XNYS:SBX Quarterly Report 10-Q Filing - 3/31/2012

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UNITED STATES SECURITIES AND

EXCHANGE COMMISSION

Washington, D.C. 20549

___________________________________

 

FORM 10-Q

 

(Mark One)

[X]          Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

            For the quarterly period ended March 31, 2012

or

 

[ ]            Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ________ to ________

 

Commission File Number 001-34204

 

SeaBright Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

56-2393241

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification No.)

 

1501 4th Avenue, Suite 2600

Seattle, WA 98101

(Address of principal executive offices, including zip code)

 

(206) 269-8500

(Registrant's telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 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 [X] No [   ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [   ] Accelerated filer [X] Non-accelerated filer [ ] Smaller reporting company [ ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes [ ] No [X]

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

 

Class

 

Shares outstanding as of May 4, 2012

Common Stock, $0.01 Par Value

 

22,390,459

 



 
 

 

 

SeaBright Holdings, Inc.

 

Index to Form 10-Q

 

Page

Part I.

Financial Information

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

2

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011

2

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three Months Ended March 31, 2012 and 2011

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011

4

 

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

5

 

 

 

 

 

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

15

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

21

Item 4.

Controls and Procedures

22

Part II. 

Other Information

 

Item 1A.

Risk Factors

22

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

22

Item 6.

Exhibits

23

Signatures

24

 

 
-1-

 

    

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

March 31, 2012

December 31, 2011

 

(As adjusted)

 

(in thousands, except share and per share amounts)

ASSETS

               
                 

Fixed income securities available for sale, at fair value (amortized cost $667,386 in 2012 and $665,891 in 2011)

  $ 692,072   $ 700,346

Cash and cash equivalents

    56,297     28,503

Premiums receivable, net

    15,671     18,332

Deferred premiums, net

    140,569     142,486

Reinsurance recoverables

    97,714     94,173

Federal income tax recoverable

    2,864     12,823

Deferred income taxes, net

    25,070     21,681

Deferred policy acquisition costs, net

    14,661     14,844

Goodwill

    2,794     2,794

Other assets

    43,773     38,314

Total assets

  $ 1,091,485   $ 1,074,296
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               
                 

Liabilities:

               

Unpaid loss and loss adjustment expense

  $ 520,008   $ 518,044

Unearned premiums

    131,250     130,300

Reinsurance funds withheld and balances payable

    9,139     7,079

Premiums payable

    6,788     6,351

Accrued expenses and other liabilities

    62,181     51,553

Surplus notes

    12,000     12,000

Total liabilities

    741,366     725,327
                 

Contingencies (Note 7)

               
                 

Stockholders' equity:

               

Series A preferred stock, $0.01 par value; 750,000 shares authorized; no shares issued and outstanding

Undesignated preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding

       

Common stock, $0.01 par value; 75,000,000 shares authorized; issued and outstanding – 22,409,710 shares at March 31, 2012 and 22,327,749 shares at December 31, 2011

    224     223

Paid-in capital

    214,242     213,746

Accumulated other comprehensive income

    16,948     23,269

Retained earnings

    118,705     111,731

Total stockholders' equity

    350,119     348,969

Total liabilities and stockholders' equity

  $ 1,091,485   $ 1,074,296

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
-2-

 

 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

Three Months Ended March 31,

 

2012

2011

         

(As adjusted)

 

(in thousands, except share and per share information)

                 

Revenue:

               

Premiums earned

  $ 59,089   $ 56,730

Claims service income

    304     333

Net investment income

    5,023     5,375

Net realized gains

    7,973     298

Other income

    932     1,064
      73,321     63,800

Losses and expenses:

               

Loss and loss adjustment expenses

    43,386     43,266

Underwriting, acquisition and insurance expenses

    16,918     18,977

Interest expense

    136     130

Other expenses

    1,832     1,970
      62,272     64,343

Income (loss) before taxes

    11,049     (543 )
                 

Income tax expense (benefit)

    2,954     (425 )

Net income (loss)

    8,095     (118 )
                 

Other comprehensive loss:

               

Change in net unrealized gains on investment securities available for sale

    (1,796 )     (1,320 )

Less: Reclassification adjustment for net realized gains recorded into net income

    (7,973 )     (298 )

Income tax benefit related to items of other comprehensive income

    3,448     578

Other comprehensive loss

    (6,321 )     (1,040 )

Comprehensive income (loss)

  $ 1,774   $ (1,158 )
                 

Basic earnings (loss) per share

  $ 0.38   $ (0.01 )

Diluted earnings (loss) per share

  $ 0.37   $ (0.01 )
                 

Dividends declared per share

  $ 0.05   $ 0.05
                 

Weighted average basic shares outstanding

    21,176,744     20,950,808

Weighted average diluted shares outstanding

    21,794,378     20,950,808
 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
-3-

 

 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

Three Months Ended March 31,

 

2012

2011

 

(As adjusted)

 

(in thousands)

                 

Cash flows from operating activities:

               

Net income (loss)

  $ 8,095   $ (118 )

Adjustments to reconcile net income to cash provided by operating activities:

               

Amortization of deferred policy acquisition costs

    8,247     8,294

Policy acquisition costs deferred

    (8,064 )     (9,141 )

Depreciation and amortization

    2,312     2,145

Compensation cost on restricted shares of common stock

    952     1,368

Compensation cost on stock options

    156     183

Net realized gain on investments

    (7,973 )     (298 )

Deferred income tax expense (benefit)

    58     (430 )

Changes in certain assets and liabilities:

               

Unpaid loss and loss adjustment expense

    1,964     6,058

Federal income tax recoverable

    9,959     4,467

Reinsurance recoverables, net of reinsurance withheld

    (2,391 )     (8,213 )

Unearned premiums, net of deferred premiums and premiums receivable

    5,528     830

Other assets and other liabilities

    504     2,431

Net cash provided by operating activities

    19,347     7,576
                 

Cash flows from investing activities:

               

Purchases of investments

    (154,711 )     (45,936 )

Sales of investments

    144,929     36,893

Maturities and redemption of investments

    20,297     12,005

Purchases of property and equipment

    (339 )     (367 )

Net cash provided by investing activities

    10,176     2,595
                 

Cash flows from financing activities:

               

Stockholder dividends paid

    (1,116 )     (1,101 )

Surrender of stock in connection with restricted stock vesting

    (613 )     (830 )

Net cash used in financing activities

    (1,729 )     (1,931 )
                 

Net increase in cash and cash equivalents

    27,794     8,240

Cash and cash equivalents at beginning of period

    28,503     15,958

Cash and cash equivalents at end of period

  $ 56,297   $ 24,198
                 

Supplemental disclosures:

               

Interest paid on surplus notes

  $ 137   $ 131

Federal income taxes recovered

    (7,018 )     (4,470 )

Accrual for unsettled purchases of investments

    11,523    

Receivable from sale of investments

    7,617    
 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
-4-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

 

1.        Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of SeaBright Holdings, Inc. (“SeaBright”) and its wholly owned subsidiaries, SeaBright Insurance Company (“SBIC”), PointSure Insurance Services, Inc. (“PointSure”), and Paladin Managed Care Services, Inc. (“PMCS”) (collectively, the “Company,” “we” or “us”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.


The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet at December 31, 2011 has been derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. The 2011 financial statements have been revised to reflect the impact of retrospective adoption on January 1, 2012 of Accounting Standards Update (“ASU”) 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. See Note 2.e. for additional disclosure regarding these adjustments. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and accompanying notes as of and for the year ended December 31, 2011 included in the Company's Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 5, 2012.


In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (including normal recurring adjustments) necessary to state fairly the financial information set forth therein. Results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results expected for the full fiscal year or for any future period.


Certain reclassifications have been made to the prior year's financial statements to conform to classifications used in the current year.

 

2.       Summary of Significant Accounting Policies

 

a.        Use of Estimates

 

The preparation of the consolidated financial statements in conformity with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company has used significant estimates in determining unpaid loss and loss adjustment expenses, including losses that have occurred but were not reported to us by the financial reporting date; the amount and recoverability of reinsurance recoverable balances; goodwill and other intangibles; retrospective premiums; earned but unbilled premiums; deferred policy acquisition costs; income taxes; and the valuation and other-than-temporary impairments of investment securities.

 

b.        Earnings Per Share

 

The following table provides the reconciliation of basic and diluted weighted average shares outstanding used in calculating earnings per share for the three month periods ended March 31, 2012 and 2011:


 

Three Months Ended March 31,

 

2012

2011

 

(in thousands)

Basic weighted average shares outstanding

    21,177     20,951

Weighted average shares issuable upon exercise of outstanding stock options and vesting of nonvested restricted stock

    617    

Diluted weighted average shares outstanding

    21,794     20,951

 

 
-5- 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The effect of including certain shares issuable upon the exercise of outstanding stock options and the vesting of non-vested restricted stock was anti-dilutive for the three month periods ended March 31, 2012 and 2011. Therefore, such shares have been excluded from the calculation of diluted weighted average shares outstanding for these periods. The numbers of such shares excluded for the three month periods ended March 31, 2012 and 2011 were approximately 855,000 and 1,445,000, respectively.

 

c.        Stockholder Dividends

 

On March 6, 2012, the Company's Board of Directors declared a quarterly dividend of $0.05 per common share. The dividend was paid on April 13, 2012 to stockholders of record on March 30, 2012. Any future determination to pay cash dividends on the Company's common stock will be at the discretion of its Board of Directors and will be dependent on the Company's earnings; financial condition; operating results; capital requirements; any contractual, regulatory or other restrictions on the payment of dividends by the Company's subsidiaries; and other factors that the Company's Board of Directors deems relevant.

 

d.        Other Significant Accounting Policies

 

For a more complete discussion of the Company's significant accounting policies, please see Note 2 to the Company's consolidated financial statements as of and for the year ended December 31, 2011 in Part II, Item 8 of the Company's 2011 Annual Report on Form 10-K filed with the SEC on March 5, 2012.

 

e.        Accounting Pronouncements

 

In October 2010, the Financial Accounting Standards Board (the “FASB”) issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU allows insurance entities to defer only direct incremental costs associated with successful insurance contract acquisitions or renewals. All other costs related to the acquisition of new or renewal insurance contracts are required to be expensed as incurred. The Company adopted this guidance retrospectively effective January 1, 2012 and has adjusted its previously issued financial information.

 

Adoption of this guidance affected the December 31, 2011 carrying value of deferred policy acquisition costs as follows:

 

 

December 31, 2011

 

As Previously Reported

Effect of Change

As Currently Reported

 

(in thousands)

Deferred policy acquisition costs, net

  $ 21,834   $ 6,990   $ 14,844
 

The effect of adoption of this new guidance on the consolidated balance sheet as of December 31, 2011 and on stockholders' equity as of December 31, 2010 was as follows:

 

 

As Previously Reported

Effect of Change

As Currently Reported

 

(in thousands)

December 31, 2011:

                       

Deferred policy acquisition costs, net

  $ 21,834   $ (6,990 )   $ 14,844

Deferred income taxes, net

    19,233     2,448     21,681

Retained earnings

    116,273     (4,542 )     111,731

Total stockholders' equity

    353,511     (4,542 )     348,969
                         

December 31, 2010:

                       

Retained earnings

    135,265     (4,487 )     130,778

Total stockholders' equity

    351,017     (4,487 )     346,530

 

 
-6- 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

The effect of adoption of this new guidance on the condensed consolidated statement of operations and comprehensive income (loss) for the three months ended March 31, 2011 was as follows:

 

 

As Previously Reported

Effect of Change

As Currently Reported

 

(in thousands)

Underwriting, acquisition and insurance expenses

  $ 18,414   $ 563   $ 18,977

Income tax expense (benefit)

    (228 )     (197 )     (425 )

Net income (loss)

    248     (366 )     (118 )

Basic earnings (loss) per share

    0.01     (0.02 )     (0.01 )

Diluted earnings (loss) per share

    0.01     (0.02 )     (0.01 )

 

3.        Investments

 

The consolidated cost or amortized cost, gross unrealized gains and losses, and estimated fair value of investment securities available for sale at March 31, 2012 and December 31, 2011 were as follows:

 

 

Cost or Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated Fair Value

 

(in thousands)

March 31, 2012:

                               

U.S. Treasury securities

  $ 28,734   $ 1,271   $ (8 )   $ 29,997

Government sponsored agency securities

    24,904     760     (31 )     25,633

Corporate securities

    158,537     5,443     (813 )     163,167

Taxable municipal securities

    22,792     1,400     (15 )     24,177

Tax-exempt municipal securities

    277,806     14,172     (216 )     291,762

Mortgage pass-through securities

    89,102     1,837     (53 )     90,886

Collateralized mortgage obligations

    11,761     124     (42 )     11,843

Asset-backed securities

    53,750     888     (31 )     54,607

Total investment securities available for sale

  $ 667,386   $ 25,895   $ (1,209 )   $ 692,072
                                 

December 31, 2011:

                               

U.S. Treasury securities

  $ 24,989   $ 1,579   $   $ 26,568

Government sponsored agency securities

    15,567     1,330         16,897

Corporate securities

    167,125     9,682     (578 )     176,229

Tax-exempt municipal securities

    308,953     17,903     (1 )     326,855

Mortgage pass-through securities

    77,532     3,399         80,931

Collateralized mortgage obligations

    14,546     168     (54 )     14,660

Asset-backed securities

    57,179     1,052     (25 )     58,206

Total investment securities available for sale

  $ 665,891   $ 35,113   $ (658 )   $ 700,346
 

The Company regularly reviews its investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of its investments. A number of criteria are considered during this process including, but not limited to: the current fair value as compared to amortized cost or cost, as appropriate, of the security; the length of time the security's fair value has been below amortized cost or cost; the likelihood that the Company will be required to sell the security before recovery of its cost basis; objective information supporting recovery in a reasonable period of time; specific credit issues related to the issuer; and current economic conditions. The Company has the ability and intent to hold impaired investments to maturity or for a period of time sufficient for recovery of their carrying amount. For the three month periods ended March 31, 2012 and 2011, the Company recognized no other-than-temporary impairment losses related to investments in debt securities.

 

 
-7-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents information about investment securities with unrealized losses at March 31, 2012:


 

Less Than 12 Months

   

12 Months or More

Total

Investment Category

Aggregate Fair Value

Aggregate Unrealized Loss

Aggregate Fair Value

Aggregate Unrealized Loss

Aggregate Fair Value

Aggregate Unrealized Loss

 
                 

(in thousands)

                 

U.S. Treasury securities

  $ 1,426   $ (8 )   $   $   $ 1,426   $ (8 )  

Government sponsored agency securities (1)

    10,409     (31 )             10,409     (31 )  

Corporate securities

    63,801     (813 )             63,801     (813 )  

Taxable municipal securities

    2,677     (15 )             2,677     (15 )  

Tax-exempt municipal securities

    15,041     (216 )             15,041     (216 )  

Mortgage pass-through securities (2)

    14,094     (53 )             14,094     (53 )  

Collateralized mortgage obligations

    2,722     (7 )     139     (35 )     2,861     (42 )  

Asset-backed securities

    5,122     (31 )             5,122     (31 )  

Total

  $ 115,292   $ (1,174 )   $ 139   $ (35 )   $ 115,431   $ (1,209 )  
_____________

(1)     Government sponsored agency securities are not backed by the full faith and credit of the U.S. Government.

(2)     Includes adjustable rate mortgage securities.

 

The following table presents information regarding gross realized gains and losses resulting from the sale of investment securities in the three month periods ended March 31, 2012 and 2011:

 

 

Three Months Ended March 31,

 

2012

2011

 

(in thousands)

Gross realized gains

  $ 7,987   $ 524

Gross realized losses

    (14 )     (226 )

Net realized gains

  $ 7,973   $ 298
                 

Proceeds

  $ 144,929   $ 36,893
 

The related reclassification adjustments in other comprehensive income on the condensed consolidated statements of operations and comprehensive income (loss) were determined by specific identification.


The Company had no direct sub-prime mortgage exposure in its investment portfolio as of March 31, 2012 and approximately $9.8 million of indirect exposure to sub-prime mortgages. The following table provides a breakdown of ratings on the bonds in the Company's municipal portfolio as of March 31, 2012:

 

 

Insured Bonds

Uninsured Bonds

Total Municipal Portfolio (1) Based On

Rating

Insured Ratings

Underlying

 Ratings

Ratings

Overall

Ratings (2)

Underlying

 Ratings

 

(in thousands)

AAA

  $ 4,786   $ 4,786   $ 27,357   $ 32,143   $ 32,143

AA+

    9,538     7,255     62,255     71,793     69,510

AA

    13,144     13,849     70,159     83,303     84,008

AA-

    27,870     24,466     40,636     68,506     65,102

A+

    9,096     15,107     7,701     16,797     22,808

A

    2,256     2,256     20,385     22,641     22,641

A-

    2,060     1,031     5,918     7,978     6,949

BBB

            2,971     2,971     2,971

Pre-refunded (3)

    6,172     6,172     3,635     9,807     9,807

Total

  $ 74,922   $ 74,922   $ 241,017   $ 315,939   $ 315,939
__________

(1)     Consists of $291.8 million of tax-exempt municipal bonds and $24.2 million of taxable municipal bonds.

 

(2)     Represents insured ratings on insured bonds and ratings on uninsured bonds.

 

(3)    These bonds have been pre-refunded by the issuer depositing highly rated government-issued securities into irrevocable trust funds established for payment of principal and interest.

 

 
-8-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As of March 31, 2012, the Company had no direct investments in any bond insurer, and the following bond insurer insured more than 10% of the municipal bond investments in the Company's portfolio:


         

Insurer Ratings

Average Underlying Bond Rating

Bond Insurer

Fair Value

S&P

Moody's

 

(Millions)

     

National Public Finance Guarantee Corporation

  $ 34.3

BBB

Baa2

AA-

 

The Company does not expect a material impact to its investment portfolio or financial position as a result of the problems currently facing monoline bond insurers.


The amortized cost and estimated fair value of fixed income securities available for sale at March 31, 2012, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Cost or

Estimated

 

Amortized Cost

Fair Value

Maturity

(in thousands)

Due in one year or less

  $ 21,595   $ 21,845

Due after one year through five years

    191,000     197,597

Due after five years through ten years

    272,787     286,544

Due after ten years

    27,390     28,750

Securities not due at a single maturity date

    154,614     157,336

Total fixed income securities

  $ 667,386   $ 692,072
 

The consolidated amortized cost of investment securities available for sale deposited with various regulatory authorities at March 31, 2012 was $307.4 million.

 

4.        Premiums

 

Direct premiums written totaled $65.2 million and $68.3 million for the three month periods ended March 31, 2012 and 2011, respectively.


Premiums receivable consisted of the following at March 31, 2012 and December 31, 2011:

 

 

March 31,

2012

December 31,

2011

Current:

(in thousands)

Premiums receivable

  $ 17,053   $ 19,362

Allowance for doubtful accounts

    (1,382 )     (1,030 )

Premiums receivable, net of allowance

  $ 15,671   $ 18,332
 

 

March 31,

2012

December 31,

2011

Deferred:

(in thousands)

Premiums receivable

  $ 140,796   $ 142,713

Allowance for doubtful accounts

    (227 )     (227 )

Premiums receivable, net of allowance

  $ 140,569   $ 142,486

 

5.        Reinsurance

 

Under reinsurance agreements, the Company cedes various amounts of risk to nonaffiliated insurance companies for the purpose of limiting the maximum potential loss arising from the underlying insurance risks. These reinsurance treaties do not relieve the Company from its obligations to policyholders.

 

 
-9-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

On October 1, 2011, the Company entered into reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $0.5 million of each loss occurrence. The next $0.5 million of losses per occurrence (excess of the first $0.5 million of losses per occurrence retained by the Company) are 50% reinsured. Losses in excess of $1.0 million per loss occurrence are fully reinsured through the program limit of $75.0 million per loss occurrence, subject to various deductibles, limitations and exclusions as more fully described in the treaties. The new reinsurance program is effective through September 30, 2012. The ceding rate for the new program decreased approximately 50% from the expiring rate primarily as a result of eliminating coverage for losses between $0.25 million and $0.5 million. The Company had different reinsurance programs in place in periods prior to October 1, 2011, as set forth in Note 8 to the Company's consolidated financial statements as of and for the year ended December 31, 2011 in Part II, Item 8 of the Company's Annual Report on Form 10-K filed with the SEC on March 5, 2012.

 

6.        Unpaid Loss and Loss Adjustment Expenses

 

The following table summarizes the activity in unpaid loss and loss adjustment expense for the three month periods ended March 31, 2012 and 2011:


 

Three Months Ended March 31,

 

2012

2011

 

(in thousands)

Beginning balance:

               

Unpaid loss and loss adjustment expense

  $ 518,044   $ 440,919

Reinsurance recoverables

    (93,710 )     (56,350 )

Net balance, beginning of period

    424,334     384,569

Incurred related to:

               

Current period

    43,341     42,031

Prior periods

    45     1,235

Total incurred

    43,386     43,266

Paid related to:

               

Current period

    (2,718 )     (4,077 )

Prior periods

    (42,107 )     (40,345 )

Total paid

    (44,825 )     (44,422 )

Net balance, end of period

    422,895     383,413

Reinsurance recoverables

    97,113     63,564

Unpaid loss and loss adjustment expense

  $ 520,008   $ 446,977

As a result of changes in estimates of insured events in prior periods, unpaid loss and loss adjustment expenses increased by a net amount of $45,000 in the three months ended March 31, 2012. Favorable development of prior year direct loss reserves totaled $11,000 and related to accident year 2011. This favorable development was offset by $56,000 of net adverse development of other amounts such as unallocated loss adjustment expense (“ULAE”), loss based assessments and losses assumed from National Council on Compensation Insurance (“NCCI”) residual market pools.

 

7.        Contingencies

 

a.   SBIC is subject to guaranty fund and other assessments by the states in which it writes business. Guaranty fund assessments are accrued at the time premiums are written. Other assessments are accrued either at the time of assessment or in the case of premium-based assessments, at the time the premiums are written, or in the case of loss-based assessments, at the time the losses are incurred. As of March 31, 2012, SBIC had a liability for guaranty fund and other assessments of $7.0 million and a guaranty fund receivable of $5.8 million. These amounts represent management's best estimate based on information received from the states in which it writes business and may change due to many factors, including the Company's share of the ultimate cost of current and future insolvencies. The majority of assessments are paid out in the year following the year in which the premium is written or the losses are paid. Guaranty fund receivables and other surcharge items are generally realized by a charge to new and renewing policyholders in the year following the year in which the related assessments were paid.

 

 
-10-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

b.  The Company is involved in various claims and lawsuits arising in the ordinary course of business. Management believes the outcome of these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.

 

c.  In 2003, the Company entered into a claims administration services agreement with Lumbermens Mutual Casualty Company (“LMC”) and certain of its affiliates under which the Company provides claims administration services for two predecessor companies that are in runoff. The Company and LMC are negotiating the finalization of the financial arrangements of that agreement. Although we are unable to predict the outcome of these negotiations, we do not expect it to have a negative impact on our future financial position or results of operations.

 

8.        Share-Based Payment Arrangements


At March 31, 2012, the Company had outstanding stock options and nonvested restricted stock granted according to the terms of two equity incentive plans. The stockholders and Board of Directors approved the 2003 Stock Option Plan (the “2003 Plan”) in September 2003, and amended and restated the 2003 Plan in February 2004 and April 2008, and approved the 2005 Long-Term Equity Incentive Plan (the “2005 Plan” and, together with the 2003 Plan, the “Stock Option Plans”) in December 2004, and amended and restated the 2005 Plan in April 2007, May 2010 and April 2012.


At March 31, 2012, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 479,946 shares had been granted, and 3,952,105 shares for issuance under the 2005 Plan, of which 3,132,767 shares had been granted. In January 2006, the Compensation Committee of the Board of Directors terminated the ability to grant future stock options awards under the 2003 Plan. Therefore, the Company anticipates that all future awards will be made under the 2005 Plan.

 

a.        Stock Options

 

The following table summarizes stock option activity for the three months ended March 31, 2012:


Weighted Average

 

Weighted Average

Remaining

Aggregate

  Shares Subject

Exercise Price

Contractual Life

Intrinsic Value

to Options

per Share

(years)

(in thousands)

Outstanding at December 31, 2011

    1,474,040   $ 10.94     5.1   $ 404

Granted

    2,600     8.06

Forfeited

    (1,487 )     10.61

Cancelled

    (1,800 )     13.63

Outstanding at March 31, 2012

    1,473,353     10.94     4.9     948
                                 

Exercisable at March 31, 2012

    1,179,281     11.08     4.0     937
 

The March 31, 2012 aggregate intrinsic values in the table above are based on the Company's closing stock price of $9.09 on March 30, 2012. There were no proceeds from or exercises of stock options during the quarter ended March 31, 2012.


As of March 31, 2012, there was approximately $0.8 million of total unrecognized compensation cost related to stock options granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.3 years.

 

 
-11-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

b.        Restricted Stock


The following table summarizes restricted stock activity for the three months ended March 31, 2012:


 

Weighted Average

Number of Shares

Grant Date Fair Value

Outstanding at December 31, 2011

1,160,556 $ 10.15

Granted

153,515 8.97

Vested

(241,637 ) 10.62

Forfeited

(3,750 ) 10.42

Outstanding at March 31, 2012

    1,068,684     9.88

 

During the three months ended March 31, 2012, the Company granted, for the first time, shares of performance-based restricted stock to certain executives of the Company. These performance-based shares, which totaled 145,715, were issued under the 2005 Plan and will vest in varying amounts if the Company's tangible book value per share, adjusted to exclude unrealized gains and losses and adjusted for dividends and share repurchases, as of December 31, 2012 equals or exceeds certain levels of improvement. The number of shares granted was based upon achievement of the target level of improvement, at which 100% will vest. The actual level of achievement of the performance-based goal will be determined using the Company's consolidated GAAP financial statements as of and for the year ending December 31, 2012 and may range from 50% of target at the threshold level to 200% of target at the maximum improvement level. If the threshold level of improvement is not achieved, all performance-based awards will be forfeited. Any shares that are earned through achievement of the performance-based goal will vest in three equal installments on the following dates: the date in early 2013 on which the Company publicly releases its results for fiscal year 2012; December 31, 2013; and December 31, 2014. Grantees must remain employed in good standing by the Company at the vesting dates in order to receive the vested shares.

 

As of March 31, 2012, there was approximately $5.7 million of total unrecognized compensation cost related to restricted stock granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.0 years.

 

c.        Stock-Based Compensation


Total stock-based compensation expense recognized in the unaudited condensed consolidated statements of operations and comprehensive income (loss) for the three month periods ended March 31, 2012 and 2011 is shown in the following table. No stock-based compensation cost was capitalized during the periods shown.


 

Three Months Ended March 31,

 

2012

2011

 

(in thousands)

Stock-based compensation expense related to:

               

Nonvested restricted stock

  $ 952   $ 1,368

Stock options

    156     183

Total

  $ 1,108   $ 1,551
                 

Total related tax benefit

  $ 356   $ 499

 

9.        Fair Values of Assets and Liabilities

 

Estimated fair value amounts, defined as the exit price of willing market participants, have been determined using available market information and other appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimating methodologies may have an effect on the estimated fair value amounts.

 

 
-12-

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments in the accompanying consolidated financial statements and notes:

 

 

Cash and cash equivalents, premiums receivable, accrued expenses, other liabilities and surplus notes: The carrying amounts for these financial instruments as reported in the accompanying condensed consolidated balance sheets approximate their fair values.

 

 

 

 

Investment securities:   The Company measures and reports its financial assets and liabilities, including investment securities, in accordance with the FASB Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures. The estimated fair values for available-for-sale securities are generally based on quoted market prices for securities traded in the public marketplace. The Company also considers the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity. Additional information with respect to fair values of the Company's investment securities is disclosed in Note 3.

 

Other financial instruments qualify as insurance-related products and are specifically exempted from fair value disclosure requirements.

 

The Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

 

Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 consists of U.S. Treasury securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

 

 

 

Level 2 — Valuations for assets and liabilities traded in less active dealer or broker markets. Level 2 valuations are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes government sponsored agency securities, corporate fixed-income securities, municipal bonds, mortgage pass-through securities, collateralized mortgage obligations and asset-backed securities.

 

 

 

 

Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. As of March 31, 2012, the Company had no Level 3 financial assets or liabilities.

 

The tables below present the March 31, 2012 and December 31, 2011 balances of assets and liabilities measured at fair value on a recurring basis.


March 31, 2012:

 

  Total Level 1 Level 2 Level 3
  (In thousands)
U.S. Treasury securities   $ 29,997   $ 29,997   $ -   $ -

Government sponsored agency securities

    25,633

    25,633     -

Corporate securities

    163,167

    163,167     -

Taxable municipal securities

    24,177

    24,177     -

Tax-exempt municipal securities

    291,762

    291,762     -

Mortgage pass-through securities

    90,886

    90,886     -

Collateralized mortgage obligations

    11,843

    11,843     -

Asset-backed securities

    54,607

    54,607     -

Total

  $ 692,072   $ 29,997   $ 662,075   $ -

 

 
-13- 

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

 

December 31, 2011:
 

Total

Level 1

Level 2

Level 3

(In thousands)

U.S. Treasury securities   $ 26,568   $ 26,568   $ -   $ -

Government sponsored agency securities

    16,897     -     16,897     -

Corporate securities

    176,229     -     176,229     -

Tax-exempt municipal securities

    326,855     -     326,855     -

Mortgage pass-through securities

    80,931     -     80,931     -

Collateralized mortgage obligations

    14,660     -     14,660     -

Asset-backed securities

    58,206     -     58,206     -

Total

  $ 700,346   $ 26,568   $ 673,778   $ -

 

At March 31, 2012, there were no liabilities measured at fair value on a recurring basis.

 

Active markets are those in which transactions occur with sufficient frequency and volume to provide reliable pricing information on an ongoing basis. Inactive markets are those in which there are few transactions for the asset, prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly. When the market for an investment is judged to be inactive, appropriate adjustments must be made to observable inputs to account for such inactivity. As of March 31, 2012, the Company's investment portfolio consisted of securities that it considered to be traded in active markets. Therefore, no adjustment for market inactivity or illiquidity was necessary. There were no transfers between levels during the three months ended March 31, 2012.


The Company obtains fair value inputs for securities in its investment portfolio from independent, nationally recognized pricing services. The pricing services utilize multidimensional pricing models that vary by asset class and incorporate relevant inputs such as available trade, bid and quote market data for identical or similar instruments, model-based valuation techniques for which significant assumptions were observable and other market information to arrive at a fair value price for each security. This process takes into consideration the relevance of observable inputs based on factors such as the level of trading activity and the volume and currency of available prices and includes appropriate adjustments for nonperformance and liquidity risks.


The Company also seeks input from independent portfolio managers and financial advisors engaged by the Company to assist in the management and oversight of its investment portfolio. The Company and an independent portfolio manager engaged by the Company review such amounts for reasonableness in relation to the following considerations, among others: recent trades of a particular security; the Company's independent observations of recent developments affecting the economy in general and certain issuers in particular; and fair values from other sources, such as statements from the Company's custodial banks.


The Company holds a limited amount ($20.9 million at March 31, 2012) of privately placed corporate bonds and estimates the fair value of these bonds using an internal matrix that is based in part on market information regarding interest rates, credit spreads and liquidity. The pricing matrix begins with current U.S. Treasury rates and uses credit spreads received from third-party sources to estimate fair value. The Company includes the fair value estimates of these corporate bonds in Level 2, since all significant inputs are market observable. As some of these securities are issued by public companies, the Company compares the estimates of fair value to the fair values of these companies' publicly traded debt to test the validity of the internal pricing matrix.

 

 
-14-

 

 

Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement


You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included in Item 1 of Part I of this quarterly report. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the U.S. Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 5, 2012.


The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 and in this Quarterly Report on Form 10-Q, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.


Some of the statements in this Item 2 and elsewhere in this quarterly report may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements, both with respect to us specifically and the insurance sector in general, and include statements about our expectations for future periods with respect to payroll levels, rate changes in states where we write business, our adverse development cover with Lumbermens Mutual Casualty Company (“LMC”), stockholder dividends, our capital needs and the expected effect of operational changes and cost savings initiatives. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,” “anticipate,” “will” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.


All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include but are not limited to the following:

 

 

greater frequency or severity of claims and loss activity, including as a result of catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

 

 

 

 

changes in the U.S. economy and workforce levels, including the length of the economic recovery;

 

 

 

 

our dependency on a concentrated geographic market;

 

 

 

 

changes in the availability, cost or quality of reinsurance and failure of our reinsurers to pay claims timely or at all;

 

 

 

 

changes in regulations or laws applicable to us, our subsidiaries, brokers or customers;

 

 

 

 

uncertainty about the effect of rules and regulations to be promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act on us and the economy and the financial services sector in particular;

 

 

 

 

potential downgrades in our rating or changes in rating agency policies or practices;

 

 

 

 

ineffectiveness or obsolescence of our business strategy due to changes in current or future market conditions;

 

 

 

 

unexpected issues relating to claims or coverage and changes in legal theories of liability under our insurance policies;

 

 

 

 

increased competition on the basis of pricing, capacity, coverage terms or other factors;

 

 

 

 

developments in financial and capital markets that adversely affect the performance of our investments;

 

 

 

 

loss of the services of any of our executive officers or other key personnel;

 

 
-15-

 


our inability to raise capital in the future;

our status as an insurance holding company with no direct operations;

our reliance on independent insurance brokers;

increased assessments or other surcharges by states in which we write policies;

our potential exposure to losses if LMC were to be placed into receivership;

the effects of mergers, acquisitions and divestitures that we may undertake;

failure of our customers to pay additional premium under our retrospectively rated policies;

the effects of acts of terrorism or war;

cyclical changes in the insurance industry;

changes in accounting policies or practices; and

changes in general economic conditions, including inflation and other factors.

 

The foregoing factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this quarterly report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.


If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this quarterly report reflect our views as of the date of this quarterly report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making an investment decision, you should carefully consider all of the factors identified in this quarterly report that could cause actual results to differ.


Additional information concerning these and other factors is contained in our SEC filings, including, but not limited to, our 2011 Annual Report on Form 10-K.


Overview


We are a holding company whose wholly-owned subsidiary, SeaBright Insurance Company, operates as a specialty provider of multi-jurisdictional workers' compensation insurance. Through our other wholly-owned subsidiaries, PointSure Insurance Services, Inc. and Paladin Managed Care Services, Inc., we also provide related wholesale brokerage services and integrated managed medical care services. SeaBright Insurance Company is domiciled in Illinois, commercially domiciled in California and headquartered in Seattle, Washington. SeaBright Insurance Company is licensed in 49 states, the District of Columbia and Guam, to write workers' compensation and other lines of insurance. Traditional underwriters of workers' compensation insurance provide coverage to employers under one or more state workers' compensation laws, which prescribe benefits that employers are obligated to provide to their employees who are injured arising out of or in the course of employment. We focus on employers with complex workers' compensation exposures and provide coverage under multiple state and federal acts, applicable common law or negotiated agreements. We also provide traditional state act coverage in markets we believe are underserved. Our workers' compensation policies are issued to employers who also pay the premiums.


Our operations and financial performance have been impacted by changes in the U.S. economy. The significant downturn in the U.S. economy from 2008 through 2010 led to lower reported payrolls, which has had a negative impact on our gross premiums written, and the recovery that began in 2010 has not resulted in a significant improvement in reported payrolls. The economic downturn had a particularly severe impact on the construction industry. When our customers reduce their workforce levels, the level of workers' compensation insurance coverage they require and, as a result the premiums that we charge, are reduced, and if our customers cease operations, they may cancel or choose not to renew their policies. The economic downturn and high levels of unemployment have the effect of increasing claims and claim severity and duration, which drives up our medical, indemnity and litigation costs. The economic downturn has also diminished opportunities for injured workers to return to transitional, modified duty positions during their recoveries, which has lengthened the periods of their recoveries and increased our medical, indemnity and litigation costs, particularly in California. The longer a claim remains open, the more exposed we become to the effects of medical cost inflation. All of these factors have had, and could continue to have, a significant negative impact on our claims costs.

 

 
-16-

 

 

If we fail to accurately assess our future claims costs, our loss reserves may be inadequate to cover our actual losses. As discussed under “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses” in our 2011 Annual Report on Form 10-K, there are many variables that can impact the adequacy of our loss and loss adjustment expense liabilities and we continually refine our loss reserve estimates. Quarterly, management determines what, if any, adjustments to prior accident years' loss reserves are necessary after considering the results of actuarial studies performed by internal and/or consulting actuaries; the impact of recent operational initiatives on our claims costs and loss reserves; discussions with key executives in Underwriting, Claims, and other relevant functional areas; changing environmental conditions; and other factors. In response to the factors described in the preceding paragraph, we strengthened our loss reserves for prior accident years by $31.4 million in 2011 and $45,000 in the first quarter of 2012. We may ultimately conclude that our current estimate of loss reserves is inadequate, if the negative claim trends experienced over the last several years described above continue or worsen. Future adverse development could require us to increase our loss reserves, which could have a material adverse effect on our earnings and financial position in the periods in which such increases are made.


It is uncertain if economic conditions will deteriorate further, or when economic conditions will show significant improvement. If the recovery from the recent economic recession continues to be slow, or the recovery fails to positively impact employment levels, or if we experience another recession, it could further reduce payrolls and increase our claims costs, which could have a significant negative impact on our business, financial condition or results of operations.


Results of Operations


Three Months Ended March 31, 2012 and 2011


Gross Premiums Written. Gross premiums written consists of direct premiums written and premiums assumed from the NCCI residual market pools. The number of customers we service, in-force payrolls and in-force premiums represent some of the factors we consider when analyzing gross premiums written.  

 

Gross premiums written for the three months ended March 31, 2012 totaled $66.7 million, a decrease of $2.8 million, or 4.0%, from $69.5 million of gross premiums written in the same period of 2011. Our “core” product lines contributed $44.4 million, or 66.6%, of the total gross premiums written for the three months ended March 31, 2012 compared to $44.1 million, or 63.5%, in the same period of 2011. The slight increase in our core product lines was offset by a net $3.4 million decrease in our “Program Business,” which contributed $21.6 million of gross premiums written for the quarter ended March 31, 2012. Our Program Business includes alternative markets and small maritime programs. The reductions in written premiums and customer count resulted in part from our previously announced efforts to reduce our concentration in the California construction and agriculture markets. We have also experienced a reduction in our renewal retention rates as a result of rate increases and other underwriting actions we've taken in response to upward trends in medical and indemnity claims costs. Our overall renewal retention rate for the first quarter of 2012 was 63.0%, down from 65.0% in the fourth quarter of 2011 and 70.0% in the first quarter of 2011.

 

Excluding work we perform as the servicing carrier for the Washington State USL&H Compensation Act Assigned Risk Plan (the “Washington USL&H Plan”), the total number of customers we serviced decreased from approximately 1,600 at March 31, 2011 to approximately 1,420 at March 31, 2012. The majority of the customer decrease was in our core business, which was offset by an increase of approximately 75 in our Program Business. By design, our Program Business will have a larger number of customers with a smaller average premium size than our core book of business. Our average premium size at March 31, 2012 was approximately $285,000 in our core business and approximately $97,000 in our Program Business, compared to approximately $242,000 in our core business and approximately $105,000 in our Program Business one year earlier.

 

Total in-force payrolls, a factor used in determining premiums charged, decreased 4.3% from $6.9 billion at March 31, 2011 to $6.6 billion a year later. California continues to be our largest market, accounting for approximately $109.3 million, or 43.3%, of our in-force premiums at March 31, 2012. This represents a decrease of $34.6 million, or 24.0%, from approximately $143.9 million, or 50.6% of total in-force premiums in California at March 31, 2011.

 

 
-17-

 

 

Premiums assumed from the NCCI residual market pools for the three months ended March 31, 2012 totaled $1.5 million, an increase of $0.3 million, or 25.0%, from $1.2 million during the same period in 2011. The majority of the increase was the result of increases in our actuarial NCCI reapportionment estimate. The balance of our gross premiums written (consisting of Washington USL&H Plan, general liability and other miscellaneous amounts) for the three months ended March 31, 2012 totaled $1.4 million, compared to $1.3 million in the same period in 2011.

 

Net Premiums Written. Net premiums written totaled $60.3 million for the three months ended March 31, 2012 compared to $59.6 million in the same period in 2011, representing an increase of $0.7 million, or 1.2%. The increase in net premiums written was primarily attributable to a decrease in gross written premium of $2.8 million, offset by a decrease in ceded premiums written of $3.5 million as a result of a lower ceding rate in our excess of loss reinsurance program that renewed in October 2011. Our ceding rate decreased by approximately 50% as a result of raising the attachment point from $0.25 million to $0.5 million and reducing maximum coverage from $100.0 million to $75.0 million. The coverage provided by the reinsurance program that renewed in October 2011 is more in line with historical levels.


Net Premiums Earned. Net premiums earned totaled $59.1 million for the three months ended March 31, 2012 compared to $56.7 million for the same period in 2011, representing an increase of $2.4 million, or 4.2%. We record the entire annual policy premium as unearned premium when written and earn the premium over the life of the policy, which is generally twelve months. Consequently, the amount of premiums earned in any given year depends on when during the current or prior year the underlying policies were written and the actual reported payroll of the underlying policies. Our direct premiums earned totaled $63.9 million for the three months ended March 31, 2012, a decrease of $1.1 million, or 1.7%, from $65.0 million for the same period in 2011.

 

The following is a summary of our top five markets based on direct premiums earned:

 

 

Quarter Ended March 31,

 

2012

2011

 

Direct Premiums Earned

%

Direct Premiums Earned

%

 

($ in thousands)

California

  $ 27,493     43.0 %   $ 32,735     50.4 %

Louisiana

    6,158     9.6     5,937     9.1

Texas

    3,681     5.8     3,777     5.8

Washington

    3,196     5.0     3,108     4.8

Pennsylvania

    2,745     4.3     2,201     3.4

Total

  $ 43,273     67.7 %   $ 47,758     73.5 %
 

Net premiums earned are also affected by premiums ceded under reinsurance agreements. Ceded premiums earned for the three months ended March 31, 2012 totaled $6.0 million compared to $9.5 million for the same period in 2011, representing a decrease of $3.5 million, or 36.8%. This decrease was primarily attributable to lower ceding rates under our October 2011 reinsurance program.

 

Net Investment Income. Net investment income was $5.0 million for the three months ended March 31, 2012 compared to $5.4 million for the same period in 2011, representing a decrease of $0.4 million, or 6.5%. Average invested assets for the three months ended March 31, 2012 increased $48.5 million, or 7.0%, from $690.1 million in 2011 to $738.6 million in 2012. Our yield on average invested assets decreased from approximately 3.1% for the three months ended March 31, 2011 to approximately 2.7% for the same period in 2012, driven mainly by reduced reinvestment rates.

 

Net Realized Gains. Net realized gains totaled $8.0 million for the three months ended March 31, 2012 compared to $0.3 million for the same period in 2011. The increase in net realized gains resulted from the sale of investment securities in order to reduce exposure to interest rate risk and realize a portion of our tax loss carry forwards. The majority of proceeds from these sales were reinvested in taxable securities in a continuing effort to shorten the overall portfolio duration and reduce the municipal exposure.


Other Income. Other income totaled $0.9 million for the three months ended March 31, 2012 compared to $1.1 million for the same period in 2011, representing a decrease of $0.2 million, or 12.4%. Other income is derived primarily from the operations of PointSure, our wholesale insurance broker, and PMCS, our provider of medical bill review, utilization review, nurse case management and related services.

 

 
-18-

 

 

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses totaled $43.4 million for the three months ended March 31, 2012 compared to $43.3 million for the same period in 2011, representing an increase of $0.1 million, or 0.3%. Our net loss ratio, which is calculated by dividing loss and loss adjustment expenses less claims service income by premiums earned, for the three months ended March 31, 2012 was 72.9% compared to 75.7% for the same period in 2011. The decrease in our net loss ratio for the three months ended March 31, 2012 was primarily attributable to lower adverse development of prior accident years' loss reserves in 2012.

As discussed under the heading “Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses – Actuarial Loss Reserve Estimation Methods” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011, we use an expected loss ratio (“ELR”) method to establish the loss reserves for the current accident year. Once the accident year is complete and begins to age, the ELR method is blended with the actual paid and incurred loss development to determine the revised estimated ultimate losses for the accident year.


Accident year 2012 is incomplete, as only three months of the year have been earned as of March 31, 2012. An ELR was established for each jurisdiction and type of loss (indemnity, medical, ALAE) and was multiplied by the booked accident year earned premium to produce the ultimate losses to date. The ELR selections are reviewed quarterly with each internal reserve study. Given the short experience period for the current accident year, the ELRs are usually maintained at least through the first 12 months of the accident year and revised thereafter as the underlying data matures. The net ELR used in the first quarter of 2012 was 65.0%, compared to 62.5% used for the 2011 accident year in the same quarter of last year. The 2011 net ELR was subsequently increased to 65.0% in the fourth quarter of 2011, after reviewing the year-to-date results for the 2011 accident year and considering the adverse development in recent accident years. The 2012 accident year ELR takes into consideration the following factors, among others: the development of recent accident years, the impact of recent rate increases, and provisions of the excess-of-loss reinsurance treaty that we entered into on October 1, 2011.


For prior accident years, the net ultimate loss estimates at March 31, 2012 were slightly higher when compared to December 31, 2011 and resulted in a net increase of $45,000 in our loss reserves in the first quarter of 2012, compared to a net increase of $1.2 million recorded in the same period of last year. Favorable development of prior year direct loss reserves totaled $11,000, which was offset by $56,000 of net adverse development of other amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools.


As of March 31, 2012, we had recorded a receivable of approximately $3.1 million for KEIC loss development under the adverse development cover we entered into with LMC on September 30, 2003, the date we acquired KEIC from LMC. We do not expect this receivable to have any material adverse effect on our future cash flows if LMC fails to perform its obligations under the adverse development cover. At March 31, 2012, we had access to approximately $3.1 million under the related collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse development cover. December 31, 2011 was the date as of which the parties are to settle amounts due under the adverse development cover. We are currently working through the final settlement of the receivable from LMC.

 

Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled $16.9 million for the three months ended March 31, 2012, compared to $19.0 million for the same period in 2011, representing a decrease of $2.2 million, or 11.7%. Our net underwriting expense ratio, which is calculated by dividing underwriting, acquisition and insurance expenses by premiums earned, for the three months ended March 31, 2012 was 28.6%, compared to 33.5% for the same period in 2011. The decrease in the expense ratio for the three months ended March 31, 2012 was primarily the result of an increase in premiums earned and a decrease in employee expenses and stock option forfeitures incurred as compared to the same period in 2011.

 

Interest Expense. Interest expense related to the surplus notes issued by our insurance subsidiary in May 2004 totaled $136,000 for the three months ended March 31, 2012, compared to $130,000 for the same period in 2011, representing an increase of $6,000, or 4.6%. The surplus notes interest rate, which is calculated at the beginning of each interest payment period using the 3-month LIBOR plus 400 basis points, was 4.5% at March 31, 2012 as compared to 4.3% at March 31, 2011.

 

 
-19-

 

 

Other Expenses. Other expenses totaled $1.8 million for the three months ended March 31, 2012 compared to $2.0 million for the same period in 2011, representing a decrease of $0.2 million, or 7.0%. Other expenses result primarily from the operations of PointSure and PMCS, which together accounted for approximately $1.5 million of expenses for the three months ended March 31, 2012, compared to approximately $1.7 million for the same period in 2011.

 

Income Tax Expense. The effective tax rate for the three months ended March 31, 2012 was 26.7%, compared to 78.3% for the same period in 2011. Our effective tax rate differed from the statutory tax rate of 35.0% primarily as a result of tax exempt interest income. At March 31, 2012, approximately 42% of our investment portfolio was invested in tax exempt municipal bonds.

 

Net Income. Net income was $8.1 million for the three months ended March 31, 2012, compared to a net loss of $0.1 million for the same period in 2011. The increase in net income for the three months ended March 31, 2012 was primarily the result of increases in net realized gains and premiums earned.

 

Liquidity and Capital Resources

 

Our principal sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Our primary use of funds is to pay claims and operating expenses, to purchase investments and to pay declared common stock dividends.

 

Our investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Since we have limited claims history, we have derived our expected future claim payments from industry and predecessor trends and included a provision for uncertainties. Our investment portfolio as of March 31, 2012 had an effective duration of 4.35 years with individual maturities extending out to 29 years. Currently, we make claim payments from positive cash flow from operations and invest excess cash in securities with appropriate maturity dates to balance against anticipated future claim payments. As these securities mature, we intend to invest any excess funds in investments with appropriate durations to match against expected future claim payments.

 

At March 31, 2012, our investment portfolio consisted of investment-grade fixed income securities with fair values subject to fluctuations in interest rates, as well as other factors such as credit. All of the securities in our investment portfolio are accounted for as “available for sale” securities. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.

 

Our ability to adequately provide funds to pay claims comes from our disciplined underwriting and pricing standards and the purchase of reinsurance to protect us against severe claims and catastrophic events. Effective October 1, 2011, our reinsurance program provides for retention of the first $0.5 million of each loss occurrence. The next $0.5 million of losses per occurrence (excess of the first $0.5 million of losses retained by us) are 50% reinsured. Losses in excess of $1.0 million per loss occurrence are fully reinsured through the program limit of $75.0 million per loss occurrence, subject to various deductibles, limitations and exclusions as more fully described in the treaties. The new reinsurance program is effective through September 30, 2012. Given industry and predecessor trends, we believe we are sufficiently capitalized to cover our retained losses.

 

SeaBright is a holding company with minimal unconsolidated revenue. As SeaBright pays stockholder dividends and has other capital needs in the future, we anticipate that it will be necessary for our insurance subsidiary to pay additional dividends to SeaBright. Our insurance subsidiary is required by law to maintain a certain minimum level of surplus on a statutory basis. The payment of such dividends will be regulated as described in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2011.

 

Our condensed consolidated net cash provided by operating activities for the three months ended March 31, 2012 was $19.3 million, compared to $7.6 million for the same period in 2011. The increase is mainly attributable to an increase in premium collections and a decrease in paid losses net of reinsurance.


Net cash provided by investing activities was $10.2 million in the three months ended March 31, 2012, compared to $2.6 million in the same period in 2011. The increase in net cash provided by investing activities was primarily driven by higher net investment sales activity (sales and maturities, net of purchases).


For the three months ended March 31, 2012, cash used in financing activities totaled $1.7 million, compared to $1.9 million in the same period in 2011. The decrease was primarily due to a decrease in tax withholding obligations associated with the vesting of restricted stock.


As of March 31, 2012, SBIC's statutory surplus totaled $299.8 million, compared to $302.2 million as of March 31, 2011.

 

 
-20-

 

 

Contractual Obligations and Commitments


During the three months ended March 31, 2012, there were no material changes to our contractual obligations and commitments.

 

Off-Balance Sheet Arrangements


As of March 31, 2012, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.


Critical Accounting Policies, Estimates and Judgments


It is important to understand our accounting policies in order to understand our financial statements. Management considers some of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Some of the estimates result from judgments that can be subjective and complex, and consequently, actual results reflected in future periods might differ from these estimates.

 

The most critical accounting policies involve the reporting of unpaid loss and loss adjustment expenses including losses that have occurred but were not reported to us by the financial reporting date, the amount and recoverability of reinsurance recoverable balances, deferred policy acquisition costs, income taxes, the valuation of goodwill, the impairment of investment securities, earned but unbilled premiums and retrospective premiums. These critical accounting policies are described in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2011.

 

Regulation


On July 21, 2010, the President signed into law the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which has significant implications for the insurance industry. In addition to imposing a number of new compliance obligations on publicly traded companies, the Dodd-Frank Act established the Financial Services Oversight Council (“FSOC”), which is authorized to recommend that certain systemically significant non-bank financial companies, including insurance companies, be regulated by the Board of Governors of the Federal Reserve. The Dodd-Frank Act also created within the United States Department of the Treasury a new Federal Insurance Office (“FIO”) and authorizes the federal preemption of certain state insurance laws. The FSOC and the FIO are authorized to study, monitor and report to Congress on the U.S. insurance industry and the significance of global reinsurance to the U.S. insurance market. Many sections of the Dodd-Frank Act become effective over time, and certain provisions of the Dodd-Frank Act require the implementation of regulations that have not yet been adopted. The potential impact of the Dodd-Frank Act on the U.S. insurance industry is not clear. However, our business could be affected by changes to the U.S. system of insurance regulation or our designation or the designation of insurers or reinsurers with which we do business as systemically significant non-bank financial companies.


Item 3.     Quantitative and Qualitative Disclosures About Market Risk

 

Credit Risk


Credit risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing generally in fixed-income securities which are rated “A” or higher by Standard & Poor's or another major rating agency. We also independently, and through our outside investment managers, monitor the financial condition of all of the issuers of fixed-income securities in the portfolio. To limit our exposure to risk, we employ stringent diversification rules that limit the credit exposure to any single issuer or business sector.

 

 
-21- 

 

 

Interest Rate Risk


We had fixed-income investments with a fair value of $692.1 million at March 31, 2012 and $700.3 million at December 31, 2011 that are subject to interest rate risk. We manage the exposure to interest rate risk through a disciplined asset/liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of the liability and capital position.

 

Since December 31, 2011, there have been no material changes in the quantitative or qualitative aspects of our market risk profile. For additional information regarding our exposure to certain market risks, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 5, 2012.


Item 4.     Controls and Procedures


Disclosure Controls and Procedures


Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we carried out an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the SEC and is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting


There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our first fiscal quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


PART II – OTHER INFORMATION


Item 1A. Risk Factors


During the quarter ended March 31, 2012, there were no material changes to the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 5, 2012.


Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds


The following table sets forth information in connection with purchases made by, or on behalf of, us or any affiliated purchaser, of shares of our common stock during the three months ended March 31, 2012:


 

(a)
Total Number of Shares

(or Units) Purchased

(b)
Average Price Paid per Share (or Unit)

(c)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs

(d)
Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs

Month #1 (January 1, 2012 through January 31, 2012)

               

Month #2 (February 1, 2012 through February 29, 2012)

               

Month # 3 (March 1, 2012 through March 31, 2012)

    67,804   $ 9.04        

 

 
-22-

 


We did not repurchase any of our common stock on the open market as part of a stock repurchase program during the three months ended March 31, 2012. The above shares of common stock were surrendered by our employees to satisfy their tax withholding obligations in connection with the vesting of restricted stock awards issued under our 2005 Plan.

 

Item 6.     Exhibits


The list of exhibits in the Exhibit Index to this quarterly report is incorporated herein by reference.


 
-23-

 

 

SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

SEABRIGHT HOLDINGS, INC.

 

Date: May 7, 2012

       
By: /s/ John G. Pasqualetto  
   

John G. Pasqualetto

 
   

Chairman, President and Chief Executive Officer

 
       

By:

/s/ Neal A. Fuller

Neal A. Fuller

Senior Vice President – Chief Financial Officer and Assistant Secretary

(Principal Financial Officer)

 

 
-24-

 

 

EXHIBIT INDEX

 

The list of exhibits in the Exhibit Index to this quarterly report on Form 10-Q is incorporated herein by reference. Exhibits 31.1 and 31.2 are being filed as part of this quarterly report on Form 10-Q. Exhibits 32.1 and 32.2 are being furnished with this quarterly report on Form 10-Q.

 

 

Exhibit Number

 

 

Description

10.1*

 

Amended and Restated 2005 Long-Term Equity Incentive Plan

 

 

 

31.1*

 

Rule 13a-14(a) Certification (Chief Executive Officer)

 

 

 

31.2*

 

Rule 13a-14(a) Certification (Chief Financial Officer)

 

 

 

32.1*

Section 1350 Certification (Chief Executive Officer)

32.2*

Section 1350 Certification (Chief Financial Officer)

101

Interactive Data Files

____________

 

*     Filed herewith.

 

 


 

 

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