | 78,441 | ||||||||||||
Total fixed maturities |
$ | 158,193 | 5,099 | 521 | $ | 162,771 | ||||||||||
Total equity securities |
$ | 10,885 | | 11 | $ | 10,874 | ||||||||||
13
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The amortized cost and estimated fair value of fixed maturity securities at June 30,
2011, by contractual maturity, are shown below:
Amortized | Estimated | |||||||
cost | fair value | |||||||
Due in one year or less |
$ | 14,239 | $ | 14,414 | ||||
Due after one year through five years |
91,127 | 94,462 | ||||||
Due after five years through ten years |
19,404 | 20,082 | ||||||
Due after ten years |
9,141 | 9,405 | ||||||
133,911 | 138,363 | |||||||
Commercial mortgage-backed securities |
284 | 287 | ||||||
Residential mortgage-backed securities |
22,775 | 23,446 | ||||||
Total fixed maturities |
$ | 156,970 | $ | 162,096 | ||||
The expected maturities may differ from contractual maturities in the foregoing table because
borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties.
At June 30, 2011 and December 31, 2010, investments with a fair value of $4,408 and $4,348,
respectively, were on deposit with regulatory authorities, as required by law.
Major categories of net investment income are as follows:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Interest on fixed maturities |
$ | 1,367 | $ | 1,574 | $ | 2,756 | $ | 3,233 | ||||||||
Dividends on equity securities |
194 | 51 | 389 | 84 | ||||||||||||
Interest on cash and cash equivalents |
2 | 1 | 3 | 4 | ||||||||||||
Total investment income |
1,563 | 1,626 | 3,148 | 3,321 | ||||||||||||
Investment expense |
(159 | ) | (174 | ) | (303 | ) | (297 | ) | ||||||||
Investment income, net of
investment expense |
$ | 1,404 | $ | 1,452 | $ | 2,845 | $ | 3,024 | ||||||||
14
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Realized gross gains from investments and the change in difference between fair value and
cost of investments, before applicable income taxes, are as follows:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Fixed maturity securities: |
||||||||||||||||
Available for sale: |
||||||||||||||||
Gross gains |
$ | 64 | $ | 1,465 | $ | 852 | $ | 1,847 | ||||||||
Gross losses |
| (171 | ) | | (181 | ) | ||||||||||
Realized investment gains, net |
$ | 64 | $ | 1,294 | $ | 852 | $ | 1,666 | ||||||||
Change in difference between fair value
and cost of investments: |
||||||||||||||||
Fixed maturity securities |
$ | 1,703 | $ | 581 | $ | 548 | $ | 1,040 | ||||||||
Equity securities |
(82 | ) | (1,363 | ) | 119 | (1,120 | ) | |||||||||
Total increase (decrease) |
$ | 1,621 | $ | (782 | ) | $ | 667 | $ | (80 | ) | ||||||
Income tax expense on net realized investment gains was $22 and $440 for the three months
ended June 30, 2011 and 2010, respectively, and $290 and $566 for the six months ended June
30, 2011 and 2010, respectively. Deferred income tax expense applicable to net unrealized
investment gains included in accumulated other comprehensive income was $2,072 and $1,845 at
June 30, 2011 and December 31, 2010, respectively. See note 10 for additional information
related to the allocation of tax between operations and accumulated other comprehensive
income.
15
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The fair value and unrealized losses for securities temporarily impaired as of June 30, 2011
and December 31, 2010 are as follows:
Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Description of securities | Fair value | losses | Fair value | losses | Fair value | losses | ||||||||||||||||||
2011: |
||||||||||||||||||||||||
U.S. Treasuries |
$ | 290 | 11 | | | $ | 290 | 11 | ||||||||||||||||
Agencies not backed by the full
faith and credit of the
State and political subdivisions |
1,126 | 13 | | | 1,126 | 13 | ||||||||||||||||||
Residential mortgage-backed securities |
3,956 | 46 | | | 3,956 | 46 | ||||||||||||||||||
Corporate securities |
6,739 | 113 | 824 | 21 | 7,563 | 134 | ||||||||||||||||||
Total temporarily impaired securities |
$ | 12,111 | 183 | 824 | 21 | $ | 12,935 | 204 | ||||||||||||||||
2010: |
||||||||||||||||||||||||
U.S. Treasuries |
$ | 284 | 17 | | | $ | 284 | 17 | ||||||||||||||||
State and political subdivisions |
9,477 | 182 | 2,803 | 47 | 12,280 | 229 | ||||||||||||||||||
Residential mortgage-backed securities |
3,094 | 64 | 361 | 2 | 3,455 | 66 | ||||||||||||||||||
Corporate securities |
9,658 | 200 | 928 | 9 | 10,586 | 209 | ||||||||||||||||||
Total fixed maturity securities |
22,513 | 463 | 4,092 | 58 | 26,605 | 521 | ||||||||||||||||||
Equity securities |
10,874 | 11 | | | 10,874 | 11 | ||||||||||||||||||
Total temporarily impaired securities |
$ | 33,387 | 474 | 4,092 | 58 | $ | 37,479 | 532 | ||||||||||||||||
These fixed maturity securities are classified as available for sale because the Company
will, from time to time, sell securities that are not impaired, consistent with its investment
goals and policies. Fair values of interest rate sensitive instruments may be affected by
increases and decreases in prevailing interest rates which generally translate, respectively,
into decreases and increases in fair values of fixed maturity investments. The fair values of
interest rate sensitive instruments also may be affected by the credit worthiness of the
issuer, prepayment options, relative values of other investments, the liquidity of the
instrument, and other general market conditions. There are $824 in fixed maturity securities,
at fair value, that at June 30, 2011, had been below cost for 12 months or longer. The $21 of
unrealized losses on such securities relates to securities which carry an investment grade
debt rating and have declined in fair value roughly in line with overall market conditions.
The Company has evaluated each fixed maturity security and taken into account the severity and
duration of the impairment, the current rating on the bond, and the outlook for the issuer
according to independent analysts. The Company has found that the declines in fair value of
these assets are most likely attributable to the current interest rate environment.
Per the Companys current policy, a fixed maturity investment is other-than-temporarily
impaired if the present value of the cash flows expected to be collected is less than the
amortized cost of the security or where the Company intends to sell, or more likely than not
will be required to sell, the security before recovery of its value.
A portion of the Companys investment portfolio is in a high-yield bond mutual fund that
invests primarily in U.S. debt securities. This is a publicly traded mutual fund in which the
Company has an ownership stake in the overall assets of the fund, which is stated as a number
of shares, and the Company is not a creditor in the underlying debt securities. Therefore,
the mutual fund is classified as an equity security.
16
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The Company believes, based on its analysis, that the fixed maturity and equity securities are
not other-than-temporarily impaired. However, depending on developments involving both the
issuers and overall economic conditions, these investments may be written down in the
consolidated statements of operations in the future.
For the six months ended June 30, 2011 and 2010, no impairment charges had been incurred by
the Company.
The Company does not engage in subprime residential mortgage lending. The only
securitized financial assets that the Company owns are residential and commercial
mortgage-backed securities of high credit quality. The Companys exposure to subprime lending
is limited to investments in corporate bonds of banks, which may contain some subprime loans
on their balance sheets. These bonds are reported at fair value. As of June 30, 2011, fixed
maturity securities issued by banks accounted for 12.9% of the bond portfolios book
value.
(7) | Comprehensive Income |
Comprehensive loss for the three months and six months ended June 30, 2011 and 2010 consisted
of the following (all amounts net of taxes):
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net loss |
$ | (4,412 | ) | $ | (1,275 | ) | $ | (2,506 | ) | $ | (1,517 | ) | ||||
Other comprehensive income: |
||||||||||||||||
Unrealized gains on securities: |
||||||||||||||||
Unrealized investment holding
gains arising during period |
1,458 | 337 | 1,292 | 1,046 | ||||||||||||
Less: |
||||||||||||||||
Reclassification adjustment for realized
gains included in net loss |
(64 | ) | (854 | ) | (852 | ) | (1,100 | ) | ||||||||
Net unrealized investment
gains (losses) |
1,394 | (517 | ) | 440 | (54 | ) | ||||||||||
Defined benefit plans |
7 | 16 | 28 | 37 | ||||||||||||
Recognition of prior service costs related to
curtailment and settlement (see note 9) |
| 306 | | 306 | ||||||||||||
Other comprehensive income (loss) |
1,401 | (195 | ) | 468 | 289 | |||||||||||
Comprehensive loss |
$ | (3,011 | ) | $ | (1,470 | ) | $ | (2,038 | ) | $ | (1,228 | ) | ||||
17
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Accumulated other comprehensive income at June 30, 2011 and December 31, 2010 consisted
of the following amounts (all amounts net of taxes):
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Unrealized investment gains |
$ | 3,162 | $ | 2,722 | ||||
Defined benefit pension plans net actuarial loss |
(640 | ) | (668 | ) | ||||
Accumulated other comprehensive income |
$ | 2,522 | $ | 2,054 | ||||
See note 10 for additional information related to the allocation of tax between
operations and accumulated other comprehensive income.
(8) | Employee Benefit Plans |
Retirement Plans
The Company has a noncontributory defined benefit pension plan covering substantially all
employees. Retirement benefits are a function of both the years of service and level of
compensation. In October 2009, the plan was amended and all participants accrued benefits
under the plan were frozen. It is the Companys policy to fund the plan in amounts not
greater than the amount deductible for federal income tax purposes and not less than the
minimum required contribution under the Pension Protection Act of 2006. The Company also
sponsored a Supplemental Executive Retirement Plan (SERP). The SERP, which was unfunded,
provided defined pension benefits outside of the qualified defined benefit pension plan to
eligible executives based on average earnings, years of service, and age at retirement.
In May 2010, upon approval by the Board of Directors, the Company terminated the SERP for four
of the five participants. The one remaining participant is a retired employee in pay status.
The accumulated benefit obligation for the one remaining participant in pay status at June 30,
2011 is $618.
18
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The net periodic pension cost for the plans consists of the following components:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Components of net periodic pension cost: |
||||||||||||||||
Service cost |
$ | 17 | $ | 28 | $ | 34 | $ | 76 | ||||||||
Interest cost |
123 | 129 | 246 | 252 | ||||||||||||
Expected return on plan assets |
(126 | ) | (97 | ) | (253 | ) | (195 | ) | ||||||||
Amortization of prior service costs |
| 4 | | 14 | ||||||||||||
Amortization of net loss |
21 | 21 | 42 | 42 | ||||||||||||
Net periodic pension cost |
35 | 85 | 69 | 189 | ||||||||||||
Curtailment loss |
| 68 | | 68 | ||||||||||||
Settlement gain |
| (747 | ) | | (747 | ) | ||||||||||
Net periodic pension cost and
additional amounts recognized |
$ | 35 | $ | (594 | ) | $ | 69 | $ | (490 | ) | ||||||
The Companys minimum required contribution to the pension plan in 2011 is expected to be
$37.
(9) | Stock-Based Compensation |
The Company accounts for its stock options in accordance with ASC 718-10, Compensation
Stock Based Compensation. ASC 718-10 addresses all forms of share-based payment awards,
including shares under stock options and restricted stock. ASC 718-10 requires all share-based
payments to be recognized as expense, based upon their fair values, in the financial
statements over the service period of the awards.
On May 12, 2010, 141,122 shares of restricted stock were granted to executives of the
Company. The restricted stock will be issued from treasury shares upon vesting. The restricted
stock had a grant date fair value of $14.83 per share, which was the Companys closing stock
price on that date. The restricted stock vests 25% in the first year and 15% in each of the
five years thereafter, based on the satisfaction of service conditions. As of June 30, 2011,
35,284 shares of restricted stock had vested. No additional grants have been awarded.
On May 12, 2010, 114,960 stock options were awarded to executives, non-management directors
and select employees of the Company. The stock options, which vest over five years at 20% per
year, have a contractual term of seven years, and vesting is based on the satisfaction of
service conditions. The stock options were awarded at a grant date fair value of $5.22 per
option as calculated using a Black-Scholes Merton valuation model. As of June 30, 2011,
23,599 stock options had vested.
19
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
On May 11, 2011, 25,000 incentive stock options were awarded to executives and select
employees of the Company. The incentive stock options, which vest over five years at 20% per
year, have a contractual term of seven years, and vesting is based on the satisfaction of
service conditions. An additional 14,000 in non-qualified stock options were awarded to
non-management directors of the Company. The non-qualified stock options, which vest over
three years at 33% per year, have a contractual term of seven years, and vesting is based on
the satisfaction of service conditions. The incentive and non-qualified stock options were
awarded at a grant date fair value of $5.21 and $4.86, respectively, per option as calculated
using a Black-Scholes Merton valuation model with the following assumptions:
Stock Options - | Stock Options - | |||||||
Incentive | Non-Qualified | |||||||
Expected volatility - |
30.00 | % | 30.00 | % | ||||
Expected term (in years) - |
5 | 4.5 | ||||||
Risk-free interest rate - |
1.87 | % | 1.64 | % | ||||
Expected dividend yield - |
0.00 | % | 0.00 | % |
The expected volatility assumption was derived from share price data over the expected term of
the options of ten companies the Company considers to be its peers based upon asset size,
market capitalization, profitability level and other relevant factors. The expected term
assumption was derived using the simplified approach for plain vanilla options as set forth
in SEC Staff Accounting Bulletin (SAB) Topic 14 for companies with insufficient historical
data. The risk-free interest rate assumption was based upon the implied yield on the
measurement date of a zero-coupon U.S. Treasury bond with a maturity period equal to the
options expected term. The Company does not expect to pay dividends; therefore, the expected
dividend yield is assumed to be zero. No post-vesting restrictions exist for these options.
The total compensation cost recognized in the statements of operations and classified as
underwriting and administrative expenses for all stock-based compensation awards, excluding
the Companys ESOP, was $175 and $321 for the three months and six months ended June 30, 2011,
respectively. The related tax benefit recognized was $48 and $90 for the same periods. The
total compensation cost recognized in the statements of operations and classified as
underwriting and administrative expenses for all stock-based compensation awards, excluding
the Companys ESOP, was $81 for the three months and six months ended June 30, 2010. The
related tax benefit recognized was $23 for the same periods.
The total compensation cost recognized in the statements of operations and classified as
underwriting and administrative expenses for the Companys ESOP was $219 and $411 for the
three months and six months ended June 30, 2011, respectively. The related tax benefit
recognized was $46 and $92 for the same periods. The total compensation cost recognized in
the statements of operations and classified as underwriting and administrative expenses for
the Companys ESOP was $192 and $340 for the three months and six months ended June 30, 2010,
respectively. The related tax benefit recognized was $46 and $92 for the same periods.
20
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The total unrecognized compensation cost related to all nonvested Plan awards at June 30, 2011
and 2010 was $1,802 and $2,523, respectively, which is expected to be recognized in future
periods over a weighted average period of 4.4 years.
The summary of stock-based award activity is as follows:
Stock Options | Restricted Stock Awards | |||||||||||||||
Weighted- | ||||||||||||||||
Number of | Average | Number of | Weighted- | |||||||||||||
Shares | Exercise Price | Shares | Average Price | |||||||||||||
Outstanding at December 31, 2010 |
114,960 | $ | 14.83 | 141,122 | $ | 14.83 | ||||||||||
Granted |
39,000 | 17.50 | | | ||||||||||||
Exercised |
| | | | ||||||||||||
Vested |
| | (35,284 | ) | 14.83 | |||||||||||
Canceled |
(2,976 | ) | 14.83 | | | |||||||||||
Outstanding at June 30, 2011 |
150,984 | $ | 15.52 | 105,838 | $ | 14.83 | ||||||||||
Exercisable at June 30, 2011 |
23,599 | $ | 14.83 | |||||||||||||
(10) | Federal Income Tax |
Deferred income taxes arise from the recognition of temporary differences between financial
statement carrying amounts and the tax bases of the Companys assets and liabilities. A
valuation allowance is provided when it is more likely than not that some portion of the
deferred tax asset will not be realized. The Company must assess the likelihood that any
recorded deferred tax assets will be recovered against future taxable income. The Company
considers many factors when assessing the likelihood of future realization of deferred tax
assets, including recent cumulative earnings experience by taxing jurisdiction, expectations
of future taxable income or loss, the carry-forward periods available for tax reporting
purposes, and other relevant factors. To the extent the Company believes that recovery is not
more likely than not, a valuation allowance must be established.
Although the Companys current financial forecasts indicate that taxable income will be
generated in the future, those forecasts were not considered sufficient positive evidence to
overcome the observable negative evidence associated with its three year cumulative loss
position. As a result, the Company carried a full valuation allowance on its total deferred
tax assets of $4,937 and $4,116 at June 30, 2011 and December 31, 2010, respectively. Of the
total valuation allowance, $4,321 and $3,468 was related to federal net deferred tax assets at
June 30, 2011 and December 31, 2010, respectively. The remainder for each period was related
to state income tax net operating loss carryforwards.
21
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
In any interim period, the Company may generate income or loss. To the extent that any income
is generated, the related tax expense may be offset by a reduction in the valuation allowance.
Conversely, any tax benefits arising from losses may be offset by an additional valuation
allowance to reduce the net deferred tax asset to an amount that is more likely than not to be
realized. Any reduction of the valuation allowance will be allocated to operations and other
comprehensive income based on the intraperiod tax allocation rules. The intraperiod tax
allocation rules in FASB ASC 740, related to items charged directly to accumulated other
comprehensive income, can result in disproportionate tax effects that remain in accumulated
other comprehensive income until certain events occur. The following schedule shows the
amounts and corresponding tax effects in accumulated other comprehensive income as of June 30,
2011 and December 31, 2010 and the related change for the period:
June 30, | December 31, | Change for | ||||||||||
2011 | 2010 | the Period | ||||||||||
Net unrealized investment gains |
||||||||||||
Before tax gain |
$ | 5,234 | $ | 4,567 | $ | 667 | ||||||
Tax expense |
(2,072 | ) | (1,845 | ) | (227 | ) | ||||||
After tax gain |
$ | 3,162 | $ | 2,722 | $ | 440 | ||||||
Defined benefit pension plans -
net actuarial loss |
||||||||||||
Before tax loss |
$ | (1,174 | ) | $ | (1,216 | ) | $ | 42 | ||||
Tax benefit |
534 | 548 | (14 | ) | ||||||||
After tax loss |
$ | (640 | ) | $ | (668 | ) | $ | 28 | ||||
Total Accumulated Other
Comprehensive Income |
||||||||||||
Before tax income |
$ | 4,060 | $ | 3,351 | $ | 709 | ||||||
Tax expense |
(1,538 | ) | (1,297 | ) | (241 | ) | ||||||
After tax income |
$ | 2,522 | $ | 2,054 | $ | 468 | ||||||
As of June 30, 2011, the Company had no material unrecognized tax benefits or accrued
interest and penalties. The Companys policy is to account for interest as a component of
interest expense and penalties as a component of other expense. Federal tax years 2007 through
2010 were open for examination as of June 30, 2011.
Income tax payments, net of refunds, were $823 in the first two quarters of 2010. No tax
payments were made in 2011, however, a refund was received in the amount of $480.
(11) | Reinsurance |
Reinsurance is ceded by the Company on a pro rata and excess of loss basis. The
Companys retention on any one risk in 2010 was $800 per occurrence. Effective January 1,
2011, the Company increased its retention on the per-risk reinsurance treaty to $1,000.
For 2010 and 2011, the Company purchased catastrophe excess-of-loss reinsurance with a
retention of $3,000 per event and a limit of $42,000 of coverage. The Company has a 5%
co-participation in any losses incurred above the $3,000 retention.
For umbrella coverages, the Company retains a 25% pro rata share of any losses on the first
$1,000 of coverage. Losses in excess of $1,000 up to $10,000 are ceded 100% to reinsurers.
22
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The Company continues to maintain a whole account, accident year aggregate excess of loss
(aggregate stop loss) contract. This contract covers the 2008 and 2009 accident years and
provides reinsurance coverage for loss and allocated loss adjustment expense (ALAE) from all
lines of business, in excess of a 72% loss and ALAE ratio. The reinsurance coverage has a
limit of 20% of subject net earned premiums. As of June 30, 2011, the Company has not ceded
any losses under the aggregate stop loss contract.
The Company has assumed reinsurance related primarily to its participation in various
involuntary pools and associations and the runoff of the Companys participation in voluntary
reinsurance agreements that have been terminated.
The effect of reinsurance, with respect to premiums and losses, for the three months and six
months ended June 30, 2011 and 2010 is as follows:
(a) Premiums
For the three months ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Written | Earned | Written | Earned | |||||||||||||
Direct |
$ | 17,875 | $ | 21,271 | $ | 19,118 | $ | 21,389 | ||||||||
Assumed |
86 | 55 | (40 | ) | (84 | ) | ||||||||||
Ceded |
(4,100 | ) | (4,518 | ) | (4,406 | ) | (4,626 | ) | ||||||||
Net |
$ | 13,861 | $ | 16,808 | $ | 14,672 | $ | 16,679 | ||||||||
For the six months ended June 30, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Written | Earned | Written | Earned | |||||||||||||
Direct |
$ | 37,932 | $ | 42,428 | $ | 39,967 | $ | 42,915 | ||||||||
Assumed |
178 | 148 | 48 | 4 | ||||||||||||
Ceded |
(8,271 | ) | (8,854 | ) | (8,969 | ) | (9,184 | ) | ||||||||
Net |
$ | 29,839 | $ | 33,722 | $ | 31,046 | $ | 33,735 | ||||||||
(b) Losses and Loss Adjustment Expenses
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Direct |
$ | 20,550 | $ | 23,786 | $ | 30,219 | $ | 39,739 | ||||||||
Assumed |
(85 | ) | 89 | 4 | (127 | ) | ||||||||||
Ceded |
(3,475 | ) | (7,990 | ) | (2,960 | ) | (10,355 | ) | ||||||||
Net |
$ | 16,990 | $ | 15,885 | $ | 27,263 | $ | 29,257 | ||||||||
23
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(c) Unearned Premiums
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Direct |
$ | 38,217 | $ | 42,800 | ||||
Assumed |
37 | 7 | ||||||
Prepaid reinsurance (ceded) |
(3,737 | ) | (4,320 | ) | ||||
Net |
$ | 34,517 | $ | 38,487 | ||||
(d) Loss and Loss Adjustment Expense Reserves
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Direct |
$ | 99,287 | $ | 101,876 | ||||
Assumed |
7,343 | 8,097 | ||||||
Gross |
$ | 106,630 | $ | 109,973 | ||||
(12) | Segment Information |
The Companys operations are organized into three segments: agribusiness, commercial business,
and other. These segments reflect the manner in which the Company currently manages the
business based on type of customer, how the business is marketed, and the manner in which
risks are underwritten. Within each segment, the Company underwrites and markets its insurance
products through a packaged offering of coverages sold to generally consistent types of
customers.
The other segment includes the runoff of discontinued lines of insurance business and the
results of mandatory assigned risk reinsurance programs that the Company must participate in
as a cost of doing business in the states in which the Company operates. The discontinued
lines of insurance business include personal lines, which the Company began exiting in 2001,
and assumed reinsurance contracts for which the Company participated on a voluntary basis.
Participation in these assumed reinsurance contracts ceased in the 1980s and early 1990s.
24
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Segment information for the three months and six months ended June 30, 2011 and 2010 is as
follows:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenues: |
||||||||||||||||
Premiums earned: |
||||||||||||||||
Agribusiness |
$ | 11,999 | $ | 11,125 | $ | 23,592 | $ | 22,167 | ||||||||
Commercial business |
4,719 | 5,591 | 9,909 | 11,472 | ||||||||||||
Other |
90 | (37 | ) | 221 | 96 | |||||||||||
Total premiums earned |
16,808 | 16,679 | 33,722 | 33,735 | ||||||||||||
Investment income, net of investment
expense |
1,404 | 1,452 | 2,845 | 3,024 | ||||||||||||
Realized investment gains, net |
64 | 1,294 | 852 | 1,666 | ||||||||||||
Other income |
70 | 88 | 156 | 180 | ||||||||||||
Total revenues |
$ | 18,346 | $ | 19,513 | $ | 37,575 | $ | 38,605 | ||||||||
Components of net loss: |
||||||||||||||||
Underwriting loss: |
||||||||||||||||
Agribusiness |
$ | (5,767 | ) | $ | (4,110 | ) | $ | (3,669 | ) | $ | (4,592 | ) | ||||
Commercial business |
(653 | ) | (588 | ) | (2,603 | ) | (2,536 | ) | ||||||||
Other |
98 | (218 | ) | 39 | 50 | |||||||||||
Total underwriting loss |
(6,322 | ) | (4,916 | ) | (6,233 | ) | (7,078 | ) | ||||||||
Investment income, net of investment
expense |
1,404 | 1,452 | 2,845 | 3,024 | ||||||||||||
Realized investment gains, net |
64 | 1,294 | 852 | 1,666 | ||||||||||||
Other income |
70 | 88 | 156 | 180 | ||||||||||||
Corporate expense |
(174 | ) | (161 | ) | (297 | ) | (311 | ) | ||||||||
Interest expense |
(1 | ) | | (16 | ) | | ||||||||||
Other expense, net |
(8 | ) | (37 | ) | (54 | ) | (70 | ) | ||||||||
Loss before income taxes |
(4,967 | ) | (2,280 | ) | (2,747 | ) | (2,589 | ) | ||||||||
Income tax benefit |
(555 | ) | (1,005 | ) | (241 | ) | (1,072 | ) | ||||||||
Net loss |
$ | (4,412 | ) | $ | (1,275 | ) | $ | (2,506 | ) | $ | (1,517 | ) | ||||
25
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
The following table sets forth the net premiums earned by major lines of business for the
Companys core insurance products in the three months and six months ended June 30, 2011 and
2010:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net premiums earned: |
||||||||||||||||
Agribusiness |
||||||||||||||||
Property |
$ | 4,353 | $ | 4,014 | $ | 8,579 | $ | 7,897 | ||||||||
Commercial auto |
3,014 | 2,853 | 5,934 | 5,667 | ||||||||||||
Liability |
2,330 | 2,356 | 4,587 | 4,647 | ||||||||||||
Workers compensation |
2,117 | 1,722 | 4,128 | 3,602 | ||||||||||||
Other |
185 | 180 | 364 | 354 | ||||||||||||
Agribusiness subtotal |
11,999 | 11,125 | 23,592 | 22,167 | ||||||||||||
Commercial lines |
||||||||||||||||
Property & liability |
2,917 | 3,416 | 5,994 | 6,938 | ||||||||||||
Workers compensation |
808 | 1,066 | 1,875 | 2,309 | ||||||||||||
Commercial auto |
944 | 1,053 | 1,937 | 2,114 | ||||||||||||
Other |
50 | 56 | 103 | 111 | ||||||||||||
Commercial lines subtotal |
4,719 | 5,591 | 9,909 | 11,472 | ||||||||||||
Other |
90 | (37 | ) | 221 | 96 | |||||||||||
Total net premiums earned |
$ | 16,808 | $ | 16,679 | $ | 33,722 | $ | 33,735 | ||||||||
(13) | Shareholders Equity |
As of June 30, 2011, 271,562 shares remain to be purchased under the share repurchase plans
approved by the Board of Directors. The authorization has no expiration date.
26
Table of Contents
PENN MILLERS HOLDING CORPORATION AND SUBSIDIARY
(Unaudited)
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(14) | Earnings Per Share |
Basic earnings per common share is computed by dividing net loss by the weighted-average
number of shares of common stock outstanding during the period. Diluted earnings per common
share is computed by dividing net income by the weighted-average number of shares of common
stock outstanding during the period increased to include the number of additional shares of
common stock that would have been outstanding if the potentially dilutive securities had been
issued. Potentially dilutive securities include outstanding stock options and unvested
restricted stock. The dilutive effect of potentially dilutive securities is reflected in
diluted earnings per common share by application of the treasury stock method. Under the
treasury stock method, an increase in the fair market value of the Companys common stock can
result in a greater dilutive effect from potentially dilutive securities. Dilutive securities
are not included in the computation of diluted earnings per share when a company is in a loss
position.
The following table sets forth the computation of basic and diluted earnings per common share
for the three month and six month periods ended June 30, 2011 and 2010:
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Numerator: |
||||||||||||||||
Net loss |
$ | (4,412 | ) | $ | (1,275 | ) | $ | (2,506 | ) | $ | (1,517 | ) | ||||
Denominator: |
||||||||||||||||
Weighted average shares
outstanding |
4,501,574 | 4,666,806 | 4,485,318 | 4,684,312 | ||||||||||||
Effect of dilutive securities |
| | | | ||||||||||||
Weighted average shares diluted |
4,501,574 | 4,666,806 | 4,485,318 | 4,684,312 | ||||||||||||
Basic loss per share |
$ | (0.98 | ) | $ | (0.27 | ) | $ | (0.56 | ) | $ | (0.32 | ) | ||||
Diluted loss per share |
$ | (0.98 | ) | $ | (0.27 | ) | $ | (0.56 | ) | $ | (0.32 | ) | ||||
Potentially dilutive securities representing approximately 47,343 and 54,024 shares of
common stock for the three months and six months ended June 30, 2011, respectively, and 23,931
and 12,032 shares of common stock for the three months and six months ended June 30, 2010,
respectively, were excluded from the computation of diluted loss per common share for these
periods because their effect would have been antidilutive.
27
Table of Contents
Item 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Dollars in Thousands, Except Per Share Amounts
(Unaudited)
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Dollars in Thousands, Except Per Share Amounts
(Unaudited)
Some of the statements contained in this document are forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, you can
identify forward-looking statements by terminology such as may, will, should, expect,
plan, intend, anticipate, believe, estimate, predict, potential or continue, the
negative of these terms or other terminology. Forward-looking statements are based on the
opinions and estimates of management at the time the statements are made and are subject to
certain risks and uncertainties that could cause actual results to differ materially from those
anticipated in the forward-looking statements. These forward-looking statements include
statements of goals, intentions and expectations; statements regarding prospects and business
strategy; and estimates of future costs, benefits and results. The forward-looking statements are
subject to numerous assumptions, risks and uncertainties, including, among other things, the
factors discussed under the heading Item 1A Risk Factors included herein and in the
Companys Annual Report on Form 10-K for the year ended December 31, 2010 that could affect the
actual outcome of future events. All of these factors are difficult to predict and many are
beyond our control.
Factors that could affect our actual results include, among others, the fact that our loss
reserves are based on estimates and may be inadequate to cover our actual losses; the uncertain
effects of emerging claim and coverage issues on our business, including the effects of climate
change and commodity prices; the geographic concentration of our business; an inability to obtain
or collect on our reinsurance protection; a downgrade in the A.M. Best rating of our insurance
subsidiaries; the impact of extensive regulation of the insurance industry and legislative and
regulatory changes; a failure to realize our investment objectives; the effects of intense
competition; the loss of one or more principal employees; the inability to acquire additional
capital on favorable terms; a failure of independent insurance brokers to adequately market our
products; and the effects of acts of terrorism or war.
The references herein to the Company, we, us, our and Penn Millers refer to Penn
Millers Holding Corporation and its direct and indirect subsidiaries.
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the consolidated financial statements and accompanying notes
included thereto in our 2010 annual report on Form 10-K.
Overview
Our lead insurance company is Penn Millers Insurance Company, which is a Pennsylvania stock
insurance company originally incorporated as a mutual insurance company in 1887. In 1999, Penn
Millers Insurance Company converted from a mutual to a stock insurance company within a mutual
holding company structure. This conversion created Penn Millers Mutual Holding Company (Penn
Millers Mutual), a Pennsylvania mutual holding company, and established a mid-tier stock
holding company, PMHC Corp. (PMHC), to hold all of the outstanding shares of Penn Millers
Insurance Company. American Millers Insurance Company is a wholly owned subsidiary of Penn
Millers Insurance Company that provides Penn Millers Insurance Company with excess of loss
reinsurance.
On April 22, 2009, Penn Millers Mutual adopted a plan of conversion to convert Penn Millers
Mutual from the mutual to the stock form of organization, which was approved by its eligible
members on October 15, 2009. Upon its conversion, Penn Millers Mutual was renamed PMMHC Corp. and
PMHC was subsequently merged with and into PMMHC Corp., thereby terminating PMHCs existence and
making PMMHC Corp. the stock holding company for Penn Millers Insurance Company and a wholly
owned subsidiary of Penn Millers Holding Corporation. The historical consolidated financial
statements of Penn Millers Mutual prior to the conversion became the consolidated financial
statements of Penn Millers Holding Corporation upon completion of the conversion. Neither PMMHC
Corp. nor Penn Millers Holding Corporation engages in any business operations. The outstanding
capital stock of Penn Millers Insurance Company and proceeds derived from the public stock
offering are the primary assets of PMMHC Corp. and Penn Millers Holding Corporation,
respectively.
On October 16, 2009, the Company completed the sale of 5,444,022 shares of Penn Millers
Holding Corporation common stock, par value $0.01 per share, at an initial offering price of
$10.00 per share in a concurrently-held subscription and community offering.
28
Table of Contents
Prior to the completion of the offering, in accordance with the provisions of the Plan of
Conversion of PMMHC Corp., our Employee Stock Ownership Plan (ESOP) purchased 539,999 of the
shares in the offering, which was funded by a loan from Penn Millers Holding Corporation.
Our common stock is traded on the Nasdaq Global Market under the symbol PMIC.
Penn Millers Insurance Company has been assigned an A- (Excellent) rating by A.M. Best
Company, Inc. (A.M. Best), which is the fourth highest out of fifteen possible ratings. The
latest rating evaluation by A.M. Best occurred on May 31, 2011.
Business Segments
We provide a variety of property and casualty insurance products designed to meet the
insurance needs of certain segments of the agricultural industry and the needs of small and
middle market commercial businesses. We are licensed in 41 states, but we currently target the
sales of our insurance products to 34 states. We discontinued writing personal insurance products
in 2003 and now offer only commercial products. We report our operating results in three
operating segments: agribusiness insurance, commercial business insurance, and our other
segment. However, assets are not allocated to segments and are reviewed in the aggregate for
decision-making purposes.
Our agribusiness insurance segment product includes property (fire and allied lines and
inland marine), liability (general, products and umbrella), commercial automobile, and workers
compensation insurance. We specialize in writing coverage for manufacturers, processors, and
distributors of products for the agricultural industry. We do not write property or liability
insurance for farms or farming operations unless written in conjunction with an eligible
agribusiness operation; and we do not write any crop or weather insurance. We market our
agribusiness lines through independent producers and our employees.
Our commercial business segment provides insurance coverage to small and middle market
commercial businesses. We target select low to medium hazard businesses such as retailers,
including beverage stores, floor covering stores, florists, grocery stores, office equipment and
supplies stores, dry cleaners, printers, and shopping centers; artisan contractor businesses,
such as electrical, plumbing, and landscaping; professional services, such as accountants,
insurance agencies, medical offices, and optometrists; office buildings; and select manufacturing
and wholesale businesses.
Our commercial business insurance segment product consists of a business owners policy
called Solutions that combines the following: property and liability coverage for small
businesses; workers compensation; commercial automobile; and umbrella liability coverage. The
types of businesses we target under our Solutions offering include retail, service, wholesalers,
and printers. These lines within our Solutions product are sold through approximately 260
independent agents in Pennsylvania, New Jersey, Connecticut, Massachusetts, Tennessee, Virginia,
New York, and Maryland.
We also carry an insurance product called PennEdge which allows us to write customized
coverages on mid-size commercial accounts. PennEdge is specifically tailored to unique business
and industry segments, including wholesalers, manufacturers, printers and commercial laundries.
In 2010, we added hunting and fishing lodges, clubs, guides and outfitters, and metal recyclers
to our target classes of insureds. We choose our targeted segments based on the experience of our
underwriting staff, the market opportunities available to our existing producers and where we
believe there are opportunities to reach producers that have not traditionally carried our
products. Currently, the PennEdge product is available in 24 states and is marketed through both
our agribusiness and commercial business producers. For segment reporting purposes, and
consistent with how we manage our business, the results of PennEdge are included in our
commercial business segment.
Our third business segment, which we refer to as our other segment, includes the runoff of
discontinued lines of insurance business and the results of mandatory assigned risk reinsurance
programs that we must participate in as a condition of doing business in the states in which we
operate.
29
Table of Contents
Financial Highlights of Results for the Three and Six Months Ended June 30, 2011:
Three Months Ended June 30, 2011
| Our net loss in the quarter was primarily driven by an unprecedented level of catastrophe and other weather-related losses of $7,737 (net of reinsurance) in the period, compared to our previously highest quarter of $5,587 (net of reinsurance) in the second quarter of 2010. Weather-related losses impacted our second quarter 2011 loss and LAE ratio by 46.0 loss ratio points. In the second quarter 2010, weather-related losses had an impact on our loss and LAE ratio of 33.5 loss ratio points. | ||
| Shareholders equity decreased $2,617 in the second quarter of 2011 primarily from the net loss of $4,412 for the period, offset by net unrealized gains on investments of $1,394 (after-tax). | ||
| Book value per share of $20.27 at June 30, 2011 compared to $21.08 at March 31, 2011. |
Six Months Ended June 30, 2011
| Catastrophe and other weather-related losses in the first six months of 2011 were $8,938 in the period, compared to $7,924 in the same period of 2010. On a year to date basis, the impact on our 2011 loss and LAE ratio from weather-related losses was 26.5 loss ratio points, compared to 23.5 loss ratio points in 2010. | ||
| Shareholders equity decreased $1,306 in the first six months of 2011 primarily from net loss of $2,506 for the period. Net unrealized gains from investments were $440 (after-tax) on a year to date basis. | ||
| We continually try to identify opportunities for process efficiencies and expense reductions throughout the organization. In February 2011, we reduced staff by nearly 10% and identified other expense reductions that, all together, we expect will total approximately $1 million annually. | ||
| Book value per share of $20.27 at June 30, 2011 compared to $20.85 at December 31, 2010. |
Results of Operations
Our results of operations are influenced by factors affecting the property and casualty
insurance industry in general. The operating results of the United States property and casualty
insurance industry are subject to significant variations due to competition, weather,
catastrophic events, regulation, general economic conditions, judicial trends, fluctuations in
interest rates and other changes in the investment environment.
Our premium growth and underwriting results have been, and continue to be, influenced by
market conditions. Pricing in the property and casualty insurance industry historically has been
cyclical. During a soft market cycle, price competition is more significant than during a hard
market cycle and makes it difficult to attract and retain properly priced agribusiness and
commercial business. The insurance industry is currently experiencing a soft market cycle.
Therefore, insurers may be unable to increase premiums and increase profit margins. A hard market
typically has a positive effect on premium growth.
We evaluate our insurance operations by monitoring certain key measures of growth and
profitability. In addition to reviewing our financial performance based on results determined in
accordance with U.S. generally accepted accounting principles (GAAP), we utilize certain non-GAAP
financial measures that we believe are valuable in managing our business and for comparison to
our peers. These non-GAAP measures are underwriting income (loss), combined ratios and written
premiums. In addition, where we feel it enhances the presentation to the reader, we may present
certain GAAP financial measures in a manner to reflect the impact of certain unusual or
non-recurring situations.
The major components of operating revenues and net income can be seen in footnote 12 to our
Consolidated Financial Statements under Item 1 of this Report on Form 10-Q.
30
Table of Contents
Insurance Operations Outlook
The property and casualty insurance industry is in the midst of a soft market that is
characterized by low premium growth, declining prices and excess capacity. Also, we and our peers
are operating in a sluggish economy with lower exposures, and some property and casualty
insurance premium has evaporated with business closings in the economic downturn. There has been
some industry consolidation, especially in agribusiness, and insurers continue to consider the
right mix of markets and product lines to achieve the best pricing while maintaining underwriting
discipline. In addition to premium pricing, our investment yields are also facing downward
pressure. Investment income is lower through the first six months of 2011; and as our fixed
maturity investments mature, it is difficult to reinvest the proceeds in investments that provide
a comparable return without excessive risk.
While the current economic and pricing environments have presented challenges, we have
positioned our long-term business model in order to capitalize on market opportunities when a
hard market returns.
Our business strategy is intended to capitalize on our core competencies in agribusiness and
utilize our strengths to continue to expand our PennEdge distribution in our commercial business
segment. We have taken certain actions in order to position the Company to take advantage of
growth opportunities that we believe will become available when the economic outlook improves,
such as:
| Identifying niche segments where competition is limited and we can add value through personal service to our producers and insureds; | ||
| Expanding our reach into geographies that complement our existing network; | ||
| Growing our network of producers that we believe will refer significant, profitable business to us; and | ||
| Differentiating our coverage offerings by entering into strategic alliances in both our agribusiness and commercial business segments to offer equipment breakdown, employment practices liability, miscellaneous professional liability, and pollution coverages. |
Revenues
Total revenues for the three and six month periods of 2011 were $18,346 and $37,575, a 6.0%
and 2.7% decrease over the same periods in 2010. The decrease is attributable to a lower level of
realized investment gains in 2011, as well as lower investment income.
31
Table of Contents
The components of premiums written and earned for the three and six months ended June 30,
2011 and 2010 are as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Direct premiums written |
||||||||||||||||
Agribusiness |
$ | 12,184 | $ | 11,815 | $ | 27,250 | $ | 26,381 | ||||||||
Commercial business |
5,656 | 7,256 | 10,609 | 13,494 | ||||||||||||
Other |
35 | 47 | 73 | 92 | ||||||||||||
Direct premiums written total |
17,875 | 19,118 | 37,932 | 39,967 | ||||||||||||
Assumed premiums written |
86 | (40 | ) | 178 | 48 | |||||||||||
Gross premiums written |
$ | 17,961 | $ | 19,078 | $ | 38,110 | $ | 40,015 | ||||||||
Ceded premiums written |
||||||||||||||||
Agribusiness |
$ | 3,016 | $ | 3,125 | $ | 6,228 | $ | 6,481 | ||||||||
Commercial business |
1,084 | 1,281 | 2,043 | 2,488 | ||||||||||||
Ceded premiums written total |
$ | 4,100 | $ | 4,406 | $ | 8,271 | $ | 8,969 | ||||||||
Net premiums written |
||||||||||||||||
Agribusiness |
$ | 9,168 | $ | 8,690 | $ | 21,022 | $ | 19,900 | ||||||||
Commercial business |
4,572 | 5,975 | 8,566 | 11,006 | ||||||||||||
Other |
121 | 7 | 251 | 140 | ||||||||||||
Net premiums written total |
$ | 13,861 | $ | 14,672 | $ | 29,839 | $ | 31,046 | ||||||||
Net premiums earned |
||||||||||||||||
Agribusiness |
$ | 11,999 | $ | 11,125 | $ | 23,592 | $ | 22,167 | ||||||||
Commercial business |
4,719 | 5,591 | 9,909 | 11,472 | ||||||||||||
Other |
90 | (37 | ) | 221 | 96 | |||||||||||
Net premiums earned total |
$ | 16,808 | $ | 16,679 | 33,722 | $ | 33,735 | |||||||||
The agribusiness marketplace has been very competitive during the last four years, putting
pressure on pricing. These competitive pressures are affecting our writing of new and renewal
business and putting downward pressure on our existing rates. Our focus on underwriting
discipline and rate adequacy in the midst of this soft market has resulted in our premium revenue
growth being relatively modest during this period.
Direct premiums written in our agribusiness segment increased from $11,815 for the three
months ended June 30, 2010 to $12,184 for the three months ended June 30, 2011, a 3.1% increase.
Direct premiums written in our agribusiness segment increased from $26,381 for the six months
ended June 30, 2010 to $27,250 for the six months ended June 30, 2011, a 3.3% increase. For the
three month period, the increase is due to a higher level of renewal business, which was partly
offset by lower new business writings. For the six month period, the increase is attributable to
the higher level of new business that was written in the first quarter. Renewal premium for 2011
to date is flat compared to the same period in 2010.
32
Table of Contents
Our direct premiums written in our commercial business segment were $5,656 and $7,256 for
the three months ended June 30, 2011 and 2010, respectively. For the six months ended June 30,
2011 and 2010, direct premiums written were $10,609 and $13,494, respectively. The factors that
contributed to the three month net decline of $1,600 or 22.1% and the six month net decline of
$2,885 or 21.4% are further described below:
| We continue to withdraw from certain unprofitable classes of business. This decision has resulted in significantly lower premium volume in our commercial business segment, but we believe that our development of PennEdge and our cost containment efforts in Solutions will improve our underwriting profit. Our goal is to have a smaller but more profitable Solutions book of business. | ||
| We have begun aggressive financial underwriting on our commercial business accounts. We have begun non-renewing accounts with the poorest commercial credit and financial stress scores, and we have begun seeking significant price increases on those accounts with below average scores. We believe there is a direct correlation between these scores and the likelihood that an account will experience losses. |
As of June 30, 2011 our PennEdge offering has been approved in 24 states. While we believe
it has been well received by our agents and policyholders, the PennEdge product was launched in a
competitive market. We believe the greatest opportunities for growth will come when the market
hardens and, therefore, we will not seek aggressive growth at substandard pricing. For the three
months ended June 30, 2011, the direct premiums written for our PennEdge product were $1,271, an
increase of $317 over the same period in 2010. For the six months ended June 30, 2011, the direct
premiums written of our PennEdge product were $2,120, an increase of $552 over the same period in
2010.
While the PennEdge product has begun to regain the momentum it was building throughout 2010,
our Solutions product has continued to decline as a result of our aggressive pricing and
underwriting actions. Despite the pricing increases we have taken thus far in 2011, we are
retaining more of the business at desirable rates than we had anticipated.
For all segments, ceded premiums written were lower in the three and six months ended June
30, 2011, compared to the same periods of 2010, mostly due to the decreases in direct premium
volume. Reinsurance costs have also decreased as a result of the increased retention on our per
risk excess of loss reinsurance treaty, which has been partly offset by higher reinsurance rates.
Our net premiums earned were $16,808 and $16,679 for the three months ended June 30, 2011
and 2010, respectively. For the three month period, the growth in our agribusiness earned premium
mostly offset the decline in our commercial business earned premium. The $129, or 0.8%, increase
for the quarter is mostly due to an increase in our assumed premium. For the six months ended
June 30, 2011 and 2010, net premiums earned were $33,722 and $33,735, respectively. For the six
month period, the $13, or 0.04%, decrease is mostly due to a reduction in net premiums earned in
our commercial business segment of $1,563, as we continue to see the effects of our efforts to
improve our underwriting results in this segment, offset by an increase in our agribusiness
segment of $1,425 for the same period.
The following table sets forth our average invested assets and investment income for the
reported periods:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Average cash and invested assets |
$ | 180,234 | $ | 187,872 | $ | 179,183 | $ | 186,758 | ||||||||
Net investment income |
1,404 | 1,452 | 2,845 | 3,024 | ||||||||||||
Return on average cash and invested assets (1) |
3.2 | % | 3.1 | % | 3.2 | % | 3.3 | % |
(1) | Return on average cash and invested assets for interim periods is calculated on an annualized basis. |
Net investment income decreased $48 and $179 for the three and six months ended June 30,
2011 as compared to the same periods ended June 30, 2010. The decrease in both periods is
attributable to lower average asset balances and the impact of declining interest rates. These
factors have been partly offset by higher dividend income on mutual fund investments.
33
Table of Contents
Underwriting Results by Segment
Our operations are organized into three business segments: agribusiness, commercial
business, and our other segment. These segments reflect the manner in which we are currently
managed based on type of customer, how the business is marketed, and the manner in which risks
are underwritten. Within each segment we underwrite and market our insurance products through
packaged offerings of coverages sold to generally consistent types of customers.
For purposes of segment reporting, the other segment includes the runoff of discontinued
lines of insurance business and the results of mandatory assigned risk reinsurance programs that
we must participate in as a cost of doing business in the states in which we operate. The
discontinued lines of insurance business include personal lines, which we discontinued writing in
2003, and assumed reinsurance contracts, in which we previously participated on a voluntary
basis. Participation in these assumed reinsurance contracts ceased in the 1980s and early 1990s.
Underwriting (loss) income measures the pre-tax profitability of our insurance segments. It
is derived by subtracting losses and loss adjustment expenses, amortization of deferred policy
acquisition costs, and underwriting and administrative expenses from earned premiums. Each of
these captions is presented in our consolidated statements of operations but not subtotaled. This
section provides more insight into the variances in the primary drivers of our profitability,
especially losses and loss adjustment expenses and total underwriting expenses, which include
amortization of deferred policy acquisition costs and underwriting and administrative expenses.
The underwriting (loss) income and key profitability ratios for each segment for the three
and six months ended June 30, 2011 and 2010 are as follows:
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | |||||||||||||||||||||||||||||||
Agri- | Commercial | Agri- | Commercial | |||||||||||||||||||||||||||||
business | Business | Other | Consolidated | business | Business | Other | Consolidated | |||||||||||||||||||||||||
Underwriting (loss) income |
$ | (5,767 | ) | (653 | ) | 98 | $ | (6,322 | ) | $ | (4,110 | ) | (588 | ) | (218 | ) | $ | (4,916 | ) | |||||||||||||
Loss and LAE ratios: |
||||||||||||||||||||||||||||||||
Losses |
56.7 | % | 89.3 | % | 25.5 | % | 65.6 | % | 63.2 | % | 75.2 | % | 37.8 | % | 67.2 | % | ||||||||||||||||
Catastrophe losses |
52.4 | % | 7.7 | % | 0.0 | % | 39.6 | % | 41.3 | % | 5.2 | % | 0.0 | % | 29.3 | % | ||||||||||||||||
Other weather losses |
7.7 | % | 3.2 | % | 0.0 | % | 6.4 | % | 5.8 | % | 0.9 | % | 0.0 | % | 4.2 | % | ||||||||||||||||
Prior year development |
-1.9 | % | -30.9 | % | -94.4 | % | -10.5 | % | -5.6 | % | -7.9 | % | -391.9 | % | -5.5 | % | ||||||||||||||||
Total loss and LAE ratio |
114.9 | % | 69.3 | % | -68.9 | % | 101.1 | % | 104.7 | % | 73.4 | % | -354.1 | % | 95.2 | % | ||||||||||||||||
Underwriting expense ratio |
33.2 | % | 44.5 | % | 60.0 | % | 37.6 | % | 32.2 | % | 37.1 | % | -135.1 | % | 35.2 | % | ||||||||||||||||
Combined ratio |
148.1 | % | 113.8 | % | -8.9 | % | 138.7 | % | 136.9 | % | 110.5 | % | -489.2 | % | 130.4 | % | ||||||||||||||||
Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | |||||||||||||||||||||||||||||||
Agri- | Commercial | Agri- | Commercial | |||||||||||||||||||||||||||||
business | Business | Other | Consolidated | business | Business | Other | Consolidated | |||||||||||||||||||||||||
Underwriting (loss) income |
$ | (3,669 | ) | (2,603 | ) | 39 | $ | (6,233 | ) | $ | (4,592 | ) | (2,536 | ) | 50 | $ | (7,078 | ) | ||||||||||||||
Loss and LAE ratios: |
||||||||||||||||||||||||||||||||
Losses |
57.5 | % | 89.8 | % | 48.0 | % | 66.9 | % | 61.1 | % | 75.1 | % | 152.1 | % | 66.2 | % | ||||||||||||||||
Catastrophe losses |
26.8 | % | 9.4 | % | 0.0 | % | 21.5 | % | 21.5 | % | 10.4 | % | 0.0 | % | 17.6 | % | ||||||||||||||||
Other weather losses |
5.0 | % | 5.2 | % | 0.0 | % | 5.0 | % | 6.0 | % | 5.6 | % | 0.0 | % | 5.8 | % | ||||||||||||||||
Prior year development |
-6.9 | % | -25.7 | % | -32.6 | % | -12.6 | % | 1.6 | % | -9.8 | % | -226.1 | % | -2.9 | % | ||||||||||||||||
Total loss and LAE ratio |
82.4 | % | 78.7 | % | 15.4 | % | 80.8 | % | 90.2 | % | 81.3 | % | -74.0 | % | 86.7 | % | ||||||||||||||||
Underwriting expense ratio |
33.2 | % | 47.6 | % | 67.0 | % | 38.5 | % | 30.5 | % | 40.8 | % | 121.9 | % | 35.2 | % | ||||||||||||||||
Combined ratio |
115.6 | % | 126.3 | % | 82.4 | % | 119.3 | % | 120.7 | % | 122.1 | % | 47.9 | % | 121.9 | % | ||||||||||||||||
(1) | Corporate expenses are not included in underwriting (loss) income. The consolidated combined ratio includes $174 and $161 of corporate expenses for the three months ended June 30, 2011 and 2010, respectively. The consolidated combined ratio includes $297 and $311 of corporate expenses for the six months ended June 30, 2011 and 2010, respectively. |
34
Table of Contents
Losses and Loss Adjustment Expenses
Our consolidated loss and loss adjustment expense (LAE) ratio was 80.8% for the six months
ended June 30, 2011, compared to 86.7% for the six months ended June 30, 2010. The changes in
losses and LAE for the six month periods are further described below:
| Catastrophe and other weather related losses were $1,014 higher in the six months ended June 30, 2011 compared to the same period of 2010, and $2,150 higher in the three months ended June 30, 2011 compared to the same period in 2010. The catastrophe losses in the second quarter were driven primarily by record high losses in our agribusiness segment from severe storm activity occurring mostly in the Midwest and Southeast. | ||
| We experienced net favorable prior year reserve development in the six months ended June 30, 2011 of $4,257, compared to net favorable development of $976 in the six months ended June 30, 2010. For the three months ended June 30, 2011, net favorable prior year development was $1,771 compared to $925 for the same period in 2010. The favorable development in 2011 was primarily driven by lower loss emergence, relative to expectations on the commercial multi-peril and workers compensation lines of business in our commercial business segment. We also experienced favorable development in the fire and allied lines of business for our agribusiness segment as a result of favorable settlements on previously reported claims and favorable development in the liability lines as a result of lower levels of claims emergence. | ||
| For the three and six month periods ended June 30, 2011, our agribusiness segment experienced improved current accident year loss ratios from non-weather related claims, primarily due to fewer severe fire losses and a reduction in frequency on the workers compensation line of business. The commercial business segment experienced an increase in the non-weather related, current accident year loss ratio for the quarter and year to date periods compared to 2010. The non-weather related current accident year loss ratio increased from 75.2% for the three month period ended June 30, 2010 to 89.3% for the same period in 2011 and increased from 75.1% for the six month period ended June 30, 2010 to 89.8% for the same period in 2011. These increases are primarily driven by increases in severity in the fire line of business due to several large fires. |
Underwriting Expenses
Our underwriting expense ratio represents the ratio of underwriting expenses (amortization
of deferred policy acquisition costs and underwriting and administrative expenses) divided by net
premiums earned. As one component of the combined ratio, along with the loss and loss adjustment
expense ratio, the underwriting expense ratio is a key measure of profitability. The underwriting
expense ratio can exhibit volatility from year to year from such factors as changes in premium
volume, one-time or infrequent expenses for strategic initiatives, or profitability based bonuses
to employees and producers.
Total underwriting and administrative expenses, including amortization of deferred policy
acquisition costs, were $6,314 and $5,871 for the three months ended June 30, 2011 and 2010,
respectively, and $12,989 and $11,867 for the six months ended June 30, 2011 and 2010,
respectively. Amortization of deferred policy acquisition costs decreased $194, or 3.8%, and
$296, or 2.9%, for the three and six months ended June 30, 2011 compared to the same periods in
2010. The decrease is attributable to the decline in earned premiums. Underwriting and
administrative expenses increased $637 and $1,418 for the three and six months ended June 30,
2011, compared to the same periods of 2010. The increase in these costs is primarily the result
of the one-time benefit of $679 in the second quarter of 2010 from the termination of our SERP
plan. Other factors include increased stock based compensation expense compared to the prior
year and one-time severance costs related to our February 2011 staff reductions.
The increase in underwriting expenses in 2011, combined with the reduction in earned
premium, resulted in the underwriting expense ratio increasing from 35.2% for the six months
ended June 30, 2010 to 38.5% for the six months ended June 30, 2011. This increase in the expense
ratio was more than offset by the decrease in the loss and LAE ratio, resulting in our combined
ratio decreasing from 121.9% for the six months ended June 30, 2010 to 119.3% for the six months
ended June 30, 2011.
35
Table of Contents
Income Tax Expense (Benefit)
For the three months ended June 30, 2011, the income tax benefit for operations was $555, or
an effective tax rate of 11.2%, compared to a tax benefit of $1,005, or an effective tax rate of
44.1%, for the same period in 2010. For the six months ended June 30, 2011, the income tax
benefit for operations was $241, or an effective tax rate of 8.8%, compared to a tax benefit of
$1,072, or an effective tax rate of 41.4%, for the same period in 2010. Our effective income tax
rate is impacted by our pre-tax loss, its relationship to the level of tax exempt interest income
earned on our municipal bond portfolio, and by the accounting for our deferred tax valuation
allowance.
Financial Position
At June 30, 2011 we had total assets of $244,523 compared to total assets of $254,721 at
December 31, 2010. The decrease in our total assets is primarily due to lower premiums
receivable, due to a lower volume of earned premiums, and lower reinsurance receivables and
recoverables due to the timing of loss payments and reinsurance recoveries.
At June 30, 2011 we had total liabilities of $152,801 compared to $161,693 at December 31,
2010. The change in our total liabilities is primarily due to a decrease in losses and LAE
reserves of $3,343, due to declining premium and timing of claims settlements. The decline is
also due to a decrease in unearned premiums due to the underwriting actions taken in our
commercial business segment and decreases in accounts payable and accrued expenses due to the
timing of expenditures.
Liquidity and Capital Resources
We generate sufficient funds from our operations and maintain a high degree of liquidity in
our investment portfolio to meet the demands of claim settlements and operating expenses. The
primary sources of recurring funds are premium collections, investment earnings and maturing
investments.
We maintain investment and reinsurance programs that are intended to provide sufficient
funds to meet our obligations without forced sales of investments. We maintain a portion of our
investment portfolio in relatively short-term and highly liquid assets to ensure the availability
of funds.
The following table summarizes the distribution of our investment portfolio as a percentage
of total estimated fair value based on credit ratings assigned by Standard & Poors Corporation
(S&P) at June 30, 2011 and at December 31, 2010:
June 30, 2011 | December 31, 2010 | |||||||||||||||
Estimated | Percent of | Estimated | Percent of | |||||||||||||
Rating(1) | Fair Value | Total(2) | Fair Value | Total(2) | ||||||||||||
Agencies not backed by
the full faith and
credit of the U.S.
government |
$ | 14,964 | 8.6 | % | $ | 14,458 | 8.3 | % | ||||||||
U.S. treasury securities |
798 | 0.5 | % | 736 | 0.4 | % | ||||||||||
AAA |
37,719 | 21.7 | % | 48,482 | 27.9 | % | ||||||||||
AA |
48,293 | 27.8 | % | 41,254 | 23.8 | % | ||||||||||
A |
46,512 | 26.8 | % | 45,354 | 26.1 | % | ||||||||||
BBB |
13,810 | 8.0 | % | 12,487 | 7.2 | % | ||||||||||
Sub-total |
162,096 | 93.4 | % | 162,771 | 93.7 | % | ||||||||||
B(3) |
11,382 | 6.6 | % | 10,874 | 6.3 | % | ||||||||||
Total |
$ | 173,478 | 100.0 | % | $ | 173,645 | 100.0 | % | ||||||||
(1) | The ratings set forth in this table are based on the ratings assigned by S&P. If S&Ps ratings were unavailable, the equivalent ratings supplied by Moodys Investor Service, Fitch Investors Service, Inc. or the National Association of Insurance Commissioners (NAIC) were used where available. | |
(2) | Represents percent of fair value for classification as a percent of the total invested assets portfolio. | |
(3) | Represents the amount invested in a high-yield bond mutual fund invested primarily in corporate fixed maturity securities with an average S&P credit rating of B. |
36
Table of Contents
The maturity profile of our fixed maturity securities at June 30, 2011 can be seen in
footnote 6 to our Consolidated Financial Statements under Item 1 of this Report on Form 10-Q.
Expected maturities could differ from contractual maturities because borrowers may have the
right to call or prepay obligations, with or without call or prepayment penalties. Fixed maturity
securities are carried at fair value in our financial statements. Mortgage-backed securities
consist of residential and commercial mortgage-backed securities and securities collateralized by
home equity loans. These securities are presented separately in the maturity schedule due to the
inherent risk associated with prepayment or early amortization. Prepayment rates are influenced
by a number of factors that cannot be predicted with certainty, including: the relative
sensitivity of the underlying mortgages or other collateral to changes in interest rates; a
variety of economic, geographic and other factors; and the repayment priority of the securities
in the overall securitization structures.
At June 30, 2011, the average effective duration of our mortgage-backed securities was 4.1
years. The average effective duration of our total fixed maturity investment portfolio was 3.1
years. The fair value of our investments may fluctuate significantly in response to changes in
interest rates. In addition, we may experience investment losses to the extent our liquidity
needs require the disposition of fixed maturity securities in unfavorable interest rate
environments.
Our fixed maturity portfolio held $23,446 and $22,915 of United States Agency-guaranteed
residential mortgage-backed securities (RMBS) at June 30, 2011 and December 31, 2010,
respectively. The RMBS had an average credit rating of AAA and AAA for each respective period and
we held no non-agency guaranteed RMBS during the six months ended June 30, 2011 and during the
year ended December 31, 2010.
Approximately 11% of our investments in fixed maturity securities at both June 30, 2011 and
December 31, 2010 were guaranteed by third party monoline insurers. As of June 30, 2011 and as of
December 31, 2010, the fixed maturity securities guaranteed by these monoline insurers were
comprised entirely of municipal bonds with a fair value of $18,208 and $20,062, respectively, and
an average credit rating of AA for each of these periods. We base our investment decision on the
credit characteristics of the municipal security, without consideration of the guarantee. We hold
no securities issued by any third party insurer.
Cash flows for the six months ended June 30, 2011 and 2010 were as follows:
Six months ended | ||||||||
June 30, | ||||||||
2011 | 2010 | |||||||
Cash flows (used in) provided by operating activities |
$ | (954 | ) | $ | 50 | |||
Cash flows used in investing activities |
(824 | ) | (5,184 | ) | ||||
Cash flows used in financing activities |
| (4,155 | ) | |||||
Net decrease in cash and cash equivalents |
$ | (1,778 | ) | $ | (9,289 | ) | ||
Cash flows from operating activities decreased by $1,004 for the six month period ended June
30, 2011 compared to the period ended June 30, 2010. The change is primarily due to increased
loss payments in 2011 compared to 2010.
Investing activities used $824 and $5,184 of net cash for the six months ended June 30, 2011
and 2010, respectively. In the first six months of 2011, net purchases of available-for-sale
securities were $679. For the first six months of 2010, net purchases of available for sale
securities were $7,803, and we received $2,682 of cash from the termination of our COLI policies.
Cash flows used in financing activities for the first six months of 2010 were comprised
entirely of amounts we paid for our outstanding stock under our share repurchase plans.
As of June 30, 2011, our parent company, Penn Millers Holding Corporation, held total cash
and invested assets in fixed maturity securities and equity securities of $13,257. In addition,
at June 30, 2011, we had no outstanding debt and, therefore, do not expect to have any need for
dividends from Penn Millers Insurance Company in the near future.
37
Table of Contents
Penn Millers Insurance Company is restricted by the insurance laws of Pennsylvania as to the
amount of dividends or other distributions it may pay to us. Under Pennsylvania law, there is a
maximum amount that may be paid by Penn Millers Insurance Company during any twelve-month period
without prior approval from the Pennsylvania Insurance Department. Penn Millers Insurance Company
may pay dividends to us after notice to, but without prior approval of the Pennsylvania Insurance
Department in an amount not to exceed the greater of (i) 10% of the surplus as regards
policyholders of Penn Millers Insurance Company as reported on its most recent annual statement
filed with the Pennsylvania Insurance Department, or (ii) the statutory net income of Penn
Millers Insurance Company for the period covered by such annual statement. Dividends in excess of
this amount are considered extraordinary and are subject to the approval of the Pennsylvania
Insurance Department. As of January 1, 2011 and June 30, 2011, the amount available for payment
of dividends from Penn Millers Insurance Company in 2011 without the prior approval of the
Pennsylvania Insurance Department is $6,819 based upon the insurance companys 2010 annual
statement. Prior to its payment of any dividend, Penn Millers Insurance Company is required to
provide notice of the dividend to the Pennsylvania Insurance Department. This notice must be
provided to the Pennsylvania Insurance Department 30 days prior to the payment of an
extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The Pennsylvania
Insurance Department has the power to limit or prohibit dividend payments if Penn Millers
Insurance Company is in violation of any law or regulation. These restrictions or any
subsequently imposed restrictions may affect our future liquidity.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures, or capital reserves.
Impact of Inflation
Inflation increases consumers needs for property and casualty insurance coverage due to the
increase in the value of the property covered and any potential liability exposure. Inflation
also increases claims incurred by property and casualty insurers as property repairs,
replacements and medical expenses increase. These cost increases reduce profit margins to the
extent that rate increases are not implemented on an adequate and timely basis. We establish
property and casualty insurance premiums levels before the amount of loss and loss expenses, or
the extent to which inflation may impact these expenses, are known. Therefore, we attempt to
anticipate the potential impact of inflation when establishing rates. Because inflation has
remained relatively low in recent years, financial results have not been significantly affected
by it.
Critical Accounting Estimates
General
The preparation of financial statements in accordance with GAAP requires both the use of
estimates and judgment relative to the application of appropriate accounting policies. We are
required to make estimates and assumptions in certain circumstances that affect amounts reported
in our financial statements and related footnotes. We evaluate these estimates and assumptions on
an on-going basis based on historical developments, market conditions, industry trends and other
information that we believe to be reasonable under the circumstances. There can be no assurance
that actual results will conform to our estimates and assumptions and that reported results of
operations will not be materially adversely affected by the need to make accounting adjustments
to reflect changes in these estimates and assumptions from time to time. Our critical accounting
estimates are more comprehensively described in our 2010 Form 10-K in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of Operations-Critical
Accounting Estimates. We believe that our most significant accounting estimates to be those
applied to losses and loss adjustment expense reserves and related reinsurance recoverables;
investment valuation and impairments; the provision for income taxes; and deferred policy
acquisition costs.
Losses and Loss Adjustment Expense Reserves
How reserves are established
We maintain reserves for the payment of claims (incurred losses) and expenses related to
adjusting those claims (loss adjustment expenses or LAE). Our loss reserves consist of case
reserves, which are reserves for claims that have been reported to us, and reserves for IBNR
which is comprised of estimated development of our case reserves and estimates of claims that
have been incurred but have not yet been reported.
38
Table of Contents
When a claim is reported to us, our claims personnel establish a case reserve for the
estimated amount of the ultimate payment. The amount of the loss reserve for the reported claim
is based primarily upon a claim-by-claim evaluation of coverage, liability, injury severity or
scope of property damage, and any other information considered pertinent to estimating the
exposure presented by the claim. Each claim is settled individually based upon its merits, and
some claims may take years to settle, especially if legal action is involved. Case reserves are
reviewed on a regular basis and are updated as new data becomes available.
In addition to case reserves, we maintain estimates of reserves for losses and loss
adjustment expenses incurred but not reported. Some claims may not be reported for many years. As
a result, the liability for unpaid losses and loss adjustment reserves includes significant
estimates for IBNR.
We utilize an independent actuary to assist with the estimation of our losses and LAE
reserves each quarter. The actuary prepares estimates of the ultimate liability for unpaid losses
and LAE based on established actuarial methods.
We estimate IBNR reserves by reducing the selected actuarial estimate of the ultimate losses
and loss adjustment expenses incurred by line of business as of the financial statement date by
losses and loss adjustment expense payments incurred by line of business as of that same date.
The process of estimating loss reserves involves a significant degree of judgment and is
subject to uncertainty from various sources. This includes both internal and external events,
such as changes in claims handling procedures, economic inflation, legal trends, and legislative
changes, among others. The impact of these items on ultimate losses and loss adjustment expenses
is difficult to estimate. Uncertainty in loss reserve estimation difficulties also differs by
line of business due to variation in claim complexity, the volume of claims, the potential
severity of individual claims, the determination of occurrence date for a claim, and reporting
lags (the time between the occurrence of the policyholder event and when it is actually reported
to the insurer). Informed judgment is applied throughout the loss reserving process, including
the application of individual expertise to multiple sets of data and analyses. We continually
refine our loss reserve estimates in a regular, ongoing process as historical loss experience
develops and additional claims are reported and settled. In establishing our estimates, we
consider all significant facts and circumstances known at the time loss reserves are established.
Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the
estimated liability for losses and loss adjustment expenses may be higher or lower than the
related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled
in the future, may be materially higher or lower in amount than current loss reserves. We reflect
adjustments to loss reserves in the results of operations in the period the estimates are
changed.
Our actuary determines a range of reasonable reserve estimates which reflects the
uncertainty inherent in the loss reserving process. This range does not represent the range of
all possible outcomes. We believe that the actuarially-determined ranges represent reasonably
likely changes in the losses and LAE estimates, however actual results could differ significantly
from these estimates. The range is determined by line of business and accident year after a
review of the output generated by the various actuarial methods utilized.
The selection of the ultimate loss is based on information unique to each line of business
and accident year and the judgment and expertise of our actuary and management. Although we
raised the net retention of our per risk excess of loss reinsurance covering many of these lines
of business in 2008, our aggregate stop loss reinsurance contract limits the potential for
further development across all lines for the reserves associated with the 2008 and 2009 accident
years. The stop loss contract was not renewed for 2010 because the reinsurance protection is no
longer necessary as we have raised additional capital through our stock offering in October 2009.
As of June 30, 2011 and at December 31, 2010 we had no ceded reinsurance loss recoverable under
this stop loss contract.
39
Table of Contents
Our reserves for unpaid losses and LAE are summarized below:
As of | As of | |||||||
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Case reserves |
$ | 51,006 | $ | 53,330 | ||||
IBNR reserves |
36,397 | 34,321 | ||||||
Net unpaid losses and LAE |
87,403 | 87,651 | ||||||
Reinsurance recoverables on unpaid losses and LAE |
19,227 | 22,322 | ||||||
Reserves for unpaid losses and LAE |
$ | 106,630 | $ | 109,973 | ||||
At June 30, 2011, the amount recorded as compared to the actuarially-determined reserve
range, net of reinsurance was as follows:
Reserve Range for Net Unpaid Losses and LAE | ||||||||||
Low End | Recorded | High End | ||||||||
$ | 79,951 | $ | 87,403 | $ | 90,460 |
At December 31, 2010, the amount recorded as compared to the actuarially-determined reserve
range, net of reinsurance was as follows:
Reserve Range for Net Unpaid Losses and LAE | ||||||||||
Low End | Recorded | High End | ||||||||
$ | 80,201 | $ | 87,651 | $ | 91,372 |
Investments
Our fixed maturity and equity securities (the securities classified as equity securities on
our consolidated balance sheets is comprised of an investment in a high-yield bond mutual fund)
are classified as available-for- sale and carried at estimated fair value as determined by
management based upon quoted market prices or a recognized pricing service at the reporting date
for those or similar investments. Changes in unrealized investment gains or losses on our
investments, net of applicable income taxes, are reflected directly in equity as a component of
comprehensive income (loss) and, accordingly, have no effect on net income (loss). Investment
income is recognized when earned, and capital gains and losses are recognized when investments
are sold, or other-than-temporarily impaired.
The fair value and unrealized losses for our securities that were temporarily impaired as of
June 30, 2011 can be seen in footnote 6 to our Consolidated Financial Statements under Item 1 of
this Report on Form 10-Q.
Fair values of interest rate sensitive instruments may be affected by increases and
decreases in prevailing interest rates, which generally translate, respectively, into decreases
and increases in fair values of fixed maturity investments. The fair values of interest rate
sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment
options, relative values of other investments, the liquidity of the instrument, and other general
market conditions.
At June 30, 2011 and December 31, 2010, we had gross unrealized losses on fixed maturity and
equity securities of $204 and $532, respectively. We have evaluated each fixed maturity security
and taken into account the severity and duration of any declines in fair value, the current
rating on the bond and the outlook for the issuer according to independent analysts. We believe
that the foregoing declines in fair value in our existing fixed maturity portfolio are most
likely attributable to current market conditions and we will recover the entire amortized cost
basis. Our fixed maturity investments and equity securities are classified as available for sale
because we will, from time to time, make sales of securities that are not impaired, consistent
with our investment goals and policies. Our investment portfolio is managed by an independent
investment manager who has discretion to buy and sell securities; however, by agreement, the
investment manager cannot sell any security without our consent if such sale will result in a net
realized loss.
40
Table of Contents
We monitor our investment portfolio and review securities that have experienced a decline in
fair value below cost to evaluate whether the decline is other-than-temporary. When assessing
whether the amortized cost basis of a fixed maturity security will be recovered, we compare the
present value of the cash flows likely to be collected, based on an evaluation of all available
information relevant to the collectability of the security, to the amortized cost basis of the
security. The shortfall of the present value of the cash flows expected to be collected in
relation to the amortized cost basis is referred to as the credit loss. If we determine that we
intend to sell the securities that have experienced a decline in fair value below cost, or that
it is more likely than not that we will be required to sell the securities prior to recovering
their amortized cost basis less any current-period credit losses, the full amount of the
other-than-temporary impairment will be recognized in earnings. If we conclude based on our
analysis that there is a credit loss, and we determine that we do not intend to sell, and it is
not more likely than not that we will be required to sell the securities, the amount of the
credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary
impairment loss will be recognized in other comprehensive income (loss), net of applicable tax.
A portion of our investment portfolio is in a high-yield bond mutual fund invested
primarily in corporate fixed maturity securities, with an average S&P credit rating of B. We
believe that a fund of this nature is generally prone to less volatility than securities that are
tied to U.S. equities (stock) markets. In evaluating the potential impairment of this fund, we
consider our ability and intent to hold this asset for a reasonable time to recover our cost
basis and the duration and magnitude of any unrealized losses. We also take into account other
relevant factors such as: any ratings agencies announcements, general economic and market sector
conditions, and input from our independent investment manager.
We developed our investment policy in conjunction with our external investment manager, and
our board of directors reviews the policy at least annually. Our investment portfolio is
professionally managed by a registered independent investment advisor specializing in the
management of insurance company assets. We use quoted values and other data provided by a
nationally recognized independent pricing service in our process for determining the fair values
of our investments. Its evaluations represent an exit price and a good faith estimate as to what
a buyer in the marketplace would pay for a security in a current sale. This pricing service
provides us with one quote per instrument. For fixed maturity securities that have quoted prices
in active markets, market quotations are provided. For fixed maturity securities that do not
trade on a daily basis, the independent pricing service prepares estimates of fair value using a
wide array of observable inputs.
In accordance with the guidance set forth by Accounting Standards Codification (ASC) 820,
the Companys financial assets and financial liabilities measured at fair value are categorized
into three levels, based on the markets in which the assets and liabilities are traded and the
reliability of the assumptions used to determine fair value. Details on level categorizations,
related inputs and pricing can be seen in footnote 5 to our Consolidated Financial Statements
under Item 1 of this Report on Form 10-Q.
Income Taxes
We utilize the asset and liability method of accounting for income taxes. Deferred income
taxes arise from the recognition of temporary differences between financial statement carrying
amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when
it is more likely than not that some portion of the deferred tax asset will not be realized. The
effect of a change in tax rates is recognized in the period of the enactment date.
We exercise significant judgment in evaluating the amount and timing of recognition of the
resulting tax liabilities and assets. These judgments require us to make projections of future
taxable income. The judgments and estimates we make in determining our deferred tax assets, which
are inherently subjective, are reviewed on a continual basis as regulatory and business factors
change. We evaluate the recoverability of deferred tax assets by taking into account the future
taxable income of the legal entity that generated the deferred tax asset. Any changes in
estimated future taxable income may require us to change our estimated valuation allowance
against our deferred tax assets. In determining whether a valuation allowance is required, we
consider all available evidence, both positive and negative, including our cumulative losses in
recent years, projected taxable income and available tax strategies.
We have deferred tax assets resulting from tax credit carryforwards, net operating losses
and other deductible temporary differences, which will reduce taxable income in future periods.
ASC 740, Income Taxes (ASC 740) requires that a valuation allowance be established when it is
more likely than not that all or a portion of deferred tax assets will not be realized. A
review of all available positive and negative evidence needs to be considered, including a
companys performance, the market environment in which it operates, the length of carryback and
carryforward periods, and future operating income projections. Where there are cumulative losses
in recent years, ASC 740 creates a strong presumption that a valuation allowance is needed.
The significant level of second quarter 2010 catastrophic losses resulted in a pre-tax loss
from operations for that year and our 2011 results to date have been similarly impacted by second
quarter catastrophe losses. Although our current financial forecasts indicate that taxable income
will be generated in the future, those forecasts were not considered sufficient positive evidence
to overcome the observable negative evidence associated with our three year cumulative loss
position. Therefore, we carry a full valuation allowance against our net deferred tax assets. In
future periods, we may be able to reduce some or all of the valuation allowance upon our
determination that we will be able to realize such deferred tax assets. In that event, we would
be able to reduce our future tax liability and recognize an income tax benefit within the
statement of operations to the extent of those assets.
As of June 30, 2011 and December 31, 2010, we had no material unrecognized tax benefits
or accrued interest and penalties. Federal tax years 2007 through 2010 were open for examination
as of June 30, 2011.
41
Table of Contents
Deferred Policy Acquisition Costs
In accordance with ASC Topic 944 Financial Services Insurance, certain direct policy
acquisition costs consisting of commissions, premium taxes and certain other direct underwriting
expenses that vary with, and are primarily related to, the production of business are deferred
and amortized over the effective period of the related insurance policies as the underlying
policy premiums are earned. The method followed in computing deferred acquisition costs (DAC)
limits the amount of deferred costs to their estimated realizable value, which gives effect to
the premium to be earned, related investment income, losses and loss adjustment expenses, and
certain other costs expected to be incurred as the premium is earned. If the sum of the expected
loss and loss adjustment expenses, the expected dividends to policyholders, unamortized
acquisition costs, and maintenance costs exceeds the related unearned premiums and anticipated
investment income, then the excess must be written off. Future changes in estimates, the most
significant of which is expected losses and loss adjustment expenses, may require adjustments to
deferred policy acquisition costs. If the estimation of net realizable value indicates that the
deferred acquisition costs are not recoverable, they would be written off, and further analysis
would be performed to determine if an additional liability would need to be accrued.
Our estimate of the expected loss and loss adjustment expenses, which is derived from our
estimate of an expected loss ratio, is the most significant factor in determining the
recoverability of our deferred acquisition cost asset. Each reporting period, we evaluate our
estimates of future losses and loss adjustment expenses associated with our unearned premium
utilizing the most recent actuarial analysis as a key input to the analysis. This evaluation is
done for our agribusiness and commercial business segments and is used to determine the expected
loss and loss adjustment expenses we will incur on each segments unearned premium. The
determination of the expected loss and loss adjustment expenses examines trends and averages in
our actual accident year loss ratios, and considers the impact of factors such as recent
inflation and premium rate changes, changes in underwriting practices, and abnormal levels of
frequency or severity that could cause the historical ratios to vary from our near term
expectations.
With the increase in the loss ratio in our commercial business segment, the excess of
unearned premiums and anticipated investment income over the expected expenses in our DAC
recoverability projection has narrowed. If the actual loss ratio in our commercial business
segment were to continue to increase in future periods significantly enough to cause the expected
loss ratio to increase by more than roughly two percentage points, we would consider a portion of
our DAC to be unrecoverable. Furthermore, if we did not consider investment income in the
expected recoverability calculation, approximately $228 of the $2,707 of deferred acquisition
costs in our commercial business segment at June 30, 2011 would be unrecoverable.
Recent Accounting Standards
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) 2011-05, Presentation of Comprehensive Income. This ASU improves the comparability,
consistency, and transparency of financial reporting and increases the prominence of items
reported in other comprehensive income. The updated guidance requires that all nonowner changes
in stockholders equity be presented either in a single continuous statement of comprehensive
income or in two separate but consecutive statements. In the two-statement approach, the first
statement should present total net income and its components followed consecutively by a second
statement that should present total other comprehensive income, the components of other
comprehensive income, and the total of comprehensive income. The amendments in the ASU are
effective for fiscal years, and interim periods within those years, beginning after December 15,
2011 and should be applied retrospectively. Early adoption is permitted, because compliance with
the amendments is already permitted. The updated guidance will result in a change in the
presentation of the Companys financial statements but will not have any impact on the Companys
results of operations, financial position or liquidity.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value
Measurements and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU
result in common fair value measurement and disclosure requirements in GAAP and IFRSs.
Consequently, the amendments change the wording used to describe many of the requirements in GAAP
for measuring fair value and for disclosing information about fair value measurements. For many
of the requirements, the FASB does not intend for the amendments in this ASU to result in a
change in the application of the requirements of Topic 820. The amendments in the ASU are
effective for fiscal years, and interim periods within those years, beginning after December 15,
2011 and should be applied prospectively. Early adoption is not permitted. The Company is
currently evaluating the impact that the adoption of this ASU will have on its financial
statements and related disclosures.
42
Table of Contents
In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring
or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force). This ASU
amends ASC Topic 944, Financial Services Insurance, to address which costs related to the
acquisition of new or renewal insurance contracts qualify for deferral. The ASU allows insurance
entities to defer costs related to the acquisition of new or renewal insurance contracts that are
(1) incremental direct costs of the contract transaction (i.e., would not have occurred without
the contract transaction), (2) a portion of the employees compensation and fringe benefits
related to certain activities for successful contract acquisitions, (3) other costs related
directly to the insurers acquisition activities in (2) that would not have been incurred had the
acquisition contract transaction not occurred, and (4) direct-response advertising costs as
defined in ASC Subtopic 340-20, Other Assets and Deferred Costs Capitalized Advertising Costs.
An insurance entity would expense as incurred all other costs related to the acquisition of new
or renewal insurance contracts. The amendments in the ASU are effective for fiscal years, and
interim periods within those years, beginning after December 15, 2011, and can be applied either
prospectively or retrospectively. Early application is permitted at the beginning of an entitys
annual reporting period. We are currently evaluating the impact that the adoption of this ASU
will have on our financial position and results of operations.
All other standards and updates of those standards issued during the six months ended June
30, 2011 either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not
applicable to us or (iv) are not expected to have a significant impact on our results of
operations or financial condition.
43
Table of Contents
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk is the risk that we will incur losses due to adverse changes in the fair value
of financial instruments. We have exposure to three principal types of market risk through our
investment activities: interest rate risk, credit risk and equity risk. Our primary market risk
exposure is to changes in interest rates. We have not entered, and do not plan to enter, into any
derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
Interest rate risk is the risk that we will incur economic losses due to adverse changes in
interest rates. Our exposure to interest rate changes primarily results from our significant
holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the
fair value of these securities.
The average effective duration of the fixed maturity securities in our investment portfolio
at June 30, 2011, was 3.1 years. Our fixed maturity securities investments include U.S.
government bonds, securities issued by government agencies, obligations of state and local
governments and governmental authorities, corporate bonds and mortgage-backed securities, most of
which are exposed to changes in prevailing interest rates and which may experience moderate
fluctuations in fair value resulting from changes in interest rates. We carry these investments
as available for sale. This allows us to manage our exposure to risks associated with interest
rate fluctuations through active review of our investment portfolio by our management and board
of directors and consultation with our external investment manager.
Approximately 7% of our investment portfolio at June 30, 2011 is in a high-yield bond mutual
fund that invests primarily in corporate fixed maturity securities. This is a publicly traded
mutual fund in which we have an ownership stake in the overall assets of the fund (that is stated
as a number of shares), and we are not a creditor in the underlying debt securities. Because this
is an investment in shares of a mutual fund, we have classified this investment as an equity
security on our consolidated balance sheets. This fund is also subject to interest rate risk and
has an option-adjusted duration of 5.06 years at June 30, 2011.
Fluctuations in near-term interest rates could have an impact on our results of operations
and cash flows. Certain of these securities may have call features. In a declining interest rate
environment these securities may be called by their issuer and replaced with securities bearing
lower interest rates. If we are required to sell these securities in a rising interest rate
environment we may recognize losses.
As a general matter, we attempt to match the durations of our assets with the durations of
our liabilities. Our investment objectives include maintaining adequate liquidity to meet our
operational needs, optimizing our after-tax investment income, and our after-tax total return,
all of which are subject to our tolerance for risk.
The table below shows the interest rate sensitivity of our fixed maturity investments
measured in terms of fair value (which is equal to the carrying value for all of our investment
securities that are subject to interest rate changes) at June 30, 2011:
Change in | ||||||||
Hypothetical Change in Interest Rates | Fair Value | Fair Value | ||||||
200 basis point increase |
$ | (12,230 | ) | 161,248 | ||||
100 basis point increase |
(6,203 | ) | 167,275 | |||||
No change |
| 173,478 | ||||||
100 basis point decrease |
6,201 | 179,679 | ||||||
200 basis point decrease |
12,296 | 185,774 |
Credit Risk
Credit risk is the potential economic loss principally arising from adverse changes in the
financial condition of a specific debt issuer. We address this risk by investing primarily in
fixed maturity securities that are rated investment grade with a minimum average portfolio
quality of Aa2 by Moodys or an equivalent rating quality. We also independently, and through
our outside investment manager, monitor the financial condition of all of the issuers of fixed
maturity securities in the portfolio. To limit our exposure to risk, we employ diversification
rules that limit the credit exposure to any single issuer or asset class.
44
Table of Contents
The insolvency or inability of any reinsurer to meet its obligations to us could have a
material adverse effect on our results of operations or financial condition. We monitor the
solvency of reinsurers through regular review of their financial statements and, if available,
their A.M. Best ratings. All of our significant reinsurance partners that A.M. Best follows have
at least an A- A.M. Best rating. According to A.M. Best, companies with a rating of A- or
better have an excellent ability to meet their ongoing obligations to policyholders. In certain
instances, we may partner with a reinsurer who is not rated by A.M. Best. However, in such
instances the reinsurer must be well capitalized and have a strong credit rating from Standard
and Poors or Moodys rating agencies. We will generally only make exceptions for property
related reinsurance in which there is typically little or no delay in the reporting of losses by
insureds and the settlement of the claims. We have experienced no significant difficulties
collecting amounts due from reinsurers. For more information regarding the credit ratings of our
reinsurers, see Item 1 Business Reinsurance included in the Companys 2010 Annual Report on
Form 10-K.
Equity Risk
Equity price risk is the risk that we will incur economic losses due to adverse changes in
equity prices. In the fourth quarter of 2010, we sold all of our equity securities (which
represented approximately 6% of our investment portfolio) that had been invested in a
passively-managed equity index fund, and invested the proceeds in a high-yield bond mutual fund.
Even though this bond fund is classified as an equity security, it does not have the same
exposure to equity price risk because the underlying assets are invested mostly in corporate
bonds.
Item 4. | Controls and Procedures |
Under the supervision and with the participation of our management, including the President
and Chief Executive Officer and the Chief Financial Officer, we have evaluated the effectiveness
of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the
end of the period covered by this report. Based on that evaluation, the President and Chief
Executive Officer and the Chief Financial Officer have concluded that these disclosure controls
and procedures are effective. There were no changes in our internal control over financial
reporting during the quarter ended June 30, 2011 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
45
Table of Contents
Part II Other Information
Item 1. | Legal Proceedings |
From time to time, we are subject to legal proceedings and claims that arise in the ordinary
course of our business. While the outcome of these proceedings cannot be predicted with
certainty, we do not currently expect them to have a material adverse effect on our financial
statements. There have been no material developments during the quarter ended June 30, 2011
regarding our currently pending legal proceedings.
Item 1A. | Risk Factors |
There are no material changes from the risk factors previously disclosed under the heading
Risk Factors in the Companys Form 10-K as filed on March 28, 2011, SEC File No. 001-34496.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None
Item 4. | (Removed and Reserved) |
Item 5. | Other Information |
None
Item 6. | Exhibits |
Exhibits marked with an asterisk are filed herewith.
Exhibit No. | Description | |||
3.1 | Articles of Incorporation of Penn Millers Holding Corporation are incorporated by reference herein
to Exhibit No. 3.1 to the Companys Pre-Effective Amendment No. 1 to Form S-1, (Commission File No.
333-156936). |
|||
3.2 | Bylaws of Penn Millers Holding Corporation are incorporated by reference herein to Exhibit No. 3.2
to the Companys Pre-Effective Amendment No. 1 to Form S-1, (Commission File No. 333-156936). |
|||
10.1 | Form of Penn Millers Stock Incentive Plan Stock Option Agreement for Nonqualified Stock Option for
Non-Management Directors.* |
|||
31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
|||
31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
|||
32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
|||
32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
|||
101 | The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language) and furnished
electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of
Operations; (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated
Statements of Cash Flows; and (v) the Notes to the Consolidated Financial Statements, tagged as
blocks of text. |
46
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PENN MILLERS HOLDING CORPORATION |
||||
Date: August 12, 2011 | By: | /s/ Douglas A. Gaudet | ||
Douglas A. Gaudet | ||||
President and Chief Executive Officer | ||||
Date: August 12, 2011 | By: | /s/ Michael O. Banks | ||
Michael O. Banks | ||||
Executive Vice President and Chief Financial Officer |
47