SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
ATLAS FINANCIAL HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Registrant’s telephone number, including area code: (847) 472-6700
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
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 ¨ Accelerated Filer ¨
Non-Accelerated Filer ¨ 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 Act). Yes ¨ No þ
There were 18,433,153 shares of the Registrant's common stock outstanding as of March 1, 2012 of which 4,628,292 shares of the Registrant’s ordinary voting common stock outstanding as of March 1, 2012 were held by non-affiliates of the Registrant. The aggregate market value of the common stock held by non-affiliates of the Registrant, computed by reference to the closing price as of the last business day of the registrant's most recently completed second fiscal quarter, June 30, 2011, was approximately $5.5 million.
For purposes of the foregoing calculation only, which is required by Form 10-K, the Registrant has included in the shares owned by affiliates those shares owned by directors and officers of the Registrant, and such inclusion shall not be construed as an admission that any such person is an affiliate for any purpose.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Definitive Proxy Statement for its 2012 Annual Meeting of Stockholders are incorporated by reference into Part III of this report.
Item 1. Business
Atlas Financial Holdings, Inc. (“Atlas” or the "Company” or “We”) is a financial services holding company incorporated under the laws of the Cayman Islands. The core business of Atlas, which is carried out through its insurance subsidiaries, American Country Insurance Company (“American Country”) and American Service Insurance Company, Inc. (“American Service” together with American Country, the “insurance subsidiaries”), is the underwriting of commercial automobile insurance policies, focusing on the “light” commercial automobile sector. This sector includes taxi cabs, non-emergency para-transit, limousine, livery and business auto. The insurance subsidiaries distribute their products through a network of independent retail agents. American Country commenced operations in 1979. With roots dating back to 1925 selling insurance for taxi cabs, American Country is one of the oldest insurers of U.S. taxi and livery business. In 1983, American Service began as a non-standard personal and commercial auto insurer writing business in the Chicago, Illinois area. Since then, the insurance subsidiaries have expanded their expertise. Together, American Country and American Service are licensed to write property and casualty ("P&C") insurance in 47 states in the United States. The management of American Country and American Service is fully integrated with a single operating infrastructure supporting the insurance subsidiaries.
The address of Atlas’ registered office is Cricket Square, Hutchins Drive, PO Box 2681, Grand Cayman, KY1-1111, Cayman Islands. The operating headquarters of Atlas and its subsidiaries is located at 150 Northwest Point Boulevard, Elk Grove Village, Illinois 60007, USA.
Atlas was formed on December 31, 2010 in a reverse merger transaction amongst:
Prior to the transaction, KAI transferred 100% of the capital stock of American Service and American Country , to American Acquisition in exchange for common and preferred shares of American Acquisition and promissory notes aggregating C$60.8 million. In addition, American Acquisition raised C$8.0 million through a private placement offering of subscription receipts to qualified investors at a price of C$2.00 per subscription receipt.
KAI received 13,804,861 restricted voting common shares of Atlas valued at $27.8 million, along with 18,000,000 non-voting preferred shares of Atlas valued at $18.0 million and C$8.0 million cash in exchange for 100% of the outstanding shares of American Acquisition and full payment of the promissory notes. Investors in the American Acquisition subscription receipts received 3,983,502 ordinary voting common shares of Atlas plus warrants to purchase one ordinary voting common share of Atlas for each subscription receipt at C$2.00 at any time until December 31, 2013. JJR VI common shares held by former shareholders of JJR VI were consolidated on the basis of one post-consolidation JJR VI common share for every 10 pre-consolidation JJR VI common shares. The post-consolidation JJR VI common shares were then exchanged on a one-for-one basis for ordinary voting common shares of Atlas.
Atlas' consolidated financial statements are those of Atlas and subsidiaries and have been prepared in accordance with Accounting Standard Codification ("ASC") 805 Business Combinations. Financial statements prepared following the reverse merger are presented in the name of the legal parent acquirer, Atlas, but are a continuation of the financial statements of the accounting acquirer, American Acquisition, with an adjustment for the capital structure (that is, the number and type of equity interests, including equity instruments issued to effect the merger) of Atlas, as the legal parent acquirer and accounting acquiree. Accordingly, and as a result of the December 31, 2010 merger date, shareholders’ equity at December 31, 2010 reflects the ordinary voting common shares outstanding at the date of the merger together with the restricted voting common shares and non-voting preferred shares that were issued to effect the merger, and also reflect the historical retained earnings (retained deficit) balances of American Acquisition, as the accounting acquirer.
On February 25, 2010, while under KAI ownership, Southern United Fire Insurance Company ("Southern United") merged into American Service. The transaction was accounted for as a merger of companies under common control with the Southern United assets and liabilities included at their carrying values and its results of operations included in the financial statements from the date of the merger.
Under Section 12(b) of the U.S. Securities Exchange Act of 1934, non-US companies must test to see if they qualify for domestic issuer status as of the last day of the second quarter of each fiscal year, and, if so, will be considered “domestic issuers” in the United States effective the beginning of the next fiscal year and report its financial statements in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") and on U.S. domestic forms. Atlas has determined that, as of June 30, 2011, it qualified to become a U.S. domestic issuer effective January 1, 2012 and, as such, has adopted U.S. GAAP for its annual financial statements beginning December 31, 2011.
In this annual report on Form 10-K, we occasionally refer to statutory financial information. All domestic United States insurance companies are required to prepare statutory-basis financial statements. As a result, industry data is available that enables comparisons between insurance companies, including competitors who are not subject to the requirement to prepare financial statements in conformity with U.S. GAAP. We frequently use industry publications containing statutory financial information to assess our competitive position.
To be the preferred specialty commercial transportation insurer in any geographic areas where our value proposition delivers benefit to all stakeholders.
To develop and deliver superior specialty insurance products that are correctly priced to meet our customers' needs and generate consistent underwriting profit for the insurance companies we own. These products will be distributed to the insured through independent retail agents utilizing Atlas' efficient operating platform.
We will achieve our Vision and Mission through the design, sophisticated pricing and efficient delivery of specialty transportation insurance products. Through constant interaction with our retail producers, we will strive to thoroughly understand each of the markets we serve. This knowledge will assist us in ensuring we deliver strategically priced products to the right market at the right time. Analysis of the substantial data available through our operating companies will drive product and pricing decisions. We will focus on our key strengths and expand our geographic footprint and products only to the extent that these activities support our Vision and Mission. We will target niche markets that support adequate pricing and will be best able to adapt to changing market needs ahead of our competitors through our strategic commitment and increasing scale.
The insurance industry is price competitive in all markets in which the insurance subsidiaries operate. Atlas strives to employ disciplined underwriting practices with the objective of rejecting under‑priced risks. Based on the current size of the commercial automobile insurance industry, Atlas requires only 1% market share to achieve its business plan.
Atlas competes on a number of factors such as distribution strength, pricing, agency relationships, policy support, claim service, and market reputation. In Atlas’ core commercial automobile lines, the primary offerings are policies at the minimum prescribed limits in each state, as established by statutory, municipal and other regulations. Atlas differentiates itself from many larger companies competing for this specialty business by exclusively focusing on these lines of insurance.
In the specialty insurance market, American Country and American Service compete against, among others, American Transit Insurance Company (New York only), Canal Insurance Company, CNA Financial Corporation, Carolina Casualty Insurance Company, Empire Fire & Marine Insurance Company (subsidiary of Zurich Financial Services Ltd.), Gateway Insurance Company, Global Liberty Insurance Company of New York, Grenada Insurance Company, Hereford Holding Company, Inc., Hartford Financial Services Group, Lancer Financial Group, MAPFRE USA, Maya Assurance Company, Mercury General Corporation, National Indemnity Company (subsidiary of Berkshire Hathaway, Inc.), National Interstate Corporation, Northland Insurance Company (subsidiary of Travelers Companies, Inc.), Safeco Corporation (subsidiary of Liberty Mutual), Scottsdale Insurance Company (National Casualty Company) and ULLICO, Inc.
To compete successfully in the specialty commercial insurance industry, Atlas relies on its ability to: identify markets that are most likely to produce an underwriting profit; operate with a disciplined underwriting approach; offer diversified products and geographic platforms; practice prudent claims management; reserve appropriately for unpaid claims; strive for cost containment through economies of scale where deemed appropriate; and provide services and competitive commissions to its independent agents and brokers.
Currently, Atlas distributes insurance only in the United States. Through our insurance subsidiaries, we are licensed to write P&C insurance in 47 states in the United States. The following table reflects, in percentages, the principal geographic distribution of premiums written for the year ended December 31, 2011. No other jurisdiction accounted for more than 5%.
The below diagram outlines the states where Atlas is actively writing insurance as of December 31, 2011 and where Atlas plans to become active in 2012.
Atlas is subject to extensive regulation, particularly at the state level. The method, extent and substance of such regulation varies by state but generally has its source in statutes which establish standards and requirements for conducting the business of insurance and that delegate regulatory authority to a state regulatory agency. In general, such regulation is intended for the protection of
those who purchase or use insurance products issued by our insurance subsidiaries, not the holders of securities issued by Atlas. These rules have a significant impact on our business and relate to a wide variety of matters including accounting methods, agent and company licensure, claims procedures, corporate governance, examination, investing practices, policy forms, pricing, trade practices, reserve adequacy and underwriting standards.
In recent years, the state insurance regulatory framework has come under increased federal oversight. Legislation which would provide for increased federal chartering of insurance companies has been proposed. Moreover, in its effort to strengthen the regulation of the financial services market overall, the federal government has proposed a set of regulatory reforms, including the establishment of an Office of National Insurance within the Department of the Treasury. In addition, state legislators and insurance regulators continue to examine the appropriate nature and scope of state insurance regulation.
Nearly all states have insurance laws dictating the protocol for P&C insurers to file or maintain price schedules, policy or coverage forms, and other information subject to that state’s regulatory authority. In many cases, such price schedules, policy forms, or both, must be approved prior to use. While these vary from state to state, the objectives of the pricing regulations are generally the same: a price cannot be excessive, inadequate or unfairly discriminatory.
As a result, the speed with which an insurer can change prices in response to competition or increased costs depends, in part, on whether the pricing regulations are (i) prior approval, (ii) file-and-use, or (iii) use-and-file. In states having prior approval laws (of which there are 18), the regulator must approve a price before an insurer may use it. In file-and-use states, the insurer does not have to wait for the regulator’s approval to use a price, but the price must be filed before being used. When a state significantly restricts both underwriting and pricing, it can become more difficult for an insurer to make adjustments quickly in response to changes which could affect profitability.
It is difficult to predict what specific measures at the state or federal level will be adopted or what effect any such measures would have on Atlas.
A primary metric used by insurance regulators is the National Association of Insurance Commissioners’ (“NAIC”) risk based capital (“RBC”) ratio which is computed at the end of each year based on annual information. The insurance subsidiaries are required to maintain certain minimum RBC ratios as provided for by insurance statutes in the states in which they write business. The insurance subsidiaries were above the 200% minimum RBC ratio threshold as measured at December 31, 2011. Based on the 2011 annual statutory financial statements, December 31, 2011 RBC ratios were 592.5% and 803.4% for American Country and American Service, respectively. The insurance subsidiaries had approximately $36.4 million of capital in excess of the 200% minimum RBC described above.
As of December 31, 2011, Atlas had 89 full-time employees, most of whom work at the corporate offices in Elk Grove Village, Illinois.
We maintain an Internet website at www.atlas-fin.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q (as well as those previously filed on the SEDAR system in Canada), current reports on Form 8-K, and any amendments to said reports are available through this website, free of charge, as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission (the "SEC"). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC available at www.sec.gov.
In addition, our code of business conduct and ethics and Audit Committee charter are available on our website.
The P&C insurance business is seasonal in nature. While Atlas’ net premiums earned generally follow a stable trend from quarter to quarter, Atlas’ gross premiums written follow certain common renewal dates for the light commercial risks that represent its core lines of business. For example, January 1 and March 1 are common taxi cab renewal dates in Illinois and New York, respectively. Net underwriting income is driven mainly by the timing and nature of claims, which can vary widely. Atlas’ ability to generate written premium is also impacted by the timing of policy periods in the states in which Atlas operates.
Over the past two years, through dispositions and by placing certain lines of business into run-off, the insurance subsidiaries have streamlined operations to focus on the lines of business they believe will produce favorable underwriting results. Significant progress has also been made in aligning the cost base to the company's expected revenue base going forward. The core functions of the insurance subsidiaries were integrated into a common operating platform. Management believes that both insurance subsidiaries are well positioned in 2012 to begin returning to the volume of premium they wrote in the recent past with better than industry level profitability. The insurance subsidiaries have a long heritage with respect to their continuing lines of business and will benefit from the efficient operating infrastructure honed in 2011. American Country and American Service will actively write business in more states during 2012 than in any prior year, utilizing its well developed underwriting and claim methodology.
Management believes that the most significant opportunities going forward are: (i) continued re-energizing of distribution channels with the objective of recapturing business generated prior to 2009, (ii) building business in previously untapped geographic markets where our insurance subsidiaries are licensed, but not recently active, and (iii) opportunistically acquiring books of business provided market conditions support this activity. Primary potential risks related to these activities include: (i) insurance market conditions remaining “soft” for a sustained period of time, (ii) not being able to achieve the expected support from distribution partners, and (iii) the insurance subsidiaries not successfully maintaining their recently improved ratings from A.M. Best.
Atlas’ sole focus going forward is the underwriting of commercial automobile insurance in the U.S. Atlas will seek to deploy its capital to maximize the return for its shareholders, either by investing in growing the operations or other capital initiatives, depending upon insurance and capital market conditions. Atlas will use historic and current data to analyze and assess future business opportunities.
Item 1A. Risk Factors
This document contains "forward-looking statements" that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These statements are made subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. We assume no obligation to update any forward-looking statements as a result of new information or future events or developments.
These forward-looking statements do not relate strictly to historical or current facts and may be identified by their use of words like "plans," "seeks," "expects," "will," "should," "anticipates," "estimates," "intends," "believes," "likely," "targets" and other words with similar meanings. These statements may address, among other things, our strategy for growth, catastrophe exposure management, product development, investment results, regulatory approvals, market position, expenses, financial results, litigation and reserves. We believe that these statements are based on reasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements.
In addition to the normal risks of business, we are subject to significant risks and uncertainties, including those listed below, which apply to us as an insurer and a provider of other financial services. These risks constitute our cautionary statements under the
Private Securities Litigation Reform Act of 1995 and readers should carefully review such cautionary statements as they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and historical trends. These cautionary statements are not exclusive and are in addition to other factors discussed elsewhere in this document, in our filings with the SEC or via SEDAR or in materials incorporated therein by reference.
Operational risk is the risk that the Company is unable to deliver its products or services to customers or perform vital functions required to conduct its business in an efficient and cost effective manner. This risk includes the potential for loss from such events as the breakdown or ineffectiveness of processes, human errors, technology and infrastructure failures, etc.
The insurance subsidiaries’ provisions for unpaid claims may be inadequate, which would result in a reduction in the Company’s net income and might adversely affect its financial condition.
Establishing an appropriate level of reserves is an inherently uncertain process. The Company’s provisions for unpaid claims do not represent an exact calculation of actual liability, but are estimates involving actuarial and statistical projections at a given point in time of what they expect to be the cost of the ultimate settlement and administration of known and unknown claims. The process for establishing the provision for unpaid claims reflects the uncertainties and significant judgmental factors inherent in estimating future results of both known and unknown claims and as such, the process is inherently complex and imprecise. These estimates are based upon various factors, including:
Most or all of these factors are not directly quantifiable, particularly on a prospective basis, and the effects of these and unforeseen factors could negatively impact the Company’s ability to accurately assess the risks of the policies that it writes. In addition, there may be significant reporting lags between the occurrence of the insured event and the time it is actually reported to the insurer and additional lags between the time of reporting and final settlement of claims. Unfavorable development in any of these factors could cause the level of reserves to be inadequate. The following factors may have a substantial impact on future claims incurred:
As time passes and more information about the claims becomes known, the estimates are appropriately adjusted upward or downward to reflect this additional information. Because of the elements of uncertainty encompassed in this estimation process, and the extended time it can take to settle many of the more substantial claims, several years of experience may be required before a meaningful comparison can be made between actual losses and the original provision for unpaid claims. The development of the provision for unpaid claims is shown by the difference between estimates of claims as of the initial year end and the re-estimated liability at each subsequent year end. Favorable development (reserve redundancy) means that the original claims estimates were higher than subsequently determined or re-estimated. Unfavorable development (reserve deficiency) means that the original claims estimates were lower than subsequently determined or re-estimated. The Company cannot guarantee that it will not have additional unfavorable reserve development in the future. In addition, it may in the future, acquire other insurance companies. The Company cannot guarantee that the provisions for unpaid claims of the companies that it acquires are or will be adequate.
Actual claims and claim adjustment expenses incurred under insurance policies may deviate, perhaps substantially, from the amounts of provisions reflected in the financial statements of the Company.
To the extent that actual claims incurred exceed expectations and the provision for unpaid claims reflected on financial statements, the Company will be required to reflect those changes by increasing reserves for unpaid claims. In addition, government regulators could require that it increase reserves if they determine that provisions for unpaid claims are understated. Increases to the provision for unpaid claims causes a reduction in the insurance subsidiaries’ surplus which could cause a downgrading of the insurance subsidiaries’ ratings. Any such downgrade could, in turn, adversely affect their ability to sell insurance policies.
The insurance subsidiaries will rely on independent agents or producers and will be exposed to risks.
The insurance subsidiaries will market and distribute automobile insurance products through a network of independent agents or producers in the United States. As a result, the Company relies heavily on these agents or producers to attract new business. These agents typically represent more than one insurance company, which may expose the insurance subsidiaries to competition within the agencies and, therefore, cannot rely on their sole commitment to the Company’s insurance products. Independent agents generally have the ability to bind insurance policies, actions over which the Company has a limited ability to exercise preventative control. In the event that an independent agent exceeds their authority by binding the Company on a risk that does not comply with its underwriting guidelines, the Company may be at risk for that policy until it effects a cancellation. Any improper use of such authority may result in losses that could have a material adverse effect on the Company's business, results of operations and financial condition.
In accordance with industry practice, customers often pay the premiums for their policies to agents for payment to the Company. These premiums may be considered paid when received by the agent and thereafter the customer is no longer liable to the Company for those amounts, whether or not the Company has actually received these premium payments from the agent. Consequently, the Company assumes a degree of risk associated with its reliance on independent agents in connection with the settlement of insurance premium balances.
The majority of gross premiums written will be derived from the commercial automobile markets. If the demand for insurance in these markets declines, results of operations could decline significantly.
The size of the commercial automobile insurance market can be affected significantly by many factors outside of the Company’s control, such as the underwriting capacity and underwriting criteria of automobile insurance carriers, and it may be specifically affected by these factors. Additionally, an economic downturn in one or more of its principal markets could result in fewer automobile sales or public transportation operators, resulting in less demand for these insurance products. To the extent that these insurance markets are affected adversely for any reason, gross premiums written will be disproportionately affected due to its substantial reliance on these insurance markets.
The insurance subsidiaries may not be successful in reducing their risk and increasing their underwriting capacity through reinsurance arrangements, which could adversely affect their business, financial condition and results of operations. If reinsurance rates rise significantly or reinsurance becomes unavailable or reinsurers are unable to pay its claims, the Company may be adversely affected.
In order to reduce underwriting risk and increase underwriting capacity, the Company transfers portions of its insurance risk to other insurers through reinsurance contracts. The availability, cost and structure of reinsurance protection are subject to prevailing market conditions that are outside of the Company’s control and which may affect its level of business and profitability. The Company purchases reinsurance from third parties in order to reduce its liability on individual risks. Reinsurance does not relieve
the Company of its primary liability to its insureds. A third party reinsurer’s insolvency or inability or unwillingness to make payments under the terms of a reinsurance treaty could have a material adverse effect on the Company's financial condition or results of operations. The amount and cost of reinsurance available to the Company are subject, in large part, to prevailing market conditions beyond the Company’s control. Its ability to provide insurance at competitive premium rates and coverage limits on a continuing basis depends in part upon the extent to which the Company can obtain adequate reinsurance in amounts and at rates that will not adversely affect its competitive position. There are no assurances that the Company will be able to maintain its current reinsurance facilities, which generally are subject to annual renewal. If it is unable to renew any of these facilities upon their expiration or to obtain other reinsurance facilities in adequate amounts and at favorable rates, the Company may need to modify its underwriting practices or reduce its underwriting commitments.
The insurance subsidiaries are subject to credit risk with respect to the obligations of reinsurers and certain of their insureds. The inability of their risk sharing partners to meet their obligations could adversely affect their profitability.
Although the reinsurers are liable to the Company to the extent of risk ceded to them, the Company remains ultimately liable to policyholders on all risks, even those reinsured. As a result, ceded reinsurance arrangements do not limit the Company’s ultimate obligations to policyholders to pay claims. The Company is subject to credit risks with respect to the financial strength of its reinsurers. The Company is also subject to the risk that their reinsurers may dispute their obligations to pay its claims. As a result, the Company may not recover sufficient amounts for claims that it submits to reinsurers, if at all. As of December 31, 2011, the Company had an aggregate of $8.0 million of unsecured reinsurance recoverables. In addition, its reinsurance agreements are subject to specified limits and the Company would not have reinsurance coverage to the extent that it exceeds those limits. With respect to insurance programs, the insurance subsidiaries are subject to credit risk with respect to the payment of claims and on the portion of risk exposure either ceded to captives established by their clients or deductibles retained by their clients. The credit worthiness of prospective risk sharing partners is a factor considered when entering into or renewing these alternative risk transfer programs. The Company typically collateralizes balances due through funds withheld, letters of credit or trust agreements. No assurance can be given regarding the future ability of these entities to meet their obligations. The inability of the Company's risk sharing partners to meet their obligations could adversely affect profitability.
Atlas is a holding company and the insurance subsidiaries are subject to dividend restrictions and are required to maintain certain capital adequacy levels.
Atlas is a holding company with no significant operations of its own and as a legal entity separate and distinct from its insurance subsidiaries. As a result, its only sources of income are dividends and other distributions from its insurance subsidiaries. Atlas will be limited by the earnings of those subsidiaries, and the distribution or other payment of such earnings to it in the form of dividends, loans, advances or the reimbursement of expenses. The payment of dividends, the making of loans and advances or the reimbursement of expenses by its insurance subsidiaries is contingent upon the earnings of those subsidiaries and is subject to various business considerations. In addition, payments of dividends by the insurance subsidiaries are subject to various statutory and regulatory restrictions imposed by the insurance laws of the domiciliary jurisdiction of such subsidiaries, which limit the aggregate amount of dividends or other distributions that they can declare or pay within any 12-month period. In most jurisdictions, payment of dividends is subject to regulatory approval, and insurance regulators have broad powers to prevent reduction of statutory capital and surplus to inadequate levels and could refuse to permit the payment of dividends calculated under any applicable formula. As a result, Atlas may not be able to receive dividends from its insurance subsidiaries at times and in amounts necessary to meet its operating needs, to pay dividends to shareholders or to pay corporate expenses. The inability of its insurance subsidiaries to pay dividends could have a material adverse effect on Atlas’ business and financial condition.
Market fluctuations, changes in interest rates or a need to generate liquidity could have significant and negative effects on the Company’s investment portfolio. The Company may not be able to realize its investment objectives, which could significantly reduce its net income.
The Company depends on income from its securities portfolio for a substantial portion of its earnings. Investment returns are an important part of overall profitability. A significant decline in investment yields in the securities portfolio or an impairment of securities owned could have a material adverse effect on the Company’s business, results of operations and financial condition. The Company currently maintains and intends to continue to maintain a securities portfolio comprised primarily of fixed income securities. As of December 31, 2011, the majority of the investment portfolio was invested in fixed income securities. The Company cannot predict which industry sectors in which it maintains investments may suffer losses as a result of potential declines in commercial and economic activity, or how any such decline might impact the ability of companies within the affected industry sectors to pay interest or principal on their securities and cannot predict how or to what extent the value of any underlying collateral might be affected. Accordingly, adverse fluctuations in the fixed income or equity markets could adversely impact profitability, financial condition or cash flows.
The Company’s ability to achieve its investment objectives is affected by general economic conditions that are beyond its control. General economic conditions can adversely affect the markets for interest rate sensitive securities, including the extent and timing of investor participation in such markets, the level and volatility of interest rates and, consequently, the value of fixed maturity securities. U.S. and global markets have been experiencing volatility since mid-2007. Initiatives taken by the U.S. and foreign governments have helped to stabilize the financial markets and restore liquidity to the banking system and credit markets. However, the financial system has not completely stabilized and market volatility could continue in the future if there is a prolonged recession or a worsening in key economic indicators. If market conditions deteriorate, the Company’s investment portfolio could be adversely impacted.
Difficult conditions in the economy generally may materially adversely affect the Company’s business, results of operations, and statement of financial position and these conditions may not improve in the near future.
Current market conditions and the instability in the global financial markets present additional risks and uncertainties for the Company’s business. In particular, deterioration in the public debt markets could lead to additional investment losses and an erosion of capital as a result of a reduction in the fair value of investment securities. The severe downturn in the public debt and equity markets, reflecting uncertainties associated with the mortgage crisis, worsening economic conditions, widening of credit spreads, bankruptcies and government intervention in large financial institutions, created significant unrealized losses in the securities portfolio at certain stages in 2009. Depending on market conditions going forward, the Company could again incur substantial realized and additional unrealized losses in future periods, which could have an adverse impact on the results of operations and financial condition. The Company could also experience a reduction in capital in the insurance subsidiaries below levels required by the regulators in the jurisdictions in which they operate. Certain trust accounts for the benefit of related companies and third parties have been established with collateral on deposit under the terms and conditions of the relevant trust agreements. The value of collateral could fall below the levels required under these agreements putting the subsidiary or subsidiaries in breach of the agreement.
The current market volatility may also make it more difficult to value the Company’s securities if trading becomes less frequent.
Disruptions, uncertainty and volatility in the global credit markets may also impact the Company’s ability to obtain financing for future acquisitions. If financing is available, it may only be available at an unattractive cost of capital, which would decrease profitability. There can be no assurance that current market conditions will improve in the near future. In addition, the Company may not have coverage by security analysts, the trading price of the Company’s ordinary voting common shares and restricted voting common shares may be lower and it may be more difficult for its shareholders to dispose of their Company’s shares due to the lower trading volume. The lack of a significant presence in the market could serve to limit the distribution of news and limit investor interest in the Company’s shares. One or more of these factors could result in price volatility and serve to depress the liquidity and market price of the Company’s shares.
The Company may not have access to capital in the future due to an economic downturn.
The Company may need new or additional financing in the future to conduct its operations, or expand its business. Any sustained weakness in the general economic conditions and/or financial markets in Canada, the United States or globally could adversely affect its ability to raise capital on favorable terms, or at all. From time-to-time, the Company may rely on access to financial markets as a source of liquidity for operations, acquisitions and general corporate purposes.
The limited public float and trading volume for the Company’s shares may have an adverse impact on the share price or make it difficult to liquidate.
The Company’s securities are held by a relatively small number of shareholders. KAI holds all of the restricted voting common shares. Also, the Company has ordinary voting shares which are not widely held. Future sales of substantial amounts of the Company’s shares in the public market, or the perception that these sales could occur, may adversely impact the market price of the Company’s shares and the Company’s shares could be difficult to liquidate.
Compliance risk includes the risk arising from violations of, or non-conformance with, laws, regulations or prescribed practices. Compliance risk also arises in situations where the laws or rules governing certain products or activities may be ambiguous or untested. Compliance risk exposes the organization to negative publicity, a potential drop in stock price, fines, criminal and civil monetary penalties, payment of damages and the voiding of contracts. Compliance risks are also sometimes referred to as legal/regulatory, tax or documentation risks.
If the Company fails to comply with applicable insurance and securities laws or regulatory requirements, its business, results of operations and financial condition could be adversely affected.
As a publicly traded holding company listed on a stock exchange which owns insurance companies domiciled in the United States, Atlas and its insurance subsidiaries are subject to numerous laws and regulations. These laws and regulations delegate regulatory, supervisory and administrative powers to federal, provincial or state regulators. Insurance regulations are generally designed to protect policyholders rather than shareholders, and are related to matters including:
Such rules and regulations are expected to increase the Company’s legal and financial compliance costs and to make some activities more time-consuming and costly. A significant amount of resources has been committed to monitor and address any internal control issues, and failure to do so could adversely impact operating results. Any failure to comply with applicable laws or regulations could result in the imposition of fines or significant restrictions on its ability to do business, which could adversely affect the Company’s results of operations or financial condition. In addition, any changes in laws or regulations, including the adoption of consumer initiatives regarding rates charged for automobile or other insurance coverage or claims handling procedures, could materially adversely affect its business, results of operations and financial condition. It is not possible to predict the future impact of changing federal, state and provincial regulation on the Company’s operations, and there can be no assurance that laws and regulations enacted in the future will not be more restrictive than existing laws and regulations. New or more restrictive regulations, including changes in current tax or other regulatory interpretations affecting an alternative risk transfer insurance model, could make it more expensive for the Company to conduct its businesses, restrict the premiums its subsidiaries able to charge or otherwise change the way it does business. In addition, economic and financial market turmoil may result in some type of U.S. federal oversight of the insurance industry in general.
The insurance subsidiaries are subject to comprehensive regulation and their ability to earn profits may be restricted by the regulations.
The insurance subsidiaries are subject to comprehensive regulation by government agencies in the United States. Failure to meet regulatory requirements could subject them to regulatory action. The regulations and associated examinations may have the effect of limiting the insurance subsidiaries’ liquidity and may adversely affect results of operations. The insurance subsidiaries must comply with statutes and regulations relating to, among other things:
In addition, state insurance department examiners perform periodic financial, market conduct and other examinations of insurance companies. Compliance with applicable laws and regulations is time consuming and personnel-intensive. In addition to financial examinations, the insurance subsidiaries may be subject to market conduct examinations of claims and underwriting practices. Any adverse findings could result in significant fines and penalties, negatively affecting profitability.
The Company’s business is subject to risks related to litigation and regulatory actions.
The Company may from time-to-time be subject to a variety of legal and regulatory actions relating to its current and past business operations, including, but not limited to:
As insurance industry practices and regulatory, judicial and industry conditions change, unexpected and unintended issues related to pricing, claims, coverage and business practices may emerge. Plaintiffs often target P&C insurers in purported class action litigation relating to claims handling and insurance sales practices. The resolution and implications of new underwriting, claims and coverage issues could have a negative effect on the Company’s business by extending coverage beyond the Company’s underwriting intent, increasing the size of claims or otherwise requiring them to change their practices. The effects of unforeseen emerging claim and coverage issues could negatively impact revenues, results of operations and reputation.
Current and future court decisions and legislative activity may increase the Company’s exposure to these types of claims. Multi-party or class action claims may present additional exposure to substantial economic, non-economic or punitive damage awards. The loss of even one of these claims, if it resulted in a significant damage award or a judicial ruling that was otherwise detrimental, could create a precedent in the industry that could have a material adverse effect on its results of operations and financial condition. This risk of potential liability may make reasonable settlements of claims more difficult to obtain. The Company cannot determine with any certainty what new theories of recovery may evolve or what their impact may be on its business.
The Company may be subject to governmental or administrative investigations and proceedings in the context of its highly regulated sectors of activity. It cannot predict the outcome of these investigations, proceedings and reviews, and cannot guarantee that such investigations, proceedings or reviews or related litigation or changes in operating policies and practices would not materially adversely affect its results of operations and financial condition. In addition, if it were to experience difficulties with its relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on its ability to do business in that jurisdiction.
The Company’s business could be adversely affected as a result of changing political, regulatory, economic or other influences.
The insurance industry is subject to changing political, economic and regulatory influences. These factors affect the practices and operation of insurance and reinsurance organizations. Legislatures in the United States and other jurisdictions have periodically considered programs to reform or amend their respective insurance and reinsurance systems. Recently, the insurance and reinsurance regulatory framework has been subject to increased scrutiny in many jurisdictions. Changes in current insurance regulation may include increased governmental involvement in the insurance industry and initiatives aimed at premium controls, or may otherwise change the business and economic environment in which insurance industry participants operate. Historically, the automobile insurance industry has been under pressure from time-to-time from regulators, legislators or special interest groups to reduce, freeze or set rates at levels that are not necessarily related to underlying costs or risks, including initiatives to roll back automobile and other personal line rates. These changes may limit the ability of the insurance subsidiaries to price automobile insurance adequately and could require the Company to discontinue unprofitable product lines, make unplanned modifications of its products and services, or result in delays or cancellations of sales of its products and services.
Strategic risk arises from adverse effects of high-level business decisions or the improper implementation of those decisions. Strategic risk also incorporates how management analyzes external factors that impact the strategic direction of the business. Strategic risk further encompasses reputation risk which is the impact to earnings, capital or the ability to do business arising from negative public opinion from whatever cause.
The Company will derive the majority of premiums from a few geographic areas, which may cause its business to be affected by catastrophic losses or business conditions in these areas.
Some jurisdictions including Illinois, Michigan, Minnesota, New York and Louisiana generate a significant percentage of total premiums. Results of operations may, therefore, be adversely affected by any catastrophic losses or material loss trends in these
areas, to the extent covered by policies underwritten by the insurance subsidiaries. Catastrophic losses can be caused by a wide variety of events, including earthquakes, hurricanes, tropical storms, tornadoes, wind, ice storms, hail, fires, terrorism, riots and explosions, and their incidence and severity are inherently unpredictable. Catastrophic losses are characterized by low frequency but high severity due to aggregation of losses, and could result in adverse effects on its results of operations or financial condition. Results of operations may also be adversely affected by general economic conditions, competition, regulatory actions or other business conditions that affect losses or business conditions in the specific areas in which it does most of its business.
The Company may experience difficulty in managing historic and future growth, which could adversely affect its results of operations and financial condition.
The Company intends to grow by expanding geographically and underwriting more market share via the Company’s distribution network. Continued growth could impose significant demands on management, including the need to identify, recruit, maintain and integrate additional employees. Growth may also place a strain on management systems and operational and financial resources, and such systems, procedures and internal controls may not be adequate to support operations as they expand.
The successful integration and management of books of business, acquired businesses and other business involve numerous risks that could adversely affect the Company’s profitability, and are contingent on many factors, including:
•expanding its financial, operational and management information systems;
•managing its relationships with independent agents, brokers, and legacy program managers including maintaining adequate controls;
•expanding its executive management and the infrastructure required to effectively control its growth;
•maintaining ratings for certain of its insurance subsidiaries;
•increasing the statutory capital of its insurance subsidiaries to support growth in written premiums;
•accurately setting claims provisions for new business where historical underwriting experience may not be available;
•obtaining regulatory approval for appropriate premium rates; and
•obtaining the required regulatory approvals to offer additional insurance products or to expand into additional states or other jurisdictions.
Failure by the Company to manage its growth effectively could have a material adverse effect on its business, financial condition or results of operations.
Engaging in acquisitions involves risks and, if the Company is unable to effectively manage these risks its business may be materially harmed.
From time-to-time the Company may engage in discussions concerning acquisition opportunities and, as a result of such discussions, may enter into acquisition transactions. Upon the announcement of an acquisition, the Company’s share price may fall depending on the size of the acquisition, the purchase price and the potential dilution to existing shareholders. It is also possible that an acquisition could dilute earnings per share.
Acquisitions entail numerous risks, including the following:
The Company may not be able to integrate or operate successfully any business, operations, personnel, services or products that
it may acquire in the future, which may result in its inability to realize expected revenue increases, cost savings, increases in geographic or product presence, and other projected benefits from the acquisition. Integration may result in the loss of key employees, disruption to the existing businesses or the business of the acquired company, or otherwise harm the Company’s ability to retain customers and employees or achieve the anticipated benefits of the acquisition. Time and resources spent on integration may also impair its ability to grow its existing businesses. Also, the negative effect of any financial commitments required by regulatory authorities or rating agencies in acquisitions or business combinations may be greater than expected.
Various factors may inhibit potential acquisition bids that could be beneficial to shareholders.
Regulatory provisions may delay, defer or prevent a takeover attempt that shareholders may consider in their best interest. For example, under the terms of applicable U.S. state statutes, any person or entity desiring to purchase more than a specified percentage (commonly 10% but can be as low as 5%) of the Company’s outstanding voting securities is required to obtain regulatory approval prior to the purchase of such shares. These requirements would require a potential bidder to obtain prior approval from the insurance departments of the states in which the insurance subsidiaries are domiciled and may require pre-acquisition notification in states that have adopted pre-acquisition notification provisions. Obtaining these approvals could result in material delays or deter any such transaction.
Regulatory requirements could make a potential acquisition of the Company more difficult and may prevent shareholders from receiving the benefit from any premium over the market price of its shares offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of its shares if they are viewed as discouraging takeover attempts in the future.
Provisions in the Company’s organizational documents, corporate laws and the insurance laws of Illinois could impede an attempt to replace or remove their management or directors or prevent or delay a merger or sale, which could diminish the value of the Company’s shares.
The Company’s Amended and Restated Articles of Incorporation and Code of Regulations and the corporate laws and the insurance laws of various states contain, or are anticipated to contain, provisions that could impede an attempt to replace or remove management or directors or prevent the sale of the insurance subsidiaries that shareholders might consider to be in their best interests. These provisions may include, among others:
These provisions may prevent shareholders from receiving the benefit of any premium over the market price of the Company’s shares offered by a bidder in a potential takeover. In addition, the existence of these provisions may adversely affect the prevailing market price of the Company’s shares if they are viewed as discouraging takeover attempts.
The insurance laws of most states require prior notice or regulatory approval of changes in control of an insurance company or its holding company. The insurance laws of the State of Illinois, where the insurance subsidiaries are domiciled, provide that no corporation or other person may acquire control of a domestic insurance or reinsurance company unless it has given notice to such insurance or reinsurance company and obtained prior written approval of the relevant insurance regulatory authorities. Any purchaser of 10% or more of the Company’s aggregate outstanding voting power could become subject to these regulations and could be required to file notices and reports with the applicable regulatory authorities prior to such acquisition. In addition, the
existence of these provisions may adversely affect the prevailing market price of the Company’s shares if they are viewed as discouraging takeover attempts.
Market and Competition Risk
Because the insurance subsidiaries are commercial automobile insurers, conditions in that industry could adversely affect their business.
The majority of the gross premiums written by the Company's insurance subsidiaries will be generated from commercial automobile insurance policies. Adverse developments in the market for commercial automobile insurance, including those which could result from potential declines in commercial and economic activity, could cause our results of operations to suffer. The commercial automobile insurance industry is cyclical. Historically, the industry has been characterized by periods of price competition and excess capacity followed by periods of higher premium rates and shortages of underwriting capacity. These fluctuations in the business cycle have negatively impacted and could continue to negatively impact the revenues of the Company. The results of the insurance subsidiaries, and in turn, the Company, may also be affected by risks, to the extent they are covered by the insurance policies we issue, that impact the commercial automobile industry related to severe weather conditions, floods, hurricanes, tornadoes, earthquakes and tsunamis, as well as explosions, terrorist attacks and riots. The insurance subsidiaries’ commercial automobile insurance business may also be affected by cost trends that negatively impact profitability, such as a continuing economic downturn, inflation in vehicle repair costs, vehicle replacement parts costs, used vehicle prices, fuel costs and medical care costs. Increased costs related to the handling and litigation of claims may also negatively impact profitability. Legacy business previously written by the Company also includes private passenger auto, surety and other P&C insurance business. Adverse developments relative to previously written business could have a negative impact on the Company’s results.
The insurance and related businesses in which the Company operates may be subject to periodic negative publicity which may negatively impact its financial results.
The products and services of the insurance subsidiaries are ultimately distributed to individual and business customers. From time-to-time, consumer advocacy groups or the media may focus attention on insurance products and services, thereby subjecting the industry to periodic negative publicity. The Company also may be negatively impacted if participants in one or more of its markets engage in practices resulting in increased public attention to its business. Negative publicity may also result in increased regulation and legislative scrutiny of practices in the P&C insurance industry as well as increased litigation. These factors may further increase its costs of doing business and adversely affect its profitability by impeding its ability to market its products and services, requiring it to change its products or services or by increasing the regulatory burdens under which it operates.
The highly competitive environment in which the Company operates could have an adverse effect on its business, results of operations and financial condition.
The commercial automobile insurance business is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. Many of the Company’s competitors are substantially larger and may enjoy better name recognition, substantially greater financial resources, higher ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships than the Company.
The Company’s underwriting profits could be adversely impacted if new entrants or existing competitors try to compete with the Company’s products, services and programs or offer similar or better products at or below the Company’s prices. Insurers in its markets generally compete on the basis of price, consumer recognition, coverages offered, claims handling, financial stability, customer service and geographic coverage. Although pricing is influenced to some degree by that of its competitors, it is not in the Company’s best interest to compete solely on price, and may from time-to-time experience a loss of market share during periods of intense price competition. Its business could be adversely impacted by the loss of business to competitors offering competitive insurance products at lower prices. This competition could affect its ability to attract and retain profitable business.
Pricing sophistication and related underwriting and marketing programs use a number of risk evaluation factors. For auto insurance, these factors can include but are not limited to vehicle make, model and year; driver age; territory; years licensed; loss history; years insured with prior carrier; prior liability limits; prior lapse in coverage; and insurance scoring based on credit report information. Atlas believes its pricing model will generate future underwriting profits.
If the Company is not able to attract and retain independent agents and brokers, its revenues could be negatively affected.
The Company competes with other insurance carriers to attract and retain business from independent agents and brokers. Some of its competitors offer a larger variety of products, lower prices for insurance coverage or higher commissions than the Company. The Company’s top ten independent agents accounted for an aggregate of 63% of its commercial auto gross premium written during the year ended December 31, 2011. While Atlas maintains rigorous standards for both new and existing agents, it is seeking to expand its agent network in many areas around the country. If the insurance subsidiaries are unable to attract and retain independent agents/brokers to sell their products, their ability to compete and attract new customers and their revenues would suffer.
If the Company is unable to maintain its claims-paying ratings, its ability to write insurance and to compete with other insurance companies may be adversely impacted. A decline in rating could adversely affect its position in the insurance market, make it more difficult to market its insurance products and cause its premiums and earnings to decrease.
Financial ratings are an important factor influencing the competitive position of insurance companies. Third party rating agencies assess and rate the claims-paying ability of insurers and reinsurers based upon criteria that they have established. Periodically these rating agencies evaluate the business to confirm that it continues to meet the criteria of the ratings previously assigned. Financial strength ratings are an important factor in establishing the competitive position of insurance companies and may be expected to have an effect on an insurance company’s premiums.
The insurance subsidiaries are rated by A.M. Best, which issues independent opinions of an insurer’s financial strength and its ability to meet policyholder obligations. A.M. Best ratings range from “A++” (Superior) to “F” (In Liquidation), with a total of 16 separate rating categories. The objective of A.M. Best’s rating system is to provide potential policyholders and other interested parties an opinion of an insurer’s financial strength and ability to meet ongoing obligations, including paying claims. On January 30, 2012, A.M. Best Co. affirmed the financial strength rating of American Country and American Service as “B” and the outlook assigned to all ratings is “Stable.”
The Company cannot provide assurance that A.M. Best will maintain these ratings in the future. If the insurance subsidiaries’ ratings are reduced by A.M. Best, their competitive position in the insurance industry could suffer and it could be more difficult to market their insurance products. A downgrade could result in a significant reduction in the number of insurance contracts written by the subsidiaries and in a substantial loss of business to other competitors with higher ratings, causing premiums and earnings to decrease. Rating agencies evaluate insurance companies based on financial strength and the ability to pay claims, factors that may be more relevant to policyholders than to investors. Financial strength ratings by rating agencies are not ratings of securities or recommendations to buy, hold or sell any security and should not be relied upon as such.
Human Resources Risk
Human resources risk is the risk that the Company is unable to maximize available human resources in the achievement of its business objectives. This includes people, their experience, knowledge, skills and work environment.
The Company’s business depends upon key employees, and if it is unable to retain the services of these key employees or to attract and retain additional qualified personnel, its business may suffer.
The Company’s success depends, to a great extent, upon the ability of executive management and other key employees to implement its business strategy and its ability to attract and retain additional qualified personnel in the future. The loss of the services of any
of its key employees, or the inability to identify, hire and retain other highly qualified personnel in the future, could adversely affect the quality and profitability of the Company's business operations. In addition, the Company must forecast volume and other factors in changing business environments with reasonable accuracy and adjust its hiring and employment levels accordingly. Its failure to recognize the need for such adjustments, or its failure or inability to react appropriately on a timely basis, could lead the Company either to over-staffing (which could adversely affect its costs structure) or under-staffing (which could impair its ability to service current products lines and new lines of business). In either event, the Company's financial results and customer relationships could be adversely affected.
U.S. Tax Risks
If the Company were not to be treated as a U.S. Corporation for U.S. federal income tax purposes, certain tax inefficiencies would result and certain adverse tax rules would apply.
Pursuant to certain “expatriation” provisions of the U.S. Internal Revenue Code of 1986, as amended, the reverse merger agreement provides that the parties intend to treat the Company as a U.S. corporation for U.S. federal income tax purposes. The expatriation provisions are complex, are largely unsettled and subject to differing interpretations, and are subject to change, perhaps retroactively. If the Company were not to be treated as a U.S. corporation for U.S. federal income tax purposes, certain tax inefficiencies and adverse tax consequences and reporting requirements would result for both the Company and the recipients and holders of stock in the Company, including that dividend distributions from its insurance subsidiaries to Atlas would be subject to 30% U.S. withholding tax, with no available reduction and that members of the consolidated group may not be permitted to file a consolidated U.S. tax return resulting in the acceleration of cash tax outflow and potential permanent loss of tax benefits associated net operating loss carry-forwards that could have otherwise been utilized.
The Company’s use of losses may be subject to limitations and the tax liability of the Company may be increased.
Generally, a change of more than 50% in the ownership of a corporation’s stock, by value, over a three-year period constitutes an ownership change for U.S. federal income tax purposes. An ownership change generally limits a U.S. corporation’s ability to use its net operating loss carry-forwards attributable to the period prior to the change. Both the insurance subsidiaries experienced ownership changes in connection with the private placement and reverse merger transaction completed in the last quarter of 2010, such that the use of their net operating loss carry-forwards will be subject to limitation. In addition, the amounts of any pre-transaction net operating losses of the insurance subsidiaries and tax basis that may be available for use by the insurance subsidiaries following the reverse merger transaction are limited and dependent on tax elections to be taken on a tax return of the insurance subsidiaries’ former parent. The Company’s former parent controls the determination of which elections are made and the extent to which the elections will impact the net operating losses and tax attributes of the insurance subsidiaries for net operating losses and tax attributes generated in periods through December 31, 2010. The Company will not be compensated to the extent the net operating losses and tax attributes are reduced or otherwise unfavorably adjusted due to changes and elections in the former parent’s 2010 and prior tax filings.
Further limitations on the utilization of losses may apply because of the “dual consolidated loss” rules, which will also require the Company to recapture into income the amount of any such utilized losses in certain circumstances. As a result of the application of these rules, the future tax liability of the Company and its insurance subsidiaries could be significantly increased. In addition, taxable income may also be recognized by the Company or its insurance subsidiaries in connection with the 2010 reverse merger transaction.
Item 1B. Unresolved Staff Comments
Item 2. Properties
Atlas' corporate headquarters is located in Elk Grove Village, Illinois. It consists of one office building totaling 176,844 net rentable square feet of office space on 7.2 acres. Atlas occupies one floor of the building and rents some of the remaining space. This building and property is currently held for sale.
We also own approximately 50 acres of vacant land in Alabama which was transferred to Atlas from Southern United. It is also currently held for sale.
Item 3. Legal Proceedings
In connection with its operations, the Company and its insurance subsidiaries are, from time to time, named as defendants in actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the outcome of the various proceedings at this time, such actions have generally been resolved with minimal damages or expense in excess of amounts provided and the Company does not believe that it will incur any significant additional loss or expense in connection with such actions.
Item 4. Mine Safety Disclosure
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of March 19, 2012, there were 100 shareholders of record of Atlas ordinary voting common shares, of which 4,628,292 were issued and outstanding. Atlas ordinary voting common shares have been exclusively listed on the TSX Venture Exchange (“TSXV”) under the symbol “AFH” since January 6, 2011.
Set forth below are the high and low listing prices of the ordinary common shares during 2011 per the TSXV (in Canadian dollars):
During 2011, Atlas did not repurchase any of its equity securities. Atlas also did not pay any dividends during 2011 and has no current plans to pay dividends to its common shareholders. The cumulative amount of dividends to which the preferred shareholders are entitled upon liquidation (or sooner, if Atlas declares dividends), is $810,000 as at December 31, 2011.
Item 7. Management’s Discussion and Analysis ("MD&A") of Financial Condition and Results of Operations
This MD&A contains “forward-looking information” which may include, but is not limited to, statements with respect to estimates of future expenses, revenue and profitability; trends affecting financial condition and results of operations; the availability and terms of additional capital; dependence on key suppliers, and other strategic partners; industry trends and the competitive and regulatory environment; the impact of losing one or more senior executives or failing to attract additional key personnel; and other factors referenced in this MD&A.
Often, but not always, forward-looking statements can be identified by the use of words such as “plans”, “expects”, “is expected”, “budget”, “scheduled”, “estimates”, “forecasts”, “intends”, “anticipates”, or “believes” or variations (including negative variations) of such words and phrases, or state that certain actions, events or results “may”, “could”, “would”, “might” or “will” be taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Atlas to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among others, general business, economic, competitive, political, regulatory and social uncertainties.
Although Atlas has attempted to identify important factors that could cause actual actions, events or results to differ materially from those described in forward-looking statements, there may be other factors that cause actions, events or results to differ from those anticipated, estimated or intended. Forward-looking statements contained herein are made as of the date of this MD&A and Atlas disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or results, or otherwise. There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Accordingly, readers should not place undue reliance on forward-looking statements due to the inherent uncertainty in them.
(All amounts in thousands of US dollars, except for amounts preceded by “C” as Canadian dollars, share and per share amounts)
I. CONSOLIDATED PERFORMANCE
Full year 2011 Highlights
The following financial data is derived from Atlas’ consolidated financial statements for the years ended December 31, 2011 and 2010:
Atlas’ full year combined ratio for 2011 was 131.4%, compared to 144.7% for the full year of 2010. The $4,971 in 2011 non-operating expenses added 13.9% to the combined ratio in 2011.
As planned, core commercial automobile lines became a more significant component of Atlas’ gross premium written as a result of the strategic focus on these core lines of business coupled with positive response from new and existing agents. Gross premium written related to these core commercial lines increased by 36.9% for 2011 as compared to 2010. As a result, the overall loss ratio for 2011 was 81.1% compared to 89.7% in 2010. The $1,800 reserve strengthening charge in the fourth quarter of 2011 related to pre-Atlas periods added 5.0% to the loss ratio in 2011.
Investment performance and other income generated $7,605 of income for 2011, of which $4,201 is realized gains. This resulted in a 4.7% yield for the full year 2011. Cash and invested assets were $127,881 as of December 31, 2011 and were $45,167 lower than December 31, 2010, resulting primarily from the payment of claim settlements. This reduction in cash and invested assets is in line with expectations as Atlas rebuilds its book of business.
Overall, Atlas generated a net loss of $(2,470). After taking the impact of the liquidation preference of the preferred shares into consideration, the basic and diluted loss per common share in 2011 was $(0.18). This compares to a net loss of $(21,812) or $(1.19) per common share diluted in 2010.
Book value per common share diluted as of December 31, 2011 was $2.03.
Atlas has a valuation allowance in the amount of $0.67 per common share diluted as of December 31, 2011. Tax loss carry-forwards were assumed through the acquisition of the insurance subsidiaries. These deferred tax assets could be realized in the future dependent upon profitability during the next twenty year period.
II. APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the consolidated financial statements. The most critical estimates include those used in determining:
•Fair value and impairment of financial assets
•Deferred policy acquisition costs amortization
•Reserve for property-liability insurance claims and claims expense estimation
•Deferred tax asset valuation
In making these determinations, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to our businesses and operations. It is reasonably likely that changes in these estimates could occur from period to period and result in a material impact on our consolidated financial statements.
A brief summary of each of these critical accounting estimates follows. For a more detailed discussion of the effect of these estimates on our consolidated financial statements, and the judgments and assumptions related to these estimates, see the referenced sections of this document. For a complete summary of our significant accounting policies, see the notes to the consolidated financial statements.
Fair values of financial instruments - Atlas has used the following methods and assumptions in estimating its fair value disclosures:
Fair values for bonds are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or values obtained from independent pricing services through a bank trustee.
Impairment of financial assets - Atlas assesses, on a quarterly basis, whether there is objective evidence that a financial asset or group of financial assets is impaired. An investment is considered impaired when the fair value of the investment is less than its cost or amortized cost. When an investment is impaired, the Company must make a determination as to whether the impairment is other-than-temporary.
Under ASC guidance, with respect to an investment in an impaired debt security, other-than temporary impairment (OTTI) occurs if (a) there is intent to sell the debt security, (b) it is more likely than not it will be required to sell the debt security before its anticipated recovery, or (c) it is probable that all amounts due will be unable to be collected such that the entire cost basis of the security will not be recovered. If Atlas intends to sell the debt security, or will more likely than not be required to sell the debt security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net realized gains (losses) on investments in the consolidated statements of income. If Atlas determines that it is probable it will be unable to collect all amounts and Atlas has no intent to sell the debt security, a credit loss is recognized in net realized gains (losses) on investments in the consolidated statements of income to the extent that the present value of expected cash flows is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in other comprehensive income (losses), net of applicable income taxes.
Deferred policy acquisition costs - Atlas defers brokers’ commissions, premium taxes and other underwriting and marketing costs directly relating to the acquisition of premiums written to the extent they are considered recoverable. These costs are then expensed as the related premiums are earned. The method followed in determining the deferred policy acquisition costs limits the deferral to its realizable value by giving consideration to estimated future claims and expenses to be incurred as premiums are earned. Changes in estimates, if any, are recorded in the accounting period in which they are determined. Anticipated investment income is included in determining the realizable value of the deferred policy acquisition costs. Atlas’ deferred policy acquisition costs are reported net of ceding commissions.
Valuation of deferred tax assets - Deferred taxes are recognized using the asset and liability method of accounting. Under this method the future tax consequences attributable to temporary differences in the tax basis of assets, liabilities and items recognized directly in equity and the financial reporting basis of such items are recognized in the financial statements by recording deferred tax liabilities or deferred tax assets.
Deferred tax assets related to the carry-forward of unused tax losses and credits and those arising from temporary differences are recognized only to the extent that it is probable that future taxable income will be available against which they can be utilized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment or substantive enactment.
Claims liabilities - The provision for unpaid claims represent the estimated liabilities for reported claims, plus those incurred but not yet reported and the related estimated loss adjustment expenses. Unpaid claims expenses are determined using case-basis evaluations and statistical analyses, including insurance industry loss data, and represent estimates of the ultimate cost of all claims incurred. Although considerable variability is inherent in such estimates, management believes that the liability for unpaid claims is adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations and are accounted for as changes in estimates.
III. OPERATING RESULTS
Gross Premium Written
Table 2 above summarizes gross premium written by line of business. For the year ended December 31, 2011, gross premium written was $42,031 compared to $46,679 in 2010, representing a 10.0% decrease primarily due to the reduction of non-core lines of business.
The commercial automobile policies we underwrite provide coverage for light weight, individual unit or small fleet commercial vehicles typically with the minimum limits prescribed by statute, municipal or other regulatory requirements. In the year ended December 31, 2011, gross premium written from commercial automobile was $18,790, representing a 36.9% increase relative to 2010. Atlas’ continued focus on these core lines of business coupled with a positive response from both new and existing agents and policyholders to Atlas’ value proposition drove the improvement. As a percentage of the insurance subsidiaries’ overall book of business, commercial auto gross premium written represented 44.7% of gross premium written in 2011 compared to 29.4% in 2010.
Commercial automobile insurance has outperformed the overall P&C industry in each of the past ten years based on data compiled by the NAIC. Each of the specialty business lines on which Atlas’ strategy is focused is a subset of this historically profitable industry segment.
Because there are a limited number of competitors specializing in these lines of business, management believes a strong value proposition is very important and can result in desirable retention levels as policies renew on an annual basis. There are also a relatively limited number of agents who specialize in these lines of business. As a result, strategic agent relationships are important to ensure efficient distribution.
There is a positive correlation between the economy and commercial automobile insurance in general. However, operators of commercial automobiles may be less likely than other business segments within the commercial auto line to take vehicles out of service as their businesses and business reputations rely heavily on availability. With respect to certain business lines such as the taxi line, there are also other factors such as the cost and limited supply of medallions which may discourage a policy holder from taking vehicles out of service in the face of reduced demand for the use of the vehicle.
Maintaining continuous insurance on all vehicles under dispatch is an important aspect of Atlas’ target policyholders’ businesses.
Non-standard automobile insurance is principally provided to individuals who do not qualify for standard automobile insurance coverage because of their payment history, driving record, place of residence, age, vehicle type or other factors. Such drivers typically represent higher than normal risks and pay higher insurance rates for comparable coverage.
Consistent with Atlas’ focus on commercial automobile insurance, Atlas continues to transition away from the non-standard auto
line. Atlas’ has ceased renewals of policies of this type in 2011, allowing surplus and additional resources to be devoted to the expected growth of the commercial automobile business. These lines comprised 41.4% of our gross written premium in 2011 versus 49.2% in 2010. In 2012, gross written premium related to non-standard auto will be negligible.
This line of business is primarily comprised of Atlas’ surety business, which is 100% reinsured.
As illustrated by the data in Table 3 above, 60.4% of Atlas’ 2011 gross premium written came from the state of Illinois and 76.0% came from the three states currently producing the most year-to-date premium volume (Illinois, Indiana and Michigan), as compared to 75.1% in 2010. Atlas is committed to diversifying geographically by expanding in new areas of the country, leveraging experience, historical data and research. In 2011, Atlas began actively writing insurance in 10 new states, 5 of which were added in the fourth quarter.
The decline of written premium for the year ended December 31, 2011 versus the year ended December 31, 2010 in Illinois and Indiana is primarily attributable to Atlas’ de-emphasis of non-standard automobile insurance. The majority of the 2010 non-standard automobile written premium came from those two states.
Ceded Premium Written
Ceded premium written is equal to premium ceded under the terms of Atlas’ in force reinsurance treaties. Ceded premium written decreased 56.5% to $6,173 for the year ended December 31, 2011 compared with $14,201 for the year ended December 31, 2010. This decrease is attributed to the reduction of Atlas’ surety gross premium written.
Net Premium Written
Net premium written is equal to gross premium written less the ceded premium written under the terms of Atlas’ in force reinsurance treaties. Net premium written increased 10.4% to $35,858 for 2011 compared with $32,478 for 2010. These changes are attributed to the combined effects of the issues cited in the ‘Gross Premium Written’ and ‘Ceded Premium Written’ sections above.
Net Premium Earned
Premiums are earned ratably over the term of the underlying policy. Net premium earned was $35,747 in 2011, a 33.3% decrease compared with $53,603 in 2010. The decrease in net premiums earned is attributable to the written premium decline experienced by the Company’s insurance subsidiaries prior to Atlas’ formation, coupled with the transition away from private passenger automobile insurance and other non-core lines of business. Policy periods in Atlas’ core lines of business are typically twelve months.
The loss ratio relating to the claims incurred in 2011 was 81.1% compared to 89.7% in 2010. The $1,800 reserve strengthening adjustment made in the fourth quarter 2011 unfavorably impacted the loss ratio by 5% in 2011. The change in loss ratios from 2010 to 2011 is attributable to the increased composition of commercial auto as a percentage of the total written premium. Atlas has extensive experience and expertise with respect to underwriting and claims management in this specialty area of insurance and expects the loss ratio to trend back towards levels seen in the second quarter 2011. The company is committed to retain this claim handling expertise as a core competency as the volume of business increases.
Acquisition costs represent commissions and taxes incurred on net premium earned. Acquisition costs were $7,294 in 2011 or 20.4% of net premium earned, as compared to 20.7% in 2010. This ratio has declined slightly due to the shift away from private passenger automobile insurance which carry higher commission rates and are anticipated to continue decreasing as Atlas transitions entirely away from these non-standard automobile lines.
Other Underwriting Expenses
The other underwriting expense ratio was 29.9% in 2011 compared to 34.3% in 2010. Atlas incurred additional expenses of approximately $627 in 2011 that are deemed non-recurring. These items are highlighted in the table below:
The combination of the settlement of the American Country Pension Plan in the fourth quarter of 2011 and the above expenses unfavorably impacted the other underwriting expense ratio by 8.8%. The favorable change in other areas of underwriting expense can be attributed to operating efficiencies realized after the reverse merger at the end of 2010 as well as the absence of significant agent receivable write-offs.
Net Investment Income
Investment income (excluding net realized gains) decreased by 28.9% to $3,280 in 2011, compared to $4,616 in 2010. These amounts are primarily comprised of interest income. This decrease is primarily due to the lower average investment balance during 2011. However, the average yield on invested assets (including net realized gains of $4,201) in 2011 increased to 4.7% as compared with 2.8% in 2010.
Net Realized Investment Gains (Losses)
Net realized investment gains in 2011 were $4,201 compared to $888 in 2010. These gains were the result of management's decision to sell certain securities during favorable market conditions in 2011.
Miscellaneous Income (Loss)
Atlas recorded miscellaneous income in 2011 of $124 compared to expense of $757 for 2010. Miscellaneous income in 2011 is primarily comprised of rental income from the corporate headquarters in Elk Grove Village, Illinois.
Atlas’ combined ratio are summarized in the table below. The underwriting loss is attributable to the factors described in the ‘Claims Incurred’, ‘Acquisition Costs’, and ‘Other Underwriting Expenses’ sections above.
*Underwriting expense is the combination of losses on claims, acquisition costs, and other underwriting expenses
2011 non-operating expenses totaled $4,971 ($3,357 net of tax) which includes a one-time $2,544 ($1,755 net of tax) non cash charge upon settlement of the American Country Pension Plan, a $1,800 ($1,188 net of tax) fourth quarter reserve strengthening charge related to pre-Atlas periods, and non-recurring expenses incurred in Q1 2011 of $627 ($414 net of tax) related to the reverse merger transaction costs and restructuring. These non-operating expenses had an unfavorable impact of 13.9% on the Company's combined ratio in 2011.
Loss before Income Taxes
Atlas generated loss before tax of $3,633 in 2011 as compared to a loss before income taxes of $19,237 in 2010.
Income Tax Benefit
Atlas recognized an income tax benefit in 2011 of $1,163, consistent with operating results for the year. No further valuation allowance was recorded on net operating losses generated in 2011. This compares to a tax expense of $2,575 in 2010. The following table reconciles tax benefit from applying the statutory U.S. Federal tax rate of 34.0% to the actual percentage of pre-tax losses provided for the years ended December 31, 2011 and 2010.
Upon formation of Atlas on December 31, 2010, a yearly limitation as required by U.S. tax law Section 382 that applies to changes in ownership on the future utilization of Atlas’ net operating loss carry-forwards was calculated. The insurance subsidiaries’ prior parent retained those tax assets previously attributed to the insurance subsidiaries which could not be utilized by Atlas as a result of this limitation. As a result, Atlas’ ability to recognize future tax benefits associated with a portion of its deferred tax assets generated during prior years and the current year have been permanently limited to the amount determined under U.S. tax law Section 382. The result is a maximum expected net deferred tax asset which Atlas has available after the merger which is believed more-likely-than-not to be utilized in the future.
Net Loss and Loss per Share
Atlas lost $2,470 during 2011 compared to net losses of $21,812 in 2010. After taking the impact of the liquidation preference of the preferred shares into consideration, the basic and diluted loss per common share in 2011 was $(0.18) versus a loss per common share of $1.19 in 2010 computed under continuation accounting rules.
The combination of the one-time $2,544 ($1,755 net of tax) non-cash charge upon settlement of the American Country Pension Plan, the $1,800 ($1,188 net of tax) fourth quarter reserve strengthening, and other non-recurring expenses incurred in Q1 2011 of $627, had an unfavorable impact of ($0.18) on earnings per common share in 2011.
There were 18,373,624 weighted average common shares outstanding at the end of 2011. In 2010, 18,358,363 common shares were used to compute both basic and dilutive earnings per common share, the number of voting common shares at the merger date as required by continuation accounting rules.
Book Value per Common Share
Book value per common share was $2.03 at December 31, 2011 as compared to $2.30 at December 31, 2010. The settlement of the American Country Pension Plan had no significant impact on book value per share.
IV. FINANCIAL CONDITION
Investments Overview and Strategy
Atlas manages its securities portfolio to support the liabilities of the insurance subsidiaries, to preserve capital and to generate investment returns. Atlas invests predominantly in corporate and government bonds with relatively short durations that correlate with the payout patterns of Atlas’ claims liabilities. A third-party investment management firm manages Atlas’ investment portfolio pursuant to the Company’s investment policies and guidelines as approved by its Board of Directors. Atlas monitors the third-party investment manager’s performance and its compliance with both its mandate and Atlas’ investment policies and guidelines.
Atlas’ investment guidelines stress the preservation of capital, market liquidity to support payment of liabilities and the diversification of risk. With respect to fixed income securities, Atlas generally purchases securities with the expectation of holding them to their maturities; however, the securities are available for sale if liquidity needs arise.
At December 31, 2011, Atlas held securities with a fair value of $104,632 which was comprised primarily of fixed income securities. The insurance subsidiaries’ securities must comply with applicable regulations that prescribe the type, quality and concentration of securities. These regulations in the various jurisdictions in which the insurance subsidiaries are domiciled permit investments in government, state, municipal and corporate bonds, preferred and common equities, and other high quality investments, within specified limits and subject to certain qualifications.
The following table summarizes the fair value of the securities portfolio, including cash and cash equivalents, as at the dates indicated.
For the year ended December 31, 2011, Atlas recognized $7,481 in total investment income, including $4,201 of realized gains.
Liquidity and Cash Flow Risk
The following table summarizes the fair value by contractual maturities of the fixed income securities portfolio excluding cash and cash equivalents at the dates indicated.
At December 31, 2011, 54.8% of the fixed income securities, including treasury bills, bankers’ acceptances, government bonds and corporate bonds had contractual maturities of five years or less. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties. Atlas holds cash and high grade short-term assets which, along with fixed income security maturities, management believes are sufficient for the payment of claims on a timely basis. In the event that additional cash is required to meet obligations to policyholders, Atlas believes that high quality securities portfolio provides us with sufficient liquidity. With a weighted average duration of 2.35 years, changes in interest rates will have a modest market value impact on the Atlas portfolio relative to longer duration portfolios. Atlas can and typically does hold bonds to maturity by matching duration with the anticipated liquidity needs.
Market risk is the risk that Atlas will incur losses due to adverse changes in interest rates, currency exchange rates or equity prices. Having disposed of a majority of its asset backed securities, its primary market risk exposures in the fixed income securities portfolio are to changes in interest rates. Because Atlas’ securities portfolio is comprised of primarily fixed income securities that are usually held to maturity, periodic changes in interest rate levels generally impact its financial results to the extent that the securities in its available for sale portfolio are recorded at market value. During periods of rising interest rates, the market value of the existing fixed income securities will generally decrease and realized gains on fixed income securities will likely be reduced. The reverse is true during periods of declining interest rates.
Credit risk is defined as the risk of financial loss due to failure of the other party to a financial instrument to discharge an obligation. Atlas is exposed to credit risk principally through its investments and balances receivable from policyholders and reinsurers. It monitors concentration and credit quality risk through policies to limit and monitor its exposure to individual issuers or related groups (with the exception of U.S. government bonds) as well as through ongoing review of the credit ratings of issuers in the securities portfolio. Credit exposure to any one individual policyholder is not material. The Company's policies, however, are distributed by agents who may manage cash collection on its behalf pursuant to the terms of their agency agreement. Atlas has policies to evaluate the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurers’ insolvency.
The following table summarizes the composition of the fair value of the fixed income securities portfolio, excluding cash and cash equivalents, as of the dates indicated, by ratings assigned by Fitch, S&P or Moody’s Investors Service. The fixed income securities portfolio consists of predominantly very high quality securities in corporate and government bonds with 95.3% rated ‘A’ or better as at December 31, 2011 compared to 97.4% as at December 31, 2010.
Atlas recognizes losses on securities for which a decline in market value was deemed to be other-than-temporary. Management performs a quarterly analysis of the securities holdings to determine if declines in market value are other-than-temporary. Atlas did not recognize charges for securities impairments that were considered other-than-temporary for the years ended December 31, 2011 and December 31, 2010.
The length of time securities may be held in an unrealized loss position may vary based on the opinion of the appointed investment manager and their respective analyses related to valuation and to the various credit risks that may prevent us from recapturing the principal investment. In cases of securities with a maturity date where the appointed investment manager determines that there is little or no risk of default prior to the maturity of a holding, Atlas would elect to hold the security in an unrealized loss position until the price recovers or the security matures. In situations where facts emerge that might increase the risk associated with recapture of principal, Atlas may elect to sell securities at a loss. As of December 31, 2011 and December 31, 2010, Atlas had no material gross unrealized losses in its portfolio.
Estimated impact of changes in interest rates and securities prices
For Atlas’ available-for-sale fixed income securities held as of December 31, 2011, a 100 basis point increase in interest rates on such held fixed income securities would have increased net investment income and income before taxes by approximately $271. Conversely, a 100 basis point decrease in interest rates on such held fixed income securities would decrease net investment income and income before taxes by $271.
A 100 basis point increase would have also decreased other comprehensive income by approximately $3,041 due to “mark-to-market” requirement; however, holding investments to maturity would mitigate this impact. Conversely, a 100 basis point decrease would increase other comprehensive income by the same amount. The impacts described here are approximately linear to the change in interest rates.
Due from Reinsurers and Other Insurers
Atlas purchases reinsurance from third parties in order to reduce its liability on individual risks and its exposure to large losses. Reinsurance is insurance purchased by one insurance company from another for part of the risk originally underwritten by the purchasing (ceding) insurance company. The practice of ceding insurance to reinsurers allows an insurance company to reduce its exposure to loss by size, geographic area, and type of risk or on a particular policy. An effect of ceding insurance is to permit an insurance company to write additional insurance for risks in greater number or in larger amounts than it would otherwise insure independently, having regard to its statutory capital, risk tolerance and other factors.
Atlas generally purchases reinsurance to limit net exposure to a maximum amount on any one loss of $500 with respect to commercial automobile liability claims. Atlas also purchases reinsurance to protect against awards in excess of its policy limits. In addition, in 2010 the insurance subsidiaries were part of a larger group of insurance companies that purchased catastrophe reinsurance providing coverage in the event of a series of claims arising out of a single occurrence, limiting exposure to $2,000
per occurrence with a maximum coverage of $38,000. This catastrophic coverage was deemed appropriate at the time based on the insurance subsidiaries being part of a larger group of companies. However, this exposure is now much more limited due to the insurance subsidiaries’ relatively low limits of first party physical damage coverage. Further, Atlas primarily operates in geographic regions believed to have less exposure to natural disasters; therefore management determined that catastrophe reinsurance was not required in 2011 and going forward. Atlas will continue to evaluate and adjust its reinsurance needs based on business volume, mix, and supply levels.
Reinsurance ceded does not relieve Atlas of its ultimate liability to its insured in the event that any reinsurer is unable to meet their obligations under its reinsurance contracts. Therefore, Atlas enters into reinsurance contracts with only those reinsurers deemed to have sufficient financial resources to provide the requested coverage. Reinsurance treaties are generally subject to cancellation by the reinsurers or Atlas on the anniversary date and are subject to renegotiation annually. Atlas regularly evaluates the financial condition of its reinsurers and monitors the concentrations of credit risk to minimize its exposure to significant losses as a result of the insolvency of a reinsurer. Atlas believes that the amounts it has recorded as reinsurance recoverables are appropriately established. Estimating amounts of reinsurance recoverables, however, is subject to various uncertainties and the amounts ultimately recoverable may vary from amounts currently recorded. As at December 31, 2011, Atlas had $8,044 recoverable from third party reinsurers (exclusive of amounts prepaid) and other insurers as compared to $4,277 as at December 31, 2010.
Estimating amounts of reinsurance recoverables is also impacted by the uncertainties involved in the establishment of provisions for unpaid claims. As underlying reserves potentially develop, the amounts ultimately recoverable may vary from amounts currently recorded. Atlas’ reinsurance recoverables are generally unsecured. Atlas regularly evaluates its reinsurers, and the respective amounts recoverable, and an allowance for uncollectible reinsurance is provided for, if needed.
Atlas’ largest reinsurance partners are Great American Insurance Company (“Great American”), a subsidiary of American Financial Group, Inc. and Gen Re, a subsidiary of Berkshire Hathaway, Inc. Great American has a financial strength rating of A+ from Standard & Poor’s, while Gen Re has a financial strength rating of Aa1 from Moody’s.
Deferred Tax Asset
Atlas established a valuation allowance of approximately $12,361 and $11,288 for its gross future deferred tax assets at December 31, 2011 and December 31, 2010, respectively.
Based on Atlas’ expectations of future taxable income, as well as the reversal of gross future deferred tax liabilities, management believes it is more likely than not that Atlas will fully realize the net future tax assets, with the exception of the aforementioned valuation allowance. Atlas has therefore established the valuation allowance as a result of the potential inability to utilize a portion
of its net operation losses in the U.S. which are subject to a yearly limitation. The uncertainty over the Company’s ability to utilize a portion of these losses over the short term has led to the recording of a valuation allowance.
Atlas has the following total net operating loss carry-forwards as of December 31, 2011:
Assets Held for Sale
As at December 31, 2010, Atlas had five properties held for sale with an aggregate carrying value of $15,004, including its headquarters building in Elk Grove Village, Illinois. During 2011, two of the properties were sold for combined proceeds of $2,436 and Atlas re-classified leasehold improvements with a net book value of $926 from office equipment to assets held for sale. At December 31, 2011, Atlas had three properties remaining as held for sale with an aggregate carrying value of $13,634.
All of the properties’ individual carrying values were less than their respective appraised values net of reasonably estimated selling costs at the time those appraisals were received and at the time properties were deemed to be held for sale. All properties were listed for sale through brokers at the appraised values and above carrying values as of December 31, 2011. Atlas expects to re-invest the proceeds from the sale of real estate in its investment portfolio.
The Elk Grove Village building and property were previously owned by KAI and were contributed to Atlas as a capital contribution in June 2010. The other three properties, all located in Alabama, were assets of Southern United Fire Insurance Company which was merged into American Service in February 2010.
On June 8, 2011, the Mobile, Alabama office building was sold for $2,100, which was the same as its carrying value as of December 31, 2010. On November 2, 2011, land in Saraland, Alabama held for sale as of December 31, 2010 was sold for $336. Its carrying value on the date of sale was $296.
In 2011, bank financing for commercial properties in the Chicago suburbs became more difficult to obtain due to high vacancy rates and tightened lending standards. This has made the sale of the property more difficult than originally envisioned in spite of a reasonable selling price relative to the appraised value. In response, Atlas began offering structured financing to prospective buyers in the fourth quarter, which Atlas believes will lead to a sale of the property in 2012.
The table below shows the amounts of total case reserves and incurred but not reported (“IBNR”) claims provision as of December 31, 2011 and December 31, 2010. The provision for unpaid claims decreased by 30.9% to $91,643 at the end of 2011 compared to $132,579 at the end of 2010. During 2011, case reserves decreased by 26.2% compared to December 31, 2010, while IBNR reserves decreased by 39.8% generally due to the payment of claims related to prior accident years, consistent with management’s expectations.
The reduction of the provision for unpaid claims is consistent with the change in written premium in prior years. However, because the establishment of reserves is an inherently uncertain process involving estimates, current provisions may not be sufficient. Adjustments to reserves, both positive and negative, are reflected quarterly in the statement of income as estimates are updated.
The financial statements are presented on a calendar year basis for all data. Claims payments and changes in reserves, however, may be made on accidents that occurred in prior years, not on business that is currently insured. Calendar year losses consist of payments and reserve changes that have been recorded in the financial statements during the applicable reporting period, without regard to the period in which the accident occurred. Calendar year results do not change after the end of the applicable reporting period, even as new claim information develops. Calendar year information is presented in Note 11 to the consolidated financial statements and shows the claims activity and impact on income for changes in estimates of unpaid claims. Accident year losses
consist of payments and reserve changes that are assigned to the period in which the accident occurred. Accident year results will change over time as the estimates of losses change due to payments and reserve changes for all accidents that occurred during that period.
Table 19 Net increase in prior years’ incurred claims estimates by line of business and accident year
Year Ended December 31, 2011
Year Ended December 31, 2010
Due to Reinsurers
The decrease in due to reinsurers is consistent with the payout patterns of the underlying claims liabilities.
Off-balance sheet arrangements
Atlas has no material off-balance sheet arrangements.
The table below identifies changes in shareholders’ equity for the years ended December 31, 2011 and December 31, 2010.
As of March 19, 2012, there are 4,628,292 ordinary voting common shares, 13,804,861 restricted voting common shares and 18,000,000 preferred shares issued and outstanding.
The restricted voting common shares are convertible into ordinary voting common shares at the option of the holder in the event that an offer is made to purchase all or substantially all of the restricted voting common shares.
The holders of restricted voting shares are entitled to vote at all meetings of shareholders, except at meetings of holders of a specific class that are entitled to vote separately as a class. The restricted voting common shares as a class shall not carry more than 30% of the aggregate votes eligible to be voted at a general meeting of common shareholders.
All of the issued and outstanding restricted voting common shares are beneficially owned or controlled by KFSI or its affiliated entities. In the event that such shares ceased to be beneficially owned or controlled by KFSI or its affiliated entities, the restricted voting common shares shall be converted into fully paid and non-assessable ordinary voting shares on a one-to-one basis.
Preferred shares are not entitled to vote. They accrue dividends on a cumulative basis whether or not declared by the Board of Directors at the rate of $0.045 per share per year (4.5%) and may be paid in cash or in additional preferred shares at the option of Atlas. Upon liquidation, dissolution or winding-up of Atlas, holders of preferred shares receive the greater of $1.00 per share plus all declared and unpaid dividends or the amount they would receive in liquidation if the preferred shares had been converted to restricted voting common shares or ordinary voting common shares immediately prior to liquidation. Preferred shares are convertible into ordinary voting common shares at the option of the holder at any date that is after December 31, 2015, the fifth year after issuance at the rate of 0.3808 ordinary voting common shares for each preferred share. The conversion rate is subject to change if the number of ordinary voting common shares or restricted voting common shares changes. The preferred shares are redeemable at the option of Atlas at a price of US$1.00 per share plus accrued and unpaid dividends commencing at the earlier of December 31, 2012, two years from issuance date, or the date at which KFSI’s beneficial interest is less than 10%.
The cumulative amount of dividends to which the preferred shareholders are entitled upon liquidation or sooner, if Atlas declares dividends, is $810 as at December 31, 2011.
Liquidity and Capital Resources
The purpose of liquidity management is to ensure there is sufficient cash to meet all financial commitments and obligations as they become due. The liquidity requirements of Atlas’ business have been met primarily by funds generated from operations, asset maturities and income and other returns received on securities. Cash provided from these sources is used primarily for payment of claims and operating expenses. The timing and amount of catastrophe claims are inherently unpredictable and may create increased liquidity requirements.
As a holding company, Atlas may derive cash from its subsidiaries generally in the form of dividends and in the future may charge management fees to the extent allowed by statute or other regulatory approval requirements to meet its obligations. The insurance subsidiaries fund their obligations primarily through premium and investment income and maturities in their securities portfolio. Refer also to the discussion “Investments Overview and Strategy” on page 18. These insurance subsidiaries require regulatory approval for the return of capital and, in certain circumstances, payment of dividends. In the event that dividends and management fees available to the holding company are inadequate to service its obligations, the holding company would need to raise capital, sell assets or incur debt obligations. At December 31, 2011, Atlas did not have any outstanding debt, and therefore, no near term debt service obligations.
Atlas currently has no material commitments for capital expenditures.
In 2010 the insurance subsidiaries paid dividends of $16,700 to their parent, KAI, during that time period.
In 2010 the insurance subsidiaries incurred losses under their former owner, as did Atlas which at the time was a newly formed capital pool company known as JJR VI with no operations. The result of the losses by the insurance subsidiaries reduces Atlas’ capital flexibility by limiting their dividend paying capacity.
In the United States, a RBC formula is used by the NAIC to identify P&C insurance companies that may not be adequately capitalized. The NAIC requires capital and surplus not fall below 200% of the authorized control level. As of December 31, 2011, the insurance subsidiaries are well above the required risk based capital levels, with risk based capital ratios based on the unaudited statutory financial statements of 592.5% and 803.4% for American Country and American Service, respectively, and have estimated aggregate capital in excess of the 200% level of approximately $36,402.
Item 8. Financial Statements and Supplementary Data
ATLAS FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
ATLAS FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION