XNAS:AFSI AmTrust Financial Services Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended June 30, 2012

 

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

 

For the transition period from ___________________ to ___________________

 

Commission file no. 001-33143

 

AmTrust Financial Services, Inc.

(Exact name of registrant as specified in its charter)

 

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

 

(212) 220-7120

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes       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:

 

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

 

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

 

As of August 2, 2012, the Registrant had one class of Common Stock ($.01 par value), of which 60,737,944 shares were issued and outstanding. 

 

 
 

 

INDEX

 

    Page
PART I FINANCIAL INFORMATION 3
     
Item 1. Unaudited Financial Statements: 3
     
  Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 (audited) 3
     
  Condensed Consolidated Statements of Income — Three and six months ended June 30, 2012 and 2011 4
     
  Condensed Consolidated Statements of Comprehensive Income – Three and six months ended June 30, 2012 and 2011 5
     
  Condensed Consolidated Statements of Cash Flows — Six months ended June 30, 2012 and 2011 6
     
  Notes to Condensed Consolidated Financial Statements 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 52
     
Item 4. Controls and Procedures 54
     
PART II OTHER INFORMATION 54
     
Item 1. Legal Proceedings 54
     
Item 1A. Risk Factors 54
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54
     
Item 3. Defaults Upon Senior Securities 55
     
Item 4. Mine Safety Disclosures 55
     
Item 5. Other Information 55
     
Item 6. Exhibits 56
     
  Signatures 57

 

2
 

 

PART 1 - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

AMTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In Thousands, Except Par Value)

   June 30,
2012
   December 31,
2011
 
   (Unaudited)   (Audited) 
ASSETS          
Investments:          
Fixed maturities, available-for-sale, at market value (amortized cost $1,773,571; $1,382,863)  $1,825,759   $1,394,243 
Equity securities, available-for-sale, at market value (cost $25,995; $34,041)   25,830    35,600 
Short-term investments   33,134    128,565 
Equity investment in unconsolidated subsidiaries – related parties   89,849    83,691 
Other investments   15,103    14,588 
Total investments   1,989,675    1,656,687 
Cash and cash equivalents   357,760    406,847 
Restricted cash and cash equivalents   45,333    23,104 
Accrued interest and dividends   17,243    12,644 
Premiums receivable, net   972,069    932,992 
Reinsurance recoverable (related party $645,510; $597,525)   1,135,435    1,098,569 
Prepaid reinsurance premium (related party $479,879; $429,124)   654,880    584,871 
Prepaid expenses and other assets (recorded at fair value $151,092; $131,387)   306,000    292,849 
Federal income tax receivable   18,329    13,024 
Deferred policy acquisition costs   335,698    280,991 
Property and equipment, net   70,308    61,553 
Goodwill   178,647    147,654 
Intangible assets   187,562    166,962 
   $6,268,939   $5,678,747 
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Liabilities:          
Loss and loss expense reserves  $2,066,455   $1,879,175 
Unearned premiums   1,537,174    1,366,170 
Ceded reinsurance premiums payable (related party $253,550; $222,408)   324,465    337,508 
Reinsurance payable on paid losses   9,075    14,731 
Funds held under reinsurance treaties   39,187    49,249 
Note payable on collateral loan – related party   167,975    167,975 
Securities sold but not yet purchased, at market   56,978    55,942 
Securities sold under agreements to repurchase, at contract value   231,919    191,718 
Accrued expenses and other current liabilities (recorded at fair value $11,465; $12,022)   333,518    267,643 
Deferred income taxes   131,612    108,775 
Debt   298,047    279,600 
Total liabilities   5,196,405    4,718,486 
Commitments and contingencies          
Redeemable non-controlling interest   600    600 
Stockholders’ equity:          
Common stock, $.01 par value; 100,000 shares authorized, 85,262 and 84,906 issued in 2012 and 2011, respectively; 60,711 and 60,106 outstanding in 2012 and 2011, respectively   851    849 
Preferred stock, $.01 par value; 10,000 shares authorized        
Additional paid-in capital   595,096    582,321 
Treasury stock at cost; 24,551 and 24,800 shares in 2012 and 2011, respectively   (297,102)   (300,365)
Accumulated other comprehensive income (loss)   14,955    (9,999)
Retained earnings   685,689    617,757 
Total AmTrust Financial Services, Inc. equity   999,489    890,563 
Non-controlling interest   72,445    69,098 
Total stockholders’ equity   1,071,934    959,661 
   $6,268,939   $5,678,747 

 

See accompanying notes to unaudited condensed consolidated statements.

 

3
 

 

AmTrust Financial Services, Inc.

Condensed Consolidated Statements of Income

(Unaudited)

(In Thousands, Except Per Share Data)  

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
Revenues:                    
Premium income:                    
Net written premium  $391,589   $375,681   $751,366   $609,700 
Change in unearned premium   (57,595)   (127,399)   (103,348)   (161,080)
Net earned premium   333,994    248,282    648,018    448,620 
Ceding commission – primarily related party   44,550    35,414    90,824    71,098 
Service and fee income (related parties – three months $6,932; $4,459 and six months $13,024; $7,898)   33,011    24,542    73,549    49,731 
Net investment income   16,344    13,167    30,862    27,359 
Net realized gain (loss) on investments   2,703    616    1,555    1,031 
Total revenues   430,602    322,021    844,808    597,839 
Expenses:                    
Loss and loss adjustment expense   211,787    170,008    411,716    298,704 
Acquisition costs and other underwriting expenses   129,713    89,580    253,738    170,814 
Other   32,320    18,564    67,959    38,760 
Total expenses   373,820    278,152    733,413    508,278 
Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiary   56,782    43,869    111,395    89,561 
Other income (expense):                    
Interest expense   (6,994)   (4,334)   (14,085)   (8,088)
Foreign currency gain (loss)   (2,455)   2,520    (2,034)   2,236 
Gain on investment in life settlement contracts net of profit commission   1,961    22,638    2,051    41,524 
Total other income (expense)   (7,488)   20,824    (14,068)   35,672 
Income before income taxes and equity in earnings of unconsolidated subsidiary   49,294    64,693    97,327    125,233 
Provision for income taxes   11,742    7,289    22,919    16,326 
Income before equity in earnings of unconsolidated subsidiary   37,552    57,404    74,408    108,907 
Equity in earnings of unconsolidated subsidiary – related party   3,088    2,514    5,452    4,333 
Net income   40,640    59,918    79,860    113,240 
Net income attributable to non-controlling interest of subsidiaries   (282)   (9,756)   (416)   (17,895)
Net income attributable to AmTrust Financial Services, Inc.   40,358    50,162    79,444    95,345 
                     
Earnings per common share:                    
Basic earnings per share  $0.67   $0.84   $1.32   $1.60 
Diluted earnings per share  $0.64   $0.81   $1.27   $1.55 
Dividends declared per common share  $0.10   $0.08   $0.19   $0.16 
                     
Net realized gain (loss) on investments:                    
Total other-than-temporary impairment loss  $(1,208)  $(345)  $(1,208)  $(345)
Portion of loss recognized in other comprehensive income                
Net impairment losses recognized in earnings   (1,208)   (345)   (1,208)   (345)
Other net realized gain (loss) on investments   3,911    961    2,763    1,376 
Net realized investment gain (loss)  $2,703   $616   $1,555   $1,031 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4
 

 

AmTrust Financial Services, Inc.

Condensed Consolidated Statement of Comprehensive Income

(Unaudited)

(In Thousands)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2012   2011   2012   2011 
                     
Net income  $40,640   $59,918   $79,860   $113,240 
Other comprehensive income, net of tax:                    
Foreign currency translation adjustments   (7,057)   679    (2,860)   4,519 
Change in fair value of interest rate swap   (570)       (627)    
Unrealized gains on securities:                    
Unrealized holding gains arising during period   2,358    7,128    33,117    10,400 
Reclassification adjustment for gains included in net income   (2,232)   498    (4,676)   1,751 
Other comprehensive income, net of tax  $(7,501)  $8,305   $24,954   $16,670 
Comprehensive income   33,139    68,223    104,814    129,910 
Less: Comprehensive income attributable to non-controlling interest   282    9,756    416    17,895 
Comprehensive income attributable to AmTrust Financial Services, Inc.  $32,857   $58,467   $104,398   $112,015 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5
 

 

AmTrust Financial Services, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(In Thousands)

 

   Six Months Ended June 30, 
   2012   2011 
Cash flows from operating activities:          
Net income  $79,860   $113,240 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   17,419    31,764 
Equity earnings and gain on investment in unconsolidated subsidiaries   (5,452)   (4,333)
Gain on investment in life settlement contracts   (2,051)   (41,524)
Realized (gain) loss on marketable securities   (2,763)   (1,376)
Non-cash write-down of marketable securities   1,208    345 
Discount on notes payable   1,515    298 
Stock based compensation   1,732    2,827 
Bad debt expense   2,479    4,167 
Foreign currency (gain) loss   2,034    (2,236)
Changes in assets - (increase) decrease:          
Premiums and note receivables   (41,556)   (130,990)
Reinsurance recoverable   (36,866)   (82,829)
Deferred policy acquisition costs, net   (54,707)   (33,886)
Prepaid reinsurance premiums   (70,009)   (23,039)
Prepaid expenses and other assets   (8,147)   (44,014)
Changes in liabilities - increase (decrease):          
Reinsurance premium payable   (13,043)   44,580 
Loss and loss expense reserve   187,280    57,179 
Unearned premiums   171,004    165,925 
Funds held under reinsurance treaties   (10,062)   52,107 
Accrued expenses and other current liabilities   5,136    87,070 
Deferred tax liability   (510)   (28,486)
Net cash provided by operating activities   224,501    166,789 
Cash flows from investing activities:          
Net purchases of securities with fixed maturities   (296,352)   (72,409)
Net sales (purchases) of equity securities   12,199    (176)
Net purchases of other investments   (332)   (451)
Acquisition of and capitalized premiums for life settlement contracts   (23,719)   (26,504)
Receipt of life settlement contract proceeds   10,074     
Acquisition of intangible assets and subsidiaries, net of cash obtained   (3,822)   30,874 
Increase in restricted cash and cash equivalents   (22,229)   (19,345)
Purchase of property and equipment   (14,701)   (18,315)
Net cash used in investing activities   (338,882)   (106,326)
Cash flows from financing activities:          
Repurchase agreements, net   40,201    (135,750)
Revolving credit facility borrowing       98,200 
Convertible senior notes proceeds   25,000     
Secured loan agreement borrowings       10,800 
Secured loan agreements payments   (482)   (387)
Promissory notes, net   (2,500)   (7,500)
Term loan payment       (6,667)
Debt financing fees   (750)   (1,394)
Capital contribution to subsidiaries   9,831    12,515 
Stock option exercise and other   4,102    3,563 
Dividends distributed on common stock   (10,824)   (9,551)
Net cash used in financing activities   64,578    (36,171)
Effect of exchange rate changes on cash   716    2,754 
Net increase in cash and cash equivalents   (49,087)   27,046 
Cash and cash equivalents, beginning of the period   406,847    192,925 
Cash and cash equivalents, end of the period  $357,760   $219,971 
Supplemental Cash Flow Information          
Income tax payments  $7,769   $6,280 
Interest payments on debt   10,706    6,566 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6
 

 

Notes to Unaudited Condensed Consolidated Financial Statements

(Unaudited)

(Dollars In Thousands, Except Per Share Data)

 

  1.Basis of Reporting

  

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These interim statements should be read in conjunction with the financial statements and notes thereto included in the AmTrust Financial Services, Inc. (“AmTrust” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2011, previously filed with the Securities and Exchange Commission (“SEC”) on March 15, 2012. The balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

 

These interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year.   The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements for the year ended December 31, 2011, included in the Company’s Form 10-K filed with the SEC.

 

All significant inter-company transactions and accounts have been eliminated in the consolidated financial statements.

 

To facilitate period-to-period comparisons, certain reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation. The Company and American Capital Acquisition Corporation (“ACAC”) currently each have a 50% ownership interest in Tiger Capital LLC (“Tiger”) and AMT Capital Alpha, LLC (“AMT Alpha”). The Company also has a 21.25% ownership share of ACAC. As a result, the Company ultimately receives 60.625% of the income and losses related to Tiger and AMT Alpha and therefore consolidates Tiger and AMT Alpha. Prior to January 1, 2012, the Company reported Tiger’s and AMT Alpha’s income and losses attributable to its 10.625% indirect ownership as a component of Equity in Earnings of Unconsolidated Subsidiaries. This amount was offset by reporting an equal amount as a component of Non-controlling interest. Effective January 1, 2012, the Company presents the impact of the 10.625% indirect ownership of Tiger and AMT Alpha on a net basis and excludes this amount from both Equity in Earnings of Unconsolidated Subsidiaries and Non-controlling Interest. All prior periods presented have been reclassed to conform to the current presentation. There was no impact on prior period Net Income Attributable to AmTrust Financial Services, Inc. The Company’s equity investment in ACAC and non-controlling interest were reduced by $3,807 as of December 31, 2011. Additionally, the non-controlling interest related to income on life settlement contracts is now presented on a pre-tax basis and the provision for income taxes has been reduced by an equivalent amount.

 

  2.Recent Accounting Pronouncements

 

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2012, as compared to those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, that are of significance, or potential significance, to the Company.

 

In December 2011, the Financial Accounting Standards Board (“FASB”) issued a new standard which indefinitely defers certain provisions of a previously issued standard, Accounting Standards Update (“ASU”) No. 2011-05 Comprehensive Income (Topic 220) that revised the manner in which companies present comprehensive income in financial statements. One of the ASU provisions required companies to present, by component, reclassification adjustments out of accumulated other comprehensive income in both the statement in which net income is presented and the statement in which other comprehensive income is presented. This requirement has been indefinitely deferred and will be further deliberated by the FASB at a future date. The new standard is effective for fiscal years and interim periods within those years that begin after December 15, 2011. The Company adopted this standard on January 1, 2012. The adoption of the new standard did not have a material impact on the Company’s results of operations, financial position or liquidity.

 

7
 

 

In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220). This update required that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-step approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. The updated guidance was effective for fiscal years and interim periods beginning on or after December 15, 2011 and was to be applied on a retrospective basis to the beginning of the annual period of adoption. The new standard does not change the items that must be reported in other comprehensive income and was effective for fiscal years and interim periods within those years that begin after December 15, 2011. The Company adopted this standard on January 1, 2012. The adoption of the new standard did not have a material impact on the Company’s results of operations, financial position or liquidity.

 

In September 2011, the FASB issued ASU No. 2011-08 Intangibles-Goodwill and Other (Topic 350). The updated guidance is intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment, using factors such as changes in management, key personnel, business strategy, technology or customers, to determine whether it should calculate the fair value of a reporting unit. Previous accounting literature required an entity to test goodwill for impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit was less than its carrying amount, then the second step of the test had to be performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the reporting unit’s goodwill was determined in the same manner as goodwill is measured in a business combination (by measuring the fair value of the reporting unit’s assets, liabilities and unrecognized intangible assets and determining the remaining amount ascribed to goodwill) and comparing the amount of the implied goodwill to the carrying amount of the goodwill. Under the updated guidance, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that is more likely than not that its fair value is less than its carrying amount. This update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 31, 2011. The Company adopted this standard January 1, 2012 and it did not have any material impact on its results of operations, financial position or liquidity.

 

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820). The ASU generally aligns the principles for fair value measurements and the related disclosure requirements under GAAP and International Financial Reporting Standards (“IFRS”). ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 fair value measurements. The amendment is effective on a prospective basis for interim and annual reporting periods beginning after December 15, 2011. The Company adopted this standard on January 1, 2012 and adoption of the standard did not have a material impact on the Company’s consolidated financial statements.

 

In April 2011, the FASB amended its guidance on accounting for repurchase agreements. The amendments eliminate as a criteria for demonstrating effective control over the transferred asset whether a transferor has the ability to repurchase or redeem the financial assets. Under the amended guidance, a transferor maintains effective control over transferred financial assets (and thus accounts for the transfer as a secured borrowing) if there is an agreement that both entitles and obligates the transferor to repurchase the financial assets before maturity and if all of the following conditions previously required are met: (i) financial assets to be repurchased or redeemed are the same or substantially the same as those transferred; (ii) repurchase or redemption date before maturity at a fixed or determinable price; and (iii) the agreement is entered into contemporaneously with, or in contemplation of, the transfer. As a result, more arrangements could be accounted for as secured borrowings rather than sales. The updated guidance is effective on a prospective basis for interim and annual reporting periods beginning on or after December 15, 2011. The Company adopted this standard January 1, 2012 and it did not have a material impact on the Company’s results of operations, financial position or liquidity.

 

In October 2010, the FASB issued ASU No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). ASU 2010-26 modifies the types of costs that may be deferred, allowing insurance companies to only defer costs directly related to a successful contract acquisition or renewal. These costs include incremental direct costs of successful contracts, the portion of employees’ salaries and benefits related to time spent on acquisition activities for successful contracts and other costs incurred in the acquisition of a contract. Additional disclosure of the type of acquisition costs capitalized is also required.

 

The Company adopted ASU 2010-26 prospectively. During 2012, the Company estimates that pre-tax expenses will increase by approximately $8,000 to $10,000 as a lower amount of acquisition costs will be capitalized and existing costs that no longer meet the criteria for deferral under ASU 2010-26 will be recognized in expense over the original amortization periods. For the three and six months ended June 30, 2012, the Company recognized approximately $300 and $3,600, respectively, of expense related to such previously deferrable costs. If the Company had adopted ASU 2010-26 retrospectively, approximately $1,700 and $6,300, respectively, of acquisition costs that were deferred would have been recognized in expense for the three and six month period ended June 30, 2011.

 

8
 

 

  3.Investments

 

(a) Available-for-Sale Securities

 

The amortized cost, estimated market value and gross unrealized appreciation and depreciation of available-for-sale securities as of June 30, 2012, are presented in the table below:

 

(Amounts in Thousands)  Original or
amortized
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
  

 

Market

value

 
Preferred stock  $5,091   $57   $(289)  $4,859 
Common stock   20,904    2,238    (2,171)   20,971 
U.S. treasury securities   44,087    2,781    (5)   46,863 
U.S. government agencies   53,619    762        54,381 
Municipal bonds   261,865    11,274    (87)   273,052 
Corporate bonds:                    
Finance   744,393    26,438    (16,202)   754,629 
Industrial   266,459    9,407    (3,105)   272,761 
Utilities   38,227    2,003    (929)   39,301 
Commercial mortgage backed securities   10,015    103        10,118 
Residential mortgage backed securities:                    
Agency backed   346,956    20,794    (320)   367,430 
Non-agency backed   7,950    2    (728)   7,224 
   $1,799,566   $75,859   $(23,836)  $1,851,589 

 

Proceeds from the sale of investments in available-for-sale securities during the six months ended June 30, 2012 and 2011 were approximately $380,614 and $738,742, respectively.

 

A summary of the Company’s available-for-sale fixed securities as of June 30, 2012, by contractual maturity, is shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Amounts in Thousands)  Amortized
Cost
  

 

Fair Value

 
Due in one year or less  $14,363   $14,907 
Due after one through five years   373,115    364,853 
Due after five through ten years   763,908    794,965 
Due after ten years   257,264    266,262 
Mortgage backed securities   364,921    384,772 
Total fixed maturities  $1,773,571   $1,825,759 

 

(b) Investment Income

 

Net investment income for the three and six months ended June 30, 2012 and 2011 was derived from the following sources:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Fixed maturity securities  $16,059   $12,302   $29,723   $25,976 
Equity maturities   100    120    498    286 
Cash and short term investments   385    966    976    1,572 
    16,544    13,388    31,197    27,834 
Less:                    
Investment expenses and interest expense on securities sold under agreement to repurchase   200    221    335    475 
   $16,344   $13,167   $30,862   $27,359 

 

9
 

 

(c) Other-Than-Temporary Impairment

 

The table below summarizes the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized position as of June 30, 2012:

 

   Less Than 12 Months   12 Months or More   Total 
(Amounts in Thousands)  Fair
Market
Value
  

 

Unrealized
Losses

   No. of
Positions
Held
   Fair
Market
Value
  

 

Unrealized
Losses

   No. of
Positions
Held
   Fair
Market
Value
  

 

Unrealized
Losses

 
Common and preferred stock  $10,377   $(2,428)   26   $306   $(32)   1   $10,683   $(2,460)
U.S. treasury securities   3,160    (5)   5                3,160    (5)
U.S. government agencies                                
Municipal bonds   56,538    (87)   14                56,538    (87)
Corporate bonds:                                        
Finance   201,962    (6,063)   48    86,509    (10,139)   16    288,471    (16,202)
Industrial   112,721    (2,551)   32    2,813    (554)   2    115,534    (3,105)
Utilities   5,372    (443)   2    5,677    (486)   1    11,049    (929)
Commercial Mortgage backed securities                                
Residential mortgage backed securities:                                        
Agency backed   17,571    (320)   1                17,571    (320)
Non-agency backed   7,138    (728)   2                7,138    (728)
Total temporarily impaired securities  $414,839   $(12,625)   130   $95,305   $(11,211)   20   $510,144   $(23,836)

  

There are 150 securities at June 30, 2012 that account for the gross unrealized loss, none of which is deemed by the Company to be OTTI. Significant factors influencing the Company’s determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that the Company will be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis.

 

(d) Derivatives

 

The Company from time to time invests in a limited amount of derivatives and other financial instruments as part of its investment portfolio to manage interest rate changes or other exposures to a particular financial market. The Company records changes in valuation on its derivative positions not designated as a hedge as a component of net realized gains and losses.

 

The Company records changes in valuation on its hedge positions as a component of other comprehensive income. As of June 30, 2012, the Company had two interest rate swaps designated as a hedge and were recorded as a liability amount of $4,472 and were included as a component of accrued expenses and other liabilities.

 

The following table presents the notional amounts by remaining maturity of the Company’s interest rate swaps as of June 30, 2012: 

 

  Remaining Life of Notional Amount (1) 

 

(Amounts in Thousands)

  One
Year
   Two
Through
Five Years
   Six Through
Ten Years
   After Ten
years
  

 

Total

 
Interest rate swaps  $   $70,000   $   $   $70,000 

 

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

 

10
 

 

(e) Restricted Cash and Investments

 

The Company, in order to conduct business in certain states, is required to maintain letters of credit or assets on deposit to support state mandated regulatory requirements and certain third party agreements. The Company also utilizes trust accounts to collateralize business with its reinsurance counterparties. These assets are primarily in the form of cash and certain high grade securities. The fair values of our restricted assets as of June 30, 2012 and December 31, 2011 are as follows:

 

(Amounts in Thousands)  2012   2011 
Restricted cash  $45,333   $23,104 
Restricted investments   280,866    187,227 
Total restricted cash and investments  $326,199   $210,331 

 

(f) Other

 

Securities sold but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price and, thereby, create a liability to purchase the security in the market at prevailing prices. The Company’s liability for securities to be delivered is measured at their fair value and as of June 30, 2012 was $56,920 for corporate bonds and $58 for equity securities. These transactions result in off-balance sheet risk, as the Company’s ultimate cost to satisfy the delivery of securities sold but not yet purchased may exceed the amount reflected at June 30, 2012. Subject to certain limitations, all securities owned, to the extent required to cover the Company’s obligations to sell or repledge the securities to others, are pledged to the clearing broker.

 

The Company enters into repurchase agreements, which are accounted for as collateralized borrowing transactions and are recorded at contract amounts. The Company receives cash or securities that it invests or holds in short term or fixed income securities. As of June 30, 2012, there were $231,919 principal amount outstanding at interest rates between .38% and .47%. Interest expense associated with these repurchase agreements for the three months ended June 30, 2012 and 2011 was $200 and $221, respectively, and interest expense associated with these repurchase agreements for the six months ended June 30, 2012 and 2011 was $335 and $475, respectively, of which $0 was accrued as of June 30, 2012. The Company has approximately $253,600 of collateral pledged in support of these agreements. Additionally, during the three and six months ended June 30, 2012, the Company entered into a reverse repurchase agreement in the amount of $57,000 that is included in cash and cash equivalents as of June 30, 2012. The Company retains collateral of $57,000 related to this agreement.

 

11
 

 

  4.Fair Value of Financial Instruments

 

The following table presents the level within the fair value hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of June 30, 2012:

 

(Amounts in Thousands)  Total   Level 1   Level 2   Level 3 
Assets:                    
U.S. treasury securities  $46,863   $46,863   $   $ 
U.S. government agencies   54,381        54,381     
Municipal bonds   273,052        273,052     
Corporate bonds and other bonds:                    
Finance   754,629        754,629     
Industrial   272,761        272,761     
Utilities   39,301        39,301     
Commercial mortgage backed securities   10,118        10,118     
Residential mortgage backed securities:                    
Agency backed   367,430        367,430     
Non-agency backed   7,224        7,224     
Equity securities   25,830    25,830         
Short term investments   33,134    33,134         
Other investments   15,103            15,103 
Life settlement contracts   151,092            151,092 
   $2,050,918   $105,827   $1,778,896   $166,195 
Liabilities:                    
Equity securities sold but not yet purchased, market  $58   $58   $   $ 
Fixed maturity securities sold but not yet purchased, market   56,920        56,920     
Securities sold under agreements to repurchase, at contract value   231,919        231,919     
Life settlement contract profit commission   11,465            11,465 
Derivatives   4,472            4,472 
   $304,834   $58   $288,839   $15,937 

 

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

 

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

 

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

 

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

 

For additional discussion regarding techniques used to value the Company’s investment portfolio, refer to Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data” in its 2011 Form 10-K.

 

12
 

 

The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities for the three and six months ended June 30, 2012 and 2011:

 

 

 

 

(Amounts in Thousands)

 

 

Balance as of
March 31,
2012

  

 

 

 

Net income

  

 

Other
comprehensive
income

  

 

Purchases
and
issuances

  

 

 

Sales and
settlements

   Net
transfers
into (out of)
Level 3
  

 

Balance as
of June 30,
2012

 
Other investments  $14,865   $(403)  $   $677   $(36)  $   $15,103 
Life settlement contracts   142,575    7,456        11,135    (10,074)       151,092 
Life settlement contract profit commission   (12,050)   585                    (11,465)
Derivatives   (3,595)       (877)               (4,472)
Total  $141,795   $7,638   $(877)  $11,812   $(10,110)  $   $150,258 

  

(Amounts in Thousands)

   

Balance as of
December 31,
2011

  

Net income

  

Other
comprehensive
income

  

Purchases
and
issuances

  

Sales and
settlements

   Net
transfers
into (out of)
Level 3
   Balance as
of
June 30,
2012
 
Other investments  $14,588   $(4,352)  $4,535   $747   $(415)  $   $15,103 
Life settlement contracts   131,387    15,416        14,363    (10,074)       151,092 
Life settlement contract profit commission   (12,022)   557                    (11,465)
Derivatives   (3,508)       (964)               (4,472)
Total  $130,445   $11,621   $3,571   $15,110   $(10,489)  $   $150,258 

 

 

 

 

(Amounts in Thousands)

 

 

Balance as of
March 31,
2011

  

 

 

 

Net income

  

 

Other
comprehensive
income

  

 

Purchases
and
issuances

  

 

 

Sales and
settlements

   Net
transfers
into (out of)
Level 3
   Balance as
of
June 30,
2011
 
Other investments  $22,512   $   $(875)  $786   $(415)  $   $22,008 
Life settlement contracts   63,686    33,842        11,182            108,710 
Life settlement contract profit commission   (5,589)   (3,678)                   (9,267)
Total  $80,609   $30,164   $(875)  $11,968   $(415)  $   $121,451 

 

 

 

 

(Amounts in Thousands)

 

 

Balance as of
December 31,
2010

  

 

 

 

Net income

  

 

Other
comprehensive
income

  

 

Purchases
and
issuances

  

 

 

Sales and
settlements

   Net
transfers
into (out of)
Level 3
   Balance as
of
June 30,
2011
 
Other investments  $21,514   $661   $(377)  $866   $(656)  $   $22,008 
Life settlement contracts   22,155    57,962        28,593            108,710 
Life settlement contract profit commission   (4,711)   (4,556)                   (9,267)
Total  $38,958   $54,067   $(377)  $29,459   $(656)  $   $121,451 

 

The Company had no transfers between levels during the three and six months ended June 30, 2012 and 2011.

 

The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:

 

  Equity and Fixed Income Investments:   Fair value disclosures for these investments are disclosed above in this note. The carrying values of cash, short term investments and investment income accrued approximate their fair values.
  Premiums Receivable:   The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values due to the short term nature of the asset.
  Subordinated Debentures and Debt:   The carrying values reported in the accompanying balance sheets for these financial instruments approximate fair value. Fair value was estimated using projected cash flows, discounted at rates currently being offered for similar notes.
  Other investments. The Company has less than one percent of its investment portfolio in limited partnerships or hedge funds where the fair value estimate is determined by a fund manager based on recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals. Due to the significant unobservable inputs in these valuations, the Company includes the estimate in the amount disclosed in Level 3 hierarchy. The Company has determined that its investments in these securities are not material to its financial position or results of operations.
  Derivatives. The Company estimates fair value using information provided by the portfolio manager for interest rate swaps and credit default swaps and the counterparty for contracts for differences and classifies each as Level 3 hierarchy.

 

13
 

 

The fair value of life settlement contracts as well as life settlement profit commission is based on information available to the Company at the end of the reporting period. The Company considers the following factors in its fair value estimates: cost at date of purchase, recent purchases and sales of similar investments, financial standing of the issuer, and changes in economic conditions affecting the issuer, maintenance cost, premiums, benefits, standard actuarially developed mortality tables and industry life expectancy reports. The fair value of a life insurance policy is estimated using present value calculations based on the data specific to each individual life insurance policy. The following summarizes data utilized in estimating the fair value of the portfolio of life insurance policies for the six months ended June 30, 2012 and December 31, 2011 and, as described in Note 5, only includes data for policies to which the Company assigned value at those dates:

 

   June 30,
2012
   December 31,
2011
 
Average age of insured   78    77 
Average life expectancy, months (1)   148    155 
Average face amount per policy (Amounts in Thousands)  $6,703   $6,703 
Fair value discount rate   7.5%   7.5%
Internal rate of return (2)   15.6%   14.1%

  

  (1) Mortality rates: standard life expectancy as adjusted for insured’s specific circumstances.

  (2)

Internal rate of return includes a risk premium which represents risk adjustments applied to the estimated present value of cash flows based on the following factors: (i) the volatility in life expectancy of insureds and the associated level of future premium payments and (ii) the projected risk of non-payment, including the financial health of the insurance carrier, the possibility of legal challenges from the insurance carrier or others and the possibility of regulatory changes that may affect payment.

  

These assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. The fair value measurements used in estimating the present value calculation are derived from valuation techniques generally used in the industry that include inputs for the asset that are not based on observable market data. The extent to which the fair value could reasonable vary in the near term has been quantified by evaluating the effect of changes in significant underlying assumptions used to estimate the fair value amount. If the life expectancies were increased or decreased by 4 months and the discount factors were increased or decreased by 1% while all other variables are held constant, the carrying value of the investment in life insurance policies would increase or (decrease) by the unaudited amounts summarized below for the six months ended June 30, 2012 and December 31, 2011:

 

   Change in life expectancy 
(Amounts in Thousands)  Plus 4
Months
   Minus 4
Months
 
Investment in life policies:          
June 30, 2012  $(23,579)  $26,574 
December 31, 2011  $(18,778)  $20,785 

 

 

   Change in discount rate 
(Amounts in Thousands)  Plus 1%   Minus 1% 
Investment in life policies:          
June 30, 2012  $(16,653)  $19,040 
December 31, 2011  $(13,802)  $15,804 

  

5.Investment in Life Settlements

 

A life settlement contract is a contract between the policy owner of a life insurance policy and a third-party investor who obtains the ownership and beneficiary rights of the underlying life insurance policy. During 2010, the Company formed Tiger Capital LLC (“Tiger”) with a subsidiary of ACAC for the purposes of acquiring certain life settlement contracts. In 2011, the Company formed AMT Capital Alpha, LLC (“AMT Alpha”) with a subsidiary of ACAC and AMT Capital Holdings, S.A. (“AMTCH”) with ACP Re, Ltd., an entity controlled by the Michael Karfunkel Grantor Retained Annuity Trust, for the purposes of acquiring additional life settlement contracts. The Company has a fifty percent ownership interest in each of Tiger, AMT Alpha and AMTCH (collectively, the “LSC entities”). The LSC entities may also acquire premium finance loans made in connection with the borrowers’ purchase of life insurance policies that are secured by the policies, which are in default at the time of purchase. The LSC entities acquire the underlying policies through the borrowers’ voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator of the Tiger life settlement contract portfolio, for which it receives an annual fee. Under the terms of an agreement for Tiger, the third party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. The Company provides for certain actuarial and finance functions related to the LSC entities. Additionally, in conjunction with the Company’s 21.25% ownership percentage of ACAC, the Company ultimately receives 60.625% of the profits and losses of Tiger and AMT Alpha. As such, in accordance with ASC 810-10, Consolidation, we have been deemed the primary beneficiary and, therefore, consolidate the LSC entities.

 

14
 

 

The Company accounts for investments in life settlements in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. The Company has elected to account for these policies using the fair value method. The Company determines fair value on a discounted cash flow basis of anticipated death benefits, incorporating current life expectancy assumptions, premium payments, the credit exposure to the insurance company that issued the life settlement contracts and the rate of return that a buyer would require on the contracts as no comparable market pricing is available.

 

Total capital contributions of approximately $20,642 and $42,000 were made to the LSC entities during the six months ended June 30, 2012 and 2011, respectively, for which the Company contributed approximately $10,321 and $21,000 in those same periods. The Company’s investments in life settlements and cash value loans were approximately $152,676 and $136,800 as of June 30, 2012 and December 31, 2011, respectively and are included in Prepaid expenses and other assets on the Consolidated Balance Sheet. The Company recorded other income for the three months ended June 30, 2012 and 2011 of approximately $1,961 and $22,638, and approximately $2,051 and $41,524 for the six months ended June 30, 2012 and 2011, respectively, related to the life settlement contracts.

 

 In addition to the 249 policies disclosed in the table below as of June 30, 2012, Tiger owned 16 premium finance loans as of the six months ended June 30, 2012, which were secured by life insurance policies and were carried at a value of $1,584. As of June 30, 2012, the face value amount of the related 249 life insurance policies and 16 premium finance loans were approximately $1,606,013 and $83,000 respectively. All of the premium finance loans are in default and Tiger is enforcing its rights in the collateral. Upon the voluntary surrender of the underlying life insurance policy in satisfaction of the loan or foreclosure, Tiger will become the owner of and beneficiary under the underlying life insurance policy and will have the option to continue to make premium payments on the policies or allow the policies to lapse. If a policyholder wishes to cure his or her default and repay the loan, Tiger will be repaid the total amount due under the premium finance loans, including all premium payments made by Tiger to maintain the policy in force since its acquisition of the loan.

 

 The following table describes the Company’s investment in life settlements as of June 30, 2012:

 

(Amounts in Thousands, except number of Life Settlement Contracts) 
Expected Maturity Term in Years
  Number of Life
Settlement
Contracts
  

Fair Value (1)

  

Face Value

 
0-1      $   $ 
1-2            
2-3   1    6,755    10,000 
3-4   3    8,182    15,000 
4-5   3    13,581    30,000 
Thereafter   242    122,574    1,551,013 
Total   249   $151,092   $1,606,013 

  

  (1) The Company determined this fair value based on 162 policies out of the 249 policies as of June 30, 2012, as the Company assigned no value to 87 of the policies as of June 30, 2012.

 

Premiums to be paid for each of the five succeeding fiscal years to keep the life insurance policies in force as of June 30, 2012, are as follows:

 

(Amounts in Thousands)  Premiums
Due on
Life 
Settlement
Contracts
   Premiums
Due on
Premium
Finance 
Loans
  

Total

 
2012  $27,596   $702   $28,298 
2013   28,713    576    29,289 
2014   30,748    725    31,473 
2015   32,259    1,279    33,538 
2016   50,730    1,256    51,986 
Thereafter   551,851    20,431    572,282 
Total  $721,897   $24,969   $746,866 

   

15
 

 

 6.Debt

 

The Company’s borrowings consisted of the following at June 30, 2012 and December 31, 2011:

 

(Amounts in Thousands)  2012   2011 
Revolving credit facility  $   $ 
Subordinated debentures   123,714    123,714 
Convertible senior notes   159,797    138,506 
Secured loan agreements   9,536    10,018 
Promissory notes   5,000    7,362 
   $298,047   $279,600 

 

Aggregate scheduled maturities of the Company’s borrowings at June 30, 2012 are:

 

(Amounts in Thousands)    
2012  $5,494 
2013   1,021 
2014   1,068 
2015   1,116 
2016   1,167 
Thereafter   288,181(1)

 

  (1) Amount reflected in balance sheet for convertible senior notes is net of unamortized original issue discount of $40,203.

 

Revolving Credit Agreement

 

On January 28, 2011, the Company entered into a three-year, $150,000 credit agreement (the “Credit Agreement”), among JPMorgan Chase Bank, N.A., as Administrative Agent, The Bank of Nova Scotia, as Syndication Agent, SunTrust Bank, as Documentation Agent, and the various lending institutions party thereto. The credit facility is a revolving credit facility with a letter of credit sublimit of $50,000 and an expansion feature not to exceed $50,000.  The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require the Company to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. The Company was in compliance with all covenants as of June 30, 2012.

 

As of June 30, 2012, the Company had no outstanding borrowings under this Credit Agreement. The Company had outstanding letters of credit in place under this Credit Agreement at June 30, 2012 for $48,895, which reduced the availability for letters of credit to $1,105 as of June 30, 2012, and the availability under the facility to $101,105 as of June 30, 2012.

 

Borrowings under the Credit Agreement bear interest at (x) the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 0.5 percent or (c) the adjusted LIBO rate for a one month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of the Company’s consolidated leverage ratio. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin that is adjusted on the basis of the Company’s consolidated leverage ratio. The interest rate on the credit facility as of June 30, 2012 and 2011 was 2.50%. The Company recorded interest expense of approximately $508 and $1,023 for the three months ended June 30, 2012 and 2011, respectively, and $1,018 and $1,418 for the six months ended June 30, 2012 and 2011, respectively, under the Credit Agreement.

 

Fees payable by the Company under the Credit Agreement include a letter of credit participation fee (which is the margin applicable to Eurodollar borrowings and was 2.25% at June 30, 2012), a letter of credit fronting fee with respect to each letter of credit (.125%) and a commitment fee on the available commitments of the lenders (a range of .35% to .45% based on the Company’s consolidated leverage ratio and was .40% at June 30, 2012).

 

16
 

 

Junior Subordinated Debt

 

The Company has established four special purpose trusts for the purpose of issuing trust preferred securities. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts, were invested by the trusts in junior subordinated debentures issued by the Company. In accordance with FASB ASC 810-10-25, the Company does not consolidate such special purpose trusts, as the Company is not considered to be the primary beneficiary. The equity investment, totaling $3,714 as of June 30, 2012 on the Company’s consolidated balance sheet, represents the Company’s ownership of common securities issued by the trusts. The debentures require interest-only payments to be made on a quarterly basis, with principal due at maturity. The debentures contain covenants that restrict declaration of dividends on the Company’s common stock under certain circumstances, including default of payment. The Company incurred $2,605 of placement fees in connection with these issuances which is being amortized over thirty years. The Company recorded $2,035 and $2,552 of interest expense for the three months ended June 30, 2012 and 2011, respectively, and $4,226 and $5,104 of interest expense for the six months ended June 30, 2012 and 2011, respectively, related to these trust preferred securities.

 

 The table below summarizes the Company’s trust preferred securities as of June 30, 2012:

 

   Aggregate                 
   Liquidation   Aggregate           Per 
   Amount of   Liquidation   Aggregate       Annum 
(Amounts in Thousands)  Trust   Amount of   Principal   Stated   Interest 
   Preferred   Common   Amount   Maturity   Rate of 
Name of Trust  Securities   Securities   of Notes   of Notes   Notes 
AmTrust Capital Financing Trust I  $25,000   $774   $25,774    3/17/2035    8.275(1)%
AmTrust Capital Financing Trust II   25,000    774    25,774    6/15/2035    7.710(1)
AmTrust Capital Financing Trust III   30,000    928    30,928    9/15/2036    3.768(2)
AmTrust Capital Financing Trust IV   40,000    1,238    41,238    3/15/2037    3.468(3)
Total trust preferred securities  $120,000   $3,714   $123,714           

 

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

 

The Company entered into two interest rate swap agreements related to these junior subordinated debentures, which effectively convert the interest rate on the trust preferred securities from a variable rate to a fixed rate. Each agreement is for a period of five years and commenced on September 15, 2011 for tranche III and March 15, 2012 for tranche IV.

 

Convertible Senior Notes

 

In December 2011, the Company issued $175,000 aggregate principal amount of its 5.5% convertible senior notes due 2021 (the “Notes”) to certain initial purchasers in a private placement. In January 2012, the Company issued an additional $25,000 of the Notes to cover the initial purchasers’ overallotment option. The Notes will bear interest at a rate equal to 5.5% per year, payable semiannually in arrears on June 15th and December 15th of each year, beginning on June 15, 2012.

 

The Notes will mature on December 15, 2021 (the “Maturity Date”), unless earlier purchased by the Company or converted into shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”). Prior to September 15, 2021, the Notes will be convertible only upon satisfaction of certain conditions, and thereafter, at any time prior to the close of business on the second scheduled trading day immediately preceding the Maturity Date. The conversion rate at June 30, 2012 is equal to 31.4326 shares of Common Stock per $1,000 principal amount of Notes, which corresponds to a conversion price of approximately $31.81 per share of Common Stock. The conversion rate is subject to adjustment upon the occurrence of certain events as set forth in the indenture governing the notes. Upon conversion of the Notes, the Company will, at its election, pay or deliver, as the case may be, cash, shares of Common Stock, or a combination of cash and shares of Common Stock.

 

Upon the occurrence of a fundamental change (as defined in the indenture governing the notes) involving the Company, holders of the Notes will have the right to require the Company to repurchase their Notes for cash, in whole or in part, at 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date.

 

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The Company separately allocated the proceeds for the issuance of the Notes to a liability component and an equity component, which is the embedded conversion option. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount (“OID”). The OID of $41,679 and deferred origination costs relating to the liability component of $4,750 will be amortized into interest expense over the term of the loan of the Notes. After considering the contractual interest payments and amortization of the original discount, the Notes effective interest rate was 8.57%. Transaction costs of $1,250 associated with the equity component were netted in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $3,329 and $6,873 for the three and six months ended June 30, 2012.

  

The following table shows the amounts recorded for the Notes as of June 30, 2012 and December 31, 2011:

  

(Amounts in Thousands)  June 30,
2012
   December 31,
2011
 
Liability component          
Outstanding principal  $200,000   $175,000 
Unamortized OID   (40,203)   (36,494)
Liability component   159,797    138,506 
Equity component, net of tax   27,092    23,785 

 

Secured Loan Agreement

 

During February 2011, the Company, through a wholly-owned subsidiary, entered into a seven-year secured loan agreement with Bank of America Leasing & Capital, LLC in the aggregate amount of $10,800 to finance the purchase of an aircraft. The loan bears interest at a fixed rate of 4.45%, requires monthly installment payments of approximately $117 commencing on March 25, 2011 and ending on February 25, 2018, and a balloon payment of $3,240 at the maturity date. The Company recorded interest expense of approximately $109 and $119 for the three months ended June 30, 2012 and 2011, respectively, and approximately $221 and $170 of interest expense for the six months ended June 30, 2012 and 2011, respectively, related to this agreement. The loan is secured by an aircraft that the subsidiary acquired in February 2011.

 

The agreement contains certain covenants that are similar to the Company’s revolving credit facility. Additionally, subsequent to February 25, 2012, but prior to payment in full, if the outstanding balance of this loan exceeds 90% of the fair value of the aircraft, the Company is required to pay the lender the entire amount necessary to reduce the outstanding principal balance to be equal to or less than 90% of the fair value of the aircraft.  The agreement allows the Company, under certain conditions, to repay the entire outstanding principal balance of this loan without penalty.

 

Promissory Notes

 

In connection with the stock and asset purchase agreement with a subsidiary of Unitrin, Inc. (now called Kemper Corporation), the Company, on June 1, 2008, issued a promissory note to Unitrin, Inc. in the amount of $30,000. The note was non-interest bearing and required four annual principal payments of $7,500. The Company paid the final annual principal payment on June 1, 2012. Upon entering into the promissory note, the Company calculated imputed interest of $3,155 based on interest rates available to the Company, which was 4.5%. Accordingly, the note’s carrying balance was adjusted to $26,845 at the acquisition. The Company included $55 and $135 of amortized discount on the note in its results of operations for the three months ended June 30, 2012 and 2011, respectively, and $138 and $298 for the six months ended June 30, 2012 and 2011, respectively.

 

In 2012, 800 Superior LLC entered into two promissory notes with ACP Re, Ltd totaling $5,000. 800 Superior LLC is an entity in which both the Company and ACAC have a 50% ownership interest. The debt matures in October 2012 and bears interest at a rate of 2.00% per annum, which resulted in $20 and $23 of interest expense for the three and six months ended June 30, 2012. For more information regarding this promissory note, see Note 11. “Related Party Transactions.”

 

 

Comerica Letter of Credit Facility

 

In connection with the Majestic acquisition discussed in Note 12 “Acquisitions,” the Company, through one of its subsidiaries, entered into a secured letter of credit facility with Comerica Bank during the three months ended September 30, 2011. The Company utilizes this letter of credit facility to comply with the deposit requirements of the State of California and the U.S. Department of Labor as security for the Company’s obligations to workers’ compensation and Federal Longshore and Harbor Workers’ Compensation Act policyholders. The credit limit is for $75,000 and was utilized for $49,801 as of June 30, 2012. The Company is required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.

 

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Other Letters of Credit

 

The Company, through certain subsidiaries, has additional existing stand-by letters of credit as of June 30, 2012 in the amount of $7,356.

 

 7.Acquisition Costs and Other Underwriting Expenses

 

The following table summarizes the components of acquisition costs and other underwriting expenses for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Policy acquisition expenses  $85,857   $56,499   $171,049   $103,316 
Salaries and benefits   40,832    31,969    76,617    59,891 
Other insurance general and administrative expenses   3,024    1,112    6,072    7,607 
   $129,713   $89,580   $253,738   $170,814 

 

 8.Earnings Per Share

 

Effective January 1, 2009, the Company adopted ASC subtopic 260-10, Determining Whether Instruments Granted in Share-Based Payments Transactions Are Participating Securities. ASC 260-10 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and are to be included in the computation of earnings per share under the two-class method. The Company’s unvested restricted shares contain rights to receive nonforfeitable dividends and are participating securities, requiring the two-class method of computing earnings per share.

 

The following table is a summary of the elements used in calculating basic and diluted earnings per share for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands except per share)  2012   2011   2012   2011 
Basic earnings per share:                
Net income attributable to AmTrust Financial Services, Inc. shareholders  $40,358   $50,162   $79,444   $95,345 
Less: Net income allocated to participating securities and redeemable non-controlling interest   182    39    197    64 
Net income allocated to AmTrust Financial Services, Inc. common shareholders  $40,176   $50,123   $79,247   $95,281 
                     
Weighted average common shares outstanding – basic   60,649    59,880    60,345    59,766 
Less: Weighted average participating shares outstanding   273    36    150    42 
Weighted average common shares outstanding - basic   60,376    59,844    60,195    59,724 
Net income per AmTrust Financial Services, Inc. common share - basic  $0.67   $0.84   $1.32   $1.60 
                     
Diluted earnings per share:                    
Net income attributable to AmTrust Financial Services, Inc. shareholders  $40,358   $50,162   $79,444   $95,345 
Less: Net income allocated to participating securities and redeemable non-controlling interest   182    39    197    64 
Net income allocated to AmTrust Financial Services, Inc. common shareholders  $40,176   $50,123   $79,247   $95,281 
                     
Weighted average common shares outstanding – basic   60,376    59,844    60,195    59,724 
Plus: Dilutive effect of stock options, other   2,124    1,778    2,086    1,670 
Weighted average common shares outstanding – dilutive   62,500    61,622    62,281    61,394 
Net income per AmTrust Financial Services, Inc. common shares – diluted  $0.64   $0.81   $1.27   $1.55 

 

As of June 30, 2012, there were less than 100,000 anti-dilutive securities excluded from diluted earnings per share.

 

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 9.Share Based Compensation

 

The Company’s 2010 Omnibus Incentive Plan (the “Plan”) permits the Company to grant to its officers, employees and non-employee directors incentive compensation directly linked to the price of the Company’s stock. The Plan authorizes up to an aggregate of 6,045,511 shares of Company stock for awards of options to purchase shares of the Company’s common stock, restricted stock, restricted stock units (“RSU”), performance shares or appreciation rights. Shares used may be either newly issued shares or treasury shares or both. The aggregate number of shares of common stock for which awards may be issued may not exceed 6,045,511 shares, subject to the authority of the Company’s board of directors to adjust this amount in the event of a consolidation, reorganization, stock dividend, stock split, recapitalization or similar transaction affecting the Company’s common stock. As of June 30, 2012, approximately 5,000,000 shares of Company common stock remained available for grants under the Plan.

 

  The Company recognizes compensation expense under FASB ASC 718-10-25 for its share-based payments based on the fair value of the awards. The Company grants stock options at prices equal to the closing stock price of the Company’s stock on the dates the options are granted. The options have a term of ten years from the date of grant and vest primarily in equal annual installments over the four-year period following the date of grant for employee options. Employees have three months after the employment relationship ends to exercise all vested options. The fair value of each option grant is separately estimated for each vesting date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The Company grants restricted shares and RSUs with a grant date value equal to the closing stock price of the Company’s stock on the dates the shares or units are granted and they vest over a period of two to four years.

 

  The following schedule shows all options granted, exercised, and expired under the Plan for the six months ended June 30, 2012 and 2011:

 

   2012   2011 
  

 

 

Shares

   Weighted
Average
Exercise Price
  

 

 

Shares

   Weighted
Average
Exercise Price
 
Outstanding at beginning of period   3,771,788   $10.96    4,126,926   $10.46 
Granted   35,000    28.50    175,000    14.98 
Exercised   (305,892)   9.10    (333,049)   9.40 
Cancelled or terminated   (74,372)   14.29    (64,533)   16.48 
Outstanding end of period   3,426,524   $12.69    3,904,344   $10.68 

 

 The weighted average grant date fair value of options granted during the six months ended June 30, 2012 and 2011 was approximately $9.32 and $7.24, respectively.

 

 A summary of the Company’s restricted stock and RSU activity for the six months ended June 30, 2012 and 2011 is shown below:

 

   2012   2011 
  

 

 

Shares or
Units

   Weighted
Average
Grant Date
Fair Value
  

 

 

Shares
or Units

   Weighted
Average
Grant Date
Fair Value
 
Non-vested at beginning of period   291,230   $18.32    139,388   $14.04 
Granted   526,664    27.88    202,456    20.37 
Vested   (77,053)   18.02    (37,973)   14.05 
Forfeited   (20)   21.11         
Non-vested at end of period   740,821   $25.15    303,871   $18.26 

 

Compensation expense for all share-based payments under ASC 718-10-30 was approximately $1,565 and $1,817 for the three months ended June 30, 2012 and 2011, respectively, and $2,746 and $3,276 for the six months ended June 30, 2012 and 2011, respectively.

 

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As of June 30, 2012, there was approximately $25,027 of total unrecognized compensation cost related to non-vested share-based compensation arrangements.

 

 10.Income Taxes

 

The following table is a reconciliation of the Company’s statutory income tax expense to its effective tax rate for the three and six months ended June 30, 2012 and 2011:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Income before equity in earnings (loss) of unconsolidated subsidiaries  $49,294   $64,693   $97,327   $125,233 
Tax at federal statutory rate of 35%   17,253    22,643    34,064    43,832 
Tax effects resulting from:                    
Net income of non-includible foreign subsidiaries   (5,697)   (9,693)   (10,265)   (17,336)
Other, net   186    (5,661)   (880)   (10,170)
   $11,742   $7,289   $22,919   $16,326 
Effective tax rate   23.8%   11.3%   23.5%   13.0%

 

 The Company’s management believes that it will realize the benefits of its deferred tax assets, which is included as a component of the Company’s net deferred tax liability, and, accordingly, no valuation allowance has been recorded for the periods presented. The earnings of certain of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations. Therefore, no provision has been made for any U.S. taxes or foreign withholding taxes that may be applicable upon any repatriation or sale. The determination of any unrecognized deferred tax liability for temporary differences related to investments in certain of the Company’s foreign subsidiaries is not practicable. As of June 30, 2012 and December 31, 2011, the financial reporting basis in excess of the tax basis for which no deferred taxes have been recognized was approximately $252,307 and $223,300, respectively.

 

   The Company’s major taxing jurisdictions include the U.S. (federal and state), the United Kingdom and Ireland. The years subject to potential audit vary depending on the tax jurisdiction. Generally, the Company’s statute of limitation is open for tax years ended December 31, 2007 and forward. As permitted by FASB ASC 740-10, the Company adopted an accounting policy to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in its income tax provision. Previously, the Company’s policy was to classify interest and penalties as an operating expense in arriving at pre-tax income. At June 30, 2012, the Company does not have any accrued interest and penalties related to unrecognized tax benefits in accordance with FASB ASC 740-10.

 

 11.Related Party Transactions

 

Maiden

 

  The Company has various reinsurance and service agreements with Maiden Holdings, Ltd. (“Maiden”). Maiden is a publicly-held Bermuda insurance holding company (Nasdaq: MHLD) formed by Michael Karfunkel, George Karfunkel and Barry Zyskind, principal shareholders, and, respectively, the chairman of the board of directors, a director, and the chief executive officer and director of the Company. As of June 30, 2012, Michael Karfunkel owns or controls approximately 13.8% of the issued and outstanding capital stock of Maiden, George Karfunkel owns or controls approximately 9.4% of the issued and outstanding capital stock of Maiden and Mr. Zyskind owns or controls approximately 5.1% of the issued and outstanding stock of Maiden. Mr. Zyskind serves as the non-executive chairman of the board of Maiden’s board of directors. Maiden Insurance Company, Ltd (“Maiden Insurance”), a wholly-owned subsidiary of Maiden, is a Bermuda reinsurer. The following section describes the agreements in place between the Company and its subsidiaries and Maiden and its subsidiaries.

 

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Reinsurance Agreements with Maiden Holdings, Ltd.

 

In 2007, the Company and Maiden entered into a master agreement, as amended, by which the parties caused the Company’s Bermuda subsidiary, AmTrust International Insurance, Ltd. (“AII”) and Maiden Insurance to enter into a quota share reinsurance agreement (the “Maiden Quota Share”), as amended, by which AII retrocedes to Maiden Insurance an amount equal to 40% of the premium written by the Company’s U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated inuring reinsurance (and in the case of the Company’s U.K. insurance subsidiary, AmTrust Europe Ltd., net of commissions) and 40% of losses excluding certain specialty risk programs that the Company commenced writing after the effective date, including the Company’s European medical liability business discussed below, and risks, other than workers’ compensation risks and certain business written by the Company’s Irish subsidiary, AmTrust International Underwriters Limited (“AIU”), for which the AmTrust Ceding Insurers’ net retention exceeds $5,000 (“Covered Business”).

 

  The Maiden Quota Share, which had an initial term of three years, was renewed through June 30, 2014 and will automatically renew for successive three-year terms unless either AII or Maiden Insurance notifies the other of its election not to renew not less than nine months prior to the end of any such three-year term. In addition, either party is entitled to terminate on thirty days’ notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Insurance, run-off, or a reduction of 50% or more of the shareholders’ equity of Maiden Insurance or the combined shareholders’ equity of AII and the AmTrust Ceding Insurers.

 

 The Maiden Quota Share, as amended, further provides that AII receives a ceding commission based on a percentage of ceded written premiums with respect to all Covered Business. Commencing January 1, 2012, the ceding commission with respect to all Covered Business other than the retail commercial package business is adjusted on a quarterly basis to (a) 30% of ceded premium, if the Specialty Risk and Extended Warranty subject premium, excluding ceded premium related to our medical liability business discussed below, is greater than or equal to 42% of the total subject premium, (b) 30.5% of ceded premium, if the Specialty Risk and Extended Warranty subject premium is less than 42% but greater than or equal to 38%, or (c) 31% of ceded premium, if the Specialty Risk and Extended Warranty subject premium is less than 38% of the total subject premium. The ceding commission for the retail commercial package business is 34.375% of ceded premium. From April 1, 2011 until December 31, 2011, AII received a ceding commission of 30% of ceded written premium with respect to all Covered Business other than the retail commercial package business, for which the ceding commission was 34.375%. Prior to April 1, 2011, AII received a ceding commission of 31% of ceded premiums with respect to all Covered Business other than the retail commercial package business, for which the ceding commission was 34.375%.

 

 Effective April 1, 2011, the Company, through its subsidiaries AEL and AIU, entered into a reinsurance agreement with Maiden Insurance by which the Company cedes to Maiden Insurance 40% of its European medical liability business, including business in force at April 1, 2011. The quota share has an initial term of one year, automatically renews for one-year terms and can be terminated by either party on four months’ prior written notice. Maiden Insurance pays the Company a 5% ceding commission, and the Company will earn a profit commission of 50% of the amount by which the ceded loss ratio is lower than 65%.

 

 Effective September 1, 2010, the Company, through its subsidiary, Security National Insurance Company (“SNIC”), entered into a reinsurance agreement with Maiden Reinsurance Company and an unrelated third party. Under the agreement, which had an initial term of one year and has been extended to August 31, 2012, SNIC cedes 80% of the gross liabilities produced under the Southern General Agency program to Maiden Reinsurance Company and 20% of the gross liabilities produced to the unrelated third party. SNIC receives a five percent commission on ceded written premiums.

 

 The following is the effect on the Company’s results of operations for the three and six months ended June 30, 2012 and 2011 related to Maiden Reinsurance agreements:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Results of operations:                
Premium written – ceded  $(196,380)  $(213,919)  $(387,281)  $(340,641)
Change in unearned premium – ceded   26,378    77,227    50,961    90,013 
Earned premium - ceded  $(170,002)  $(136,692)  $(336,320)  $(250,628)
                     
Ceding commission on premium written  $50,858   $44,160   $105,269   $83,885 
Ceding commission – deferred   (6,308)   (9,796)   (14,445)   (13,712)
Ceding commission – earned  $44,550   $34,364   $90,824   $70,173 
                     
Incurred loss and loss adjustment expense – ceded  $125,970   $98,957   $248,780   $181,064 

 

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Fronting Arrangement with Maiden Specialty Insurance Company

 

 Effective September 1, 2010, the Company, through its subsidiary Technology Insurance Company, Inc.  (“TIC”), entered into a quota share reinsurance agreement with Maiden Specialty Insurance Company (“Maiden Specialty”) by which TIC assumes a portion (generally 90%) of premiums and losses with respect to certain surplus lines programs written by Maiden Specialty on behalf of the Company (the “Surplus Lines Facility”). The Surplus Lines Facility enables the Company to write business on a surplus lines basis throughout the United States. Currently, the Company is utilizing the Surplus Lines Facility for two programs for which Maiden Specialty receives a five percent ceding commission on all premiums ceded by Maiden Specialty to TIC. The Surplus Lines Facility shall remain continuously in force until terminated. The Company has surplus lines authority for two of its insurance company subsidiaries, which has significantly decreased the need for the Surplus Lines Facility. As a result of this agreement, the Company assumed approximately $300 and $9,400 of written premium during the six months ended June 30, 2012 and 2011, respectively. The Company recorded earned premium of approximately $600 and $4,000 and incurred losses of approximately $700 and $2,800 for the three and six months ended June 30, 2012. The Company recorded earned premium of approximately $3,400 and incurred losses of approximately $2,200 for the three and six months ended June 30, 2011.

   

Note Payable to Maiden – Collateral for Proportionate Share of Reinsurance Obligations

 

 In conjunction with the Maiden Quota Share, as described above, AII entered into a loan agreement with Maiden Insurance during the fourth quarter of 2007, whereby Maiden Insurance loaned to AII the amount equal to its quota share of the obligations of the AmTrust Ceding Insurers that AII was then obligated to secure. The loan agreement provides for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Advances under the loan are secured by a promissory note and totaled $167,975 as of June 30, 2012. The Company recorded $914 and $472 of interest expense during the three months ended June 30, 2012 and 2011, respectively, and $1,542 and $958 of interest expense during the six months ended June 30, 2012 and 2011, respectively. Effective December 1, 2008, AII and Maiden Insurance entered into a Reinsurer Trust Assets Collateral agreement whereby Maiden Insurance is required to provide AII the assets required to secure Maiden’s proportional share of the Company’s obligations to its U.S. subsidiaries. The amount of this collateral as of June 30, 2012 was approximately $701,603. Maiden retains ownership of the collateral in the trust account.

 

 Reinsurance Brokerage Agreement

 

 Effective July 1, 2007, the Company, through a subsidiary, entered into a reinsurance brokerage agreement with Maiden. Pursuant to the brokerage agreement, the Company provides brokerage services relating to the Maiden Quota Share for a fee equal to 1.25% of reinsured premium. The Company recorded $2,151 and $2,674 of brokerage commission (recorded as a component of service and fee income) during the three months ended June 30, 2012 and 2011, respectively, and $4,345 and $4,258 of brokerage commission during the six months ended June 30, 2012 and 2011, respectively.

 

Asset Management Agreement

 

  Effective July 1, 2007, the Company, through a subsidiary, entered into an asset management agreement with Maiden, pursuant to which the Company provides investment management services to Maiden and its affiliates. As of June 30, 2012, the Company managed approximately $2,200,000 of assets related to this agreement. The investment management services fee is 0.20% per annum for periods in which average invested assets are $1,000,000 or less and 0.15% per annum for periods in which the average invested assets exceeds $1,000,000. As a result of this agreement, the Company earned approximately $830 and $776 of investment management fees (recorded as a component of service and fee income) for the three months ended June 30, 2012 and 2011, respectively, and $1,660 and $1,501 of investment management fees for the six months ended June 30, 2012 and 2011, respectively.

 

Senior Notes

 

In June 2011, the Company, through a subsidiary, participated as a purchaser in a registered public offering by Maiden Holdings North America, Ltd., a subsidiary of Maiden, for $12,500 of an aggregate $107,500 principal amount of 8.25% Senior Notes due 2041 (the “Notes”) that are fully and unconditionally guaranteed by Maiden. The Notes are redeemable for cash, in whole or in part, on or after June 15, 2016, at 100% of the principal amount of the Notes to be redeemed plus accrued and unpaid interest to, but not including, the redemption date. The fair value of the notes as of June 30, 2012 was $13,220.

 

23
 

 

American Capital Acquisition Corporation

 

During the three months ended March 31, 2010, the Company completed its strategic investment in American Capital Acquisition Corporation (“ACAC”). ACAC was formed by The Michael Karfunkel 2005 Grantor Retained Annuity Trust (the “Trust”) and the Company for the purpose of acquiring from GMAC Insurance Holdings, Inc. and Motor Insurance Corporation (“MIC”, together with GMAC Insurance Holdings, Inc., “GMACI”), GMACI’s U.S. consumer property and casualty insurance business (the “GMACI Business”), a writer of automobile coverages through independent agents in the United States. Its coverages include standard/preferred auto, RVs, non-standard auto and commercial auto. The acquisition included ten statutory insurance companies (the “GMACI Insurers”). Michael Karfunkel, individually, and the Trust own 100% of ACAC’s common stock (subject to the Company’s conversion rights described below). Michael Karfunkel is the chairman of the board of directors of the Company and the father-in-law of Barry D. Zyskind, the chief executive officer of the Company. The ultimate beneficiaries of the Trust include Michael Karfunkel’s children, one of whom is married to Mr. Zyskind. In addition, Michael Karfunkel is the Chairman of the Board of Directors of ACAC.

 

Pursuant to the Amended Stock Purchase Agreement, ACAC issued and sold to the Company for an initial purchase price of approximately $53,000, which was equal to 25% of the capital initially required by ACAC, 53,054 shares of Series A Preferred Stock, which provides an 8% cumulative dividend, is non-redeemable and is convertible, at the Company’s option, into 21.25% of the issued and outstanding common stock of ACAC (the “Preferred Stock”). The Company has pre-emptive rights with respect to any future issuances of securities by ACAC and the Company’s conversion rights are subject to customary anti-dilution protections. The Company has the right to appoint two members of ACAC’s board of directors, which consists of six members. Subject to certain limitations, the board of directors of ACAC may not take any action in the absence of the Company’s appointees and ACAC may not take certain corporate actions without the unanimous prior approval of its board of directors (including the Company’s appointees).

 

 The Company, the Trust and Michael Karfunkel, individually, each shall be required to make its or his proportionate share of deferred payments payable by ACAC to GMACI pursuant to the GMACI Securities Purchase Agreement, which are payable, annually on March 1 through March 1, 2013, to the extent that ACAC is unable to otherwise provide for such payments. The Company’s proportionate share of such deferred payments as of June 30, 2012 will not exceed $7,500. In addition, in connection with the Company’s investment, ACAC will grant the Company a right of first refusal to purchase or to reinsure commercial auto insurance business acquired from GMACI.

 

 In accordance with ASC 323-10-15, Investments-Equity Method and Joint Ventures, the Company accounts for its investment in ACAC under the equity method. The Company recorded $3,088 and $2,514 of income during the three months ended June 30, 2012 and 2011, respectively, and $5,452 and $4,333 during the six months ended June 30, 2012 and 2011, related to its equity investment in ACAC.  

 

Personal Lines Quota Share

 

 The Company, effective March 1, 2010, reinsures 10% of the net premiums of the GMACI Business, pursuant to a 50% quota share reinsurance agreement (“Personal Lines Quota Share”) among Integon National Insurance Company, lead insurance company on behalf of the GMACI Insurers, as cedents, and the Company, ACP Re, Ltd., a Bermuda reinsurer that is a wholly-owned indirect subsidiary of the Trust, and Maiden Insurance Company, Ltd., as reinsurers. The Personal Lines Quota Share provides that the reinsurers, severally, in accordance with their participation percentages, receive 50% of the net premium of the GMACI Insurers and assume 50% of the related net losses. The Company has a 20% participation in the Personal Lines Quota Share, by which it receives 10% of the net premiums of the personal lines business and assumes 10% of the related net losses. The Personal Lines Quota Share has an initial term of three years and will renew automatically for successive three-year terms unless terminated by written notice not less than nine months prior to the expiration of the current term. In addition, either party is entitled to terminate on 60 days’ written notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of the Company or the GMACI Insurers, run-off, or a reduction of 50% or more of the shareholders’ equity. The GMACI Insurers also may terminate on nine months’ written notice following the effective date of an initial public offering or private placement of stock by ACAC or a subsidiary. The Personal Lines Quota Share provides that the reinsurers pay a provisional ceding commission equal to 32.5% of ceded earned premium, net of premiums ceded by the personal lines companies for inuring reinsurance, subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.5% or less and a minimum of 30.5% if the loss ratio is 64.5% or higher. The Personal Lines Quota Share is subject to a premium cap that limits the premium that could be ceded by the GMACI Insurers to TIC to $133,100 during calendar year 2012 to the extent TIC was to determine, in good faith, that it could not assume additional premium. The premium cap increases by 10% per annum thereafter. As a result of this agreement, the Company assumed $28,823 and $24,999 of business from the GMACI Insurers during the three months ended June 30, 2012 and 2011, respectively, and $59,432 and $50,586 of business from the GMACI Insurers during the six months ended June 30, 2012 and 2011, respectively.

 

Information Technology Service Agreement

 

 The Company provides ACAC and its affiliates information technology development services in connection with the development and licensing of a policy management system at a cost which is currently 1.25% of gross written premium of ACAC and its affiliates plus the Company’s costs for development and support services. The Company recorded approximately $3,577 and $627 of fee income for the three months ended June 30, 2012 and 2011, respectively, and $6,039 and $1,358 of fee income for the six months ended June 30, 2012 and 2011, respectively, related to this agreement.

 

24
 

 

Asset Management Agreement

 

 The Company manages the assets of ACAC and its subsidiaries for an annual fee equal to 0.20% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for the preceding quarter is $1,000,000 or less and 0.15% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for that quarter is more than $1,000,000. The Company currently manages approximately $700,000 of assets as of June 30, 2012 related to this agreement. As a result of this agreement, the Company earned approximately $373 and $382 of investment management fees for the three months ended June 30, 2012 and 2011, respectively, and $746 and $781 of investment management fees for the six months ended June 30, 2012 and 2011, respectively.

 

 As a result of the above service agreements with ACAC, the Company recorded fees totaling approximately $3,950 and $1,009 for the three months ended June 30, 2012 and 2011, respectively, and $6,785 and $2,139 for the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, the outstanding balance payable by ACAC related to these service fees and reimbursable costs was approximately $5,054.

 

800 Superior

 

 In August 2011, the Company formed 800 Superior, LLC with a subsidiary of ACAC for the purposes of acquiring an office building in Cleveland, Ohio. The Company and ACAC each have a fifty percent ownership interest in 800 Superior, LLC. The cost of the building was approximately $7,500. The Company has been appointed managing member of the LLC. Additionally, in conjunction with the Company’s 21.25% ownership percentage of ACAC, the Company ultimately receives 60.6% of the profits and losses of the LLC. As such, in accordance with ASC 810-10, Consolidation, the Company has been deemed the primary beneficiary and, therefore, consolidates this entity. In 2012, 800 Superior, LLC entered into two promissory notes with ACP Re, Ltd. totaling $5,000. The proceeds from the notes will be used for leasehold improvements on the office building. The debt matures in October 2012 and bears interest at a rate of 2.00% per annum, which resulted in $20 and $23 of interest expense for the three and six months ended June 30, 2012. Additionally in 2012, ACAC entered into an office lease with 800 Superior, LLC for approximately 134,000 square feet. The lease period is for fifteen years and ACAC paid 800 Superior, LLC $345 for the three months ended June 30, 2012.

 

Lease Agreements

 

  In January 2008, the Company entered into an amended agreement for 14,807 square feet of office space at 59 Maiden Lane in New York, New York from 59 Maiden Lane Associates, LLC, an entity that is wholly-owned by Michael Karfunkel and George Karfunkel. The Company paid approximately $181 and $166 for the lease for the three months ended June 30, 2012 and 2011, respectively, and $363 and $345 for the six months ended June 30, 2012 and 2011, respectively.

 

  In January 2011, the Company entered into an amended agreement to lease 9,030 square feet of office space in Chicago, Illinois from 33 West Monroe Associates, LLC, an entity that is wholly-owned by entities controlled by Michael Karfunkel and George Karfunkel. The Company paid approximately $67 and $65 for the three months ended June 30, 2012 and 2011, respectively, and $134 and $148 for the six months ended June 30, 2012 and 2011, respectively.  

  

Management Agreement with ACP Re, Ltd.

 

The Company provides investment management services and accounting and administrative services to ACP Re, Ltd. for a monthly fee of $10 and (i) a quarterly rate of 0.05% of the average value of ACP Re, Ltd.’s invested assets for the preceding calendar quarter if the average value of such assets for the quarter was $1,000,000 or less, or (ii) a quarterly rate of 0.0375% of the average value of ACP Re, Ltd.’s invested assets for the preceding calendar quarter if the average value of such assets for the quarter was greater than $1,000,000. The Company currently manages approximately $100,000 of assets as of June 30, 2012. The Company entered into this management agreement in March 2012, and it covers all services rendered prior to the execution of the agreement. The Company recorded approximately $0 and $233 for these services for the three and six months ended June 30, 2012.

 

25
 

 

Use of the Company Aircraft

 

 The Company’s wholly-owned subsidiary, AmTrust Underwriters, Inc. (“AUI”), is a party to an aircraft time share agreement with each of Maiden and ACAC. The agreements provide for payment to AUI for usage of its company-owned aircraft and covers actual expenses incurred and permissible under federal aviation regulations, including travel and lodging expenses of the crew, in-flight catering, flight planning and weather contract services, ground transportation, fuel, landing and hanger fees, airport taxes, among others. AUI does not charge Maiden or ACAC for the fixed costs that would be incurred in any event to operate the aircraft (for example, aircraft purchase costs, insurance and flight crew salaries). During the three and six months ended June 30, 2012, Maiden paid AUI $1 and $20, respectively, and ACAC paid AUI $29 and $96, respectively, for the use of AUI’s aircraft under these agreements. In addition, during the three and six months ended June 30, 2011, Maiden paid AUI $0 and $42, respectively, and ACAC paid AUI $0 and $51, respectively, for the use of AUI’s aircraft under these agreements.

 

 In addition, for personal travel, Mr. Zyskind, the Company’s President and Chief Executive Officer and Michael Karfunkel, the Chairman of the Board, each entered into an aircraft reimbursement agreement with AUI and, since entering into such agreement, has fully reimbursed AUI for the incremental cost billed by AUI for their personal use of AUI’s aircraft. During the three and six months ended June 30, 2012, Mr. Zyskind reimbursed the Company $36 and $89, respectively. In addition, during the six months ended June 30, 2011, Mr. Zyskind reimbursed the Company $69. Neither Mr. Zyskind nor Mr. Karfunkel used the aircraft for personal use during the three months ended June 30, 2011 and Mr. Karfunkel did not use the aircraft for personal use during the six months ended June 30, 2011.

 

 12.Acquisitions

 

  BTIS

 

 In December 2011, the Company acquired the California-based Builders & Tradesmen’s Insurance Services, Inc. (“BTIS”), an insurance wholesaler and general agent specializing in insurance policies and bonds for small artisan contractors. The purchase agreement required the Company to make an initial payment of $5,000 on the acquisition date and pay future incentives measured primarily on the overall profitability of the business for a period of approximately four years. In accordance with FASB ASC 805, Business Combinations, the Company recorded a purchase price of approximately $47,000, and included goodwill and intangibles of approximately $59,000. The intangible assets included renewal rights, distribution networks and trademarks. The trademarks were determined to have an indefinite life while the renewal rights and distribution networks were determined to have lives of 11 and 17 years, respectively. Additionally, the Company recorded a liability for approximately $2,400 related to an unfavorable lease assumed in the transaction. BTIS’s revenues are included within the Company’s Small Business segment as a component of service and fee income. The Company recorded approximately $4,000 and $11,000 of fee revenue as a result of this acquisition during the three and six months ended June 30, 2012.

   

Majestic

 

 The Company, through certain of its subsidiaries and the Insurance Commissioner of the State of California acting solely in the capacity as the statutory conservator (the “Conservator”) of Majestic Insurance Company (“Majestic”), entered into a Rehabilitation Agreement that set forth a plan for the rehabilitation of Majestic (the “Rehabilitation Plan”) by which the Company acquired the business of Majestic through a Renewal Rights and Asset Purchase Agreement (the “Purchase Agreement”), and a Loss Portfolio Transfer and Quota Share Reinsurance Agreement (the “Reinsurance Agreement”). On July 1, 2011, the Company, through one of its subsidiaries, entered into the Reinsurance Agreement, which was effective June 1, 2011, and assumed all of Majestic’s liability for losses and loss adjustment expenses under workers’ compensation insurance policies of approximately $331,660, without any aggregate limit, and certain contracts related to Majestic’s workers” compensation business, including leases for Majestic’s California office space. In addition, the Company assumed 100% of the unearned premium reserve of approximately $25,997 on all in-force Majestic policies. In connection with this transaction, the Company received approximately $224,532 of cash and investments, which included $26,000 for a reserve deficiency and also included the assignment of Majestic’s reinsurance recoverables of approximately $51,715. The Reinsurance Agreement also contains a profit sharing provision whereby the Company pays Majestic up to 3% of net earned premium related to current Majestic policies that are renewed by the Company in the three year period commencing on the closing date should the loss ratio on such policies for the three year period be 65% or less. The insurance premiums, which are included in the Company’s Small Commercial Business segment, have been recorded since the acquisition date and were approximately $16,000 and $35,000 for the year three and six months ended June 30, 2012.

 

26
 

 

 As a result of entering into the Purchase Agreement, the Company, in accordance with FASB ASC 805, Business Combinations, recorded $3,870 of intangible assets related to distribution networks and trademarks. The distribution networks have a life of 13 years and the trademarks have a life of two years. Additionally, the Company recorded a liability for approximately $390 related to an unfavorable lease assumed in the transaction and a liability for approximately $815 related to the above-mentioned profit sharing provision. In accordance with FASB ASC 944-805, Business Combinations, the Company adjusted to fair value Majestic’s loss and LAE reserves by taking the acquired loss reserves recorded and discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk-free interest rate was then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and the Company’s best estimate of the fair value of such reserves at acquisition date is amortized ratably over the payout period of the acquired loss and LAE reserves. The Company determined the fair value of the loss reserves to be $328,905. Accordingly, the amortization will be recorded as an expense on the Company’s income statement until fully amortized.

 

  13.Shareholder Equity

 

The following table summarizes the ownership components of total equity for the six months ended June 30, 2012:

 

 

(Amounts in Thousands)

 

 

AmTrust

   Non-Controlling
Interests
  

 

Total

 
Beginning Balance, January 1, 2012  $890,563   $69,098   $959,661 
Net income   79,444    416    79,860 
Unrealized holding gains  and reclassification   28,441        28,441 
Foreign currency translation   (2,860)       (2,860)
Unrealized loss on interest rate swap   (627)       (627)
Equity component of convertible senior notes, net of income tax and issue costs   3,306        3,306 
Capital contribution       9,831    9,831 
Acquisition of non-controlling interest   6,900    (6,900)    
Dividends   (11,512)       (11,512)
Share exercises and compensation, other   5,834        5,834 
Ending Balance, June 30, 2012  $999,489   $72,445   $1,071,934 

 

 The Company acquired the remaining twenty percent interest of its subsidiary, AMT Warranty Corp., during the three months ended June 30, 2012. The purchase price for the non-controlling interest of AMT Warranty Corp. was not material to the Company.

 

 14.Contingent Liabilities

 

Litigation

 

 The Company’s insurance subsidiaries are named as defendants in various legal actions arising principally from claims made under insurance policies and contracts. Those actions are considered by the Company in estimating the loss and LAE reserves. The Company’s management believes the resolution of those actions will not have a material adverse effect on the Company’s financial position or results of operations.

 

 Vehicle service contract industry inquiry and related proceedings

 

As previously described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, the Company’s subsidiary Warrantech Corporation (“Warrantech”) is involved in a number of disputes that relate to U.S. Fidelis, a direct marketer of vehicle service contracts that filed a petition for Chapter 11 bankruptcy protection in February 2010 in the United States Bankruptcy Court for the Eastern District of Missouri (the “Bankruptcy Proceeding”).

 

27
 

 

On April 27, 2012, the parties to the various disputes reached agreement on a comprehensive settlement, the terms of which were incorporated into the plan of liquidation for U.S. Fidelis, which was filed in the Bankruptcy Proceeding on May 1, 2012 (the “Plan”). In connection with the Plan, Warrantech, the Unsecured Creditors Committee of U.S. Fidelis, Mepco Finance Corporation (“Mepco”), and the States of Missouri, Texas, Washington and Ohio, by and through the offices of their respective Attorneys General, entered into a plan support agreement (the “PSA”). Pursuant to the PSA, provided that the Plan had not been modified in such a manner that would materially adversely affect the rights, recoveries, or obligations of the parties and subject to an opt-out right in favor of Warrantech and Mepco, each of the parties agreed to support the Plan throughout the Bankruptcy Proceeding and to cooperate to the fullest extent in obtaining confirmation of the Plan. On July 16, 2012, the United States Bankruptcy Court for the Eastern District of Missouri (the “Bankruptcy Court”) held a Plan confirmation hearing. The Bankruptcy Court has not issued a ruling on the confirmation of the Plan. Upon confirmation, Warrantech will become obligated to pay $4,800 to Mepco, $1,400 to the liquidating trustee and $1,100 to the U.S. Fidelis Consumer Restitution Fund (as described in the Plan). The Plan also provides the Warrantech Released Parties (as described in the Plan) with releases from certain consumer claims and claims by States Attorneys General and Governmental Units (as described in the Plan).

 

As part of the overall settlement, Warrantech also entered into assurances of voluntary compliance with the states of Ohio, Missouri, Texas and Washington (the “AVCs”) that will become binding on the effective date of the Plan. The AVCs require Warrantech to adhere to certain compliance terms in connection with the marketing and sale of vehicle service contracts through authorized telemarketers, pay certain funds to consumers in connection with vehicle service contracts that were marketed and sold by U.S. Fidelis and administered by Warrantech and contribute the funds referenced above to the U.S. Fidelis Consumer Restitution Fund.

 

Investment in ACAC

 

As a result of its equity investment in ACAC, the Company made an initial investment in ACAC in the amount of approximately $53,000.  In addition, the Company, the Trust and Michael Karfunkel, individually, each shall be required to make its or his proportional share of the deferred payments payable by ACAC to GMAC pursuant to the GMAC Securities Purchase Agreement (See Note 11. Related Party Transactions), the final payment of which is payable on March 1, 2013, to the extent that ACAC is unable to otherwise provide for such payments. The Company’s proportionate share of such deferred payments shall not exceed $7,500.

 

  15.Segments

 

  The Company currently operates four business segments, Small Commercial Business; Specialty Risk and Extended Warranty; Specialty Program and Personal Lines Reinsurance. The “Corporate & Other” segment represents the activities of the holding company as well as a portion of service and fee revenue. In determining total assets (excluding cash and invested assets) by segment, the Company identifies those assets that are attributable to a particular segment such as deferred acquisition cost, reinsurance recoverable, goodwill, intangible assets and prepaid reinsurance while the remaining assets are allocated based on net written premium by segment. In determining cash and invested assets by segment, the Company matches certain identifiable liabilities such as unearned premium and loss and loss adjustment expense reserves by segment. The remaining cash and invested assets are then allocated based on net written premium by segment. Investment income and realized gains (losses) are determined by calculating an overall annual return on cash and invested assets and applying that overall return to the cash and invested assets by segment. Ceding commission revenue is allocated to each segment based on that segment’s proportionate share of the Company’s overall acquisition costs. Interest expense is allocated based on net written premium by segment. Income taxes are allocated on a pro-rata basis based on the Company’s effective tax rate. Additionally, management reviews the performance of underwriting income in assessing the performance of and making decisions regarding the allocation of resources to the segments. Underwriting income excludes, primarily, service and fee revenue, investment income and other revenues, other expenses, interest expense and income taxes. Management believes that providing this information in this manner is essential to providing Company’s shareholders with an understanding of the Company’s business and operating performance.

 

 During the six months ended June 30, 2012, the Company derived over ten percent of gross written premium from one broker in its Specialty Risk and Extended Warranty segment and was approximately $85,000.

 

28
 

 

The following tables summarize the results of operations of the business segments for the three and six months ended June 30, 2012 and 2011:

 

(Amounts in Thousands)  Small
Commercial
Business
   Specialty Risk
and Extended
Warranty
   Specialty
Program
   Personal
Lines
Reinsurance
   Corporate
and Other
   Total 
Three months ended June 30, 2012:                              
Gross written premium  $214,127   $272,610   $121,878   $28,823   $   $637,438 
                               
Net written premium   104,270    172,259    86,237    28,823        391,589 
Change in unearned premium   (10,702)   (30,652)   (15,369)   (872)       (57,595)
Net earned premium   93,568    141,607    70,868    27,951        333,994 
                               
Ceding commission - primarily related party   15,458    16,174    12,918            44,550 
                               
Loss and loss adjustment expense   (60,305)   (85,628)   (47,826)   (18,028)       (211,787)
Acquisition costs and other underwriting expenses   (42,165)   (44,038)   (34,985)   (8,525)       (129,713)
    (102,470)   (129,666)   (82,811)   (26,553)       (341,500)
Underwriting income   6,556    28,115    975    1,398        37,044 
                               
Service and fee income   10,545    15,429    10        7,027    33,011 
Investment income and realized gain (loss)   6,759    8,123    3,475    690        19,047 
Other expenses   (10,742)   (14,078)   (6,062)   (1,438)       (32,320)
Interest expense   (2,343)   (3,035)   (1,307)   (309)       (6,994)
Foreign currency loss       (2,455)               (2,455)
Gain on life settlement contracts   714    813    352    82        1,961 
Provision for income taxes   (2,576)   (7,379)   575   (95)   (2,267)   (11,742)
Equity in earnings of unconsolidated subsidiary  – related party                   3,088    3,088 
Non-controlling interest   (100)   (119)   (51)   (12)       (282)
Net income attributable to AmTrust Financial Services, Inc.  $8,813   $25,414   $(2,033)  $316   $7,848   $40,358 

  

(Amounts in Thousands)  Small
Commercial
Business
   Specialty Risk
and Extended
Warranty
   Specialty
Program
   Personal
Lines
Reinsurance
   Corporate
and Other
   Total 
Three months ended June 30, 2011:                              
Gross written premium  $174,607   $265,502   $93,354   $24,999   $   $558,462 
                               
Net written premium   113,221    185,178    52,283    24,999        375,681 
Change in unearned premium   (39,187)   (75,547)   (12,145)   (520)       (127,399)
Net earned premium   74,034    109,631    40,138    24,479        248,282 
                               
Ceding commission - primarily related party   13,570    13,787    8,057            35,414 
                               
Loss and loss adjustment expense   (49,927)   (70,053)   (28,362)   (15,666)       (170,008)
Acquisition costs and other underwriting expenses   (31,653)   (31,658)   (18,314)   (7,955)       (89,580)
    (81,580)   (107,711)   (46,676)   (23,621)       (259,588)
                               
Underwriting income   6,024    15,707    1,519    858         24,108 
Service and fee income   5,177    14,904    1        4,460    24,542 
Investment income and realized gain (loss)   7,059    4,491    1,902    331        13,783 
Other expenses   (4,713)   (10,488)   (2,732)   (631)       (18,564)
Interest expense   (1,150)   (2,394)   (625)   (165)       (4,334)
Foreign currency gain       2,520                2,520 
Gain on life settlement contracts   6,045    12,464    3,259    870        22,638 
Provision for income taxes   (2,066)   (4,228)   (335)   (143)   (517)   (7,289)
Equity in earnings of unconsolidated subsidiary – related party                   2,514    2,514 
Non-controlling interest   (2,604)   (5,372)   (1,404)   (376)       (9,756)
Net income attributable to AmTrust Financial Services, Inc.  $13,772   $27,604   $1,585   $744   $6,457   $50,162 

   

29
 

 

(Amounts in Thousands)  Small
Commercial
Business
   Specialty Risk
and Extended
Warranty
   Specialty
Program
   Personal
Lines
Reinsurance
   Corporate
and Other
   Total 
Six months ended June 30, 2012:                              
Gross written premium  $446,478   $506,699   $226,516   $59,432   $   $1,239,125 
                               
Net written premium   223,160    313,420    155,354    59,432        751,366 
Change in unearned premium   (37,264)   (36,240)   (24,825)   (5,019)       (103,348)
Net earned premium   185,896    277,180    130,529    54,413        648,018 
                               
Ceding commission - primarily related party   32,590    33,368    24,866            90,824 
                               
Loss and loss adjustment expense   (119,529)   (169,071)   (88,020)   (35,096)       (411,716)
Acquisition costs and other underwriting expenses   (85,095)   (87,123)   (64,924)   (16,596)       (253,738)
    (204,624)   (256,194)   (152,944)   (51,692)       (665,454)
Underwriting income   13,862    54,354    2,451    2,721        73,388 
                               
Service and fee income   25,980    33,647    19        13,903    73,549 
Investment income and realized gain (loss)   12,252    13,164    5,808    1,193        32,417 
Other expenses   (24,865)   (28,113)   (12,167)   (2,814)       (67,959)
Interest expense   (5,153)   (5,827)   (2,522)   (583)       (14,085)
Foreign currency loss       (2,034)               (2,034)
Gain on life settlement contracts   751    848    367    85        2,051 
Provision for income taxes   (5,090)   (14,726)   1,348    (135)   (4,316)   (22,919)
Equity in earnings of unconsolidated subsidiary  – related party                   5,452    5,452 
Non-controlling interest   (153)   (172)   (74)   (17)       (416)
Net income attributable to AmTrust Financial Services, Inc.  $17,584   $51,141   $(4,770)  $450   $15,039   $79,444 

 

(Amounts in Thousands)  Small
Commercial
Business
   Specialty Risk
and Extended
Warranty
   Specialty
Program
   Personal
Lines
Reinsurance
   Corporate
and Other
   Total 
Six months ended June 30, 2011:                              
Gross written premium  $315,323   $493,250   $143,330   $50,586   $   $1,002,489 
                               
Net written premium   190,872    289,725    78,517    50,586        609,700 
Change in unearned premium   (54,977)   (95,517)   (7,609)   (2,977)       (161,080)
Net earned premium   135,895    194,208    70,908    47,609        448,620 
                               
Ceding commission - primarily related party   31,895    26,686    12,517            71,098 
                               
Loss and loss adjustment expense   (86,690)   (133,477)   (48,067)   (30,470)       (298,704)
Acquisition costs and other underwriting expenses   (66,409)   (58,306)   (30,626)   (15,473)       (170,814)
    (153,099)   (191,783)   (78,693)   (45,943)       (469,518)
                               
Underwriting income   14,691    29,111    4,732    1,666        50,200 
Service and fee income   10,418    31,410    5        7,898    49,731 
Investment income and realized gain (loss)   12,809    10,006    4,505    1,070        28,390 
Other expenses   (12,025)   (19,509)   (5,163)   (2,063)       (38,760)
Interest expense   (2,509)   (4,071)   (1,077)   (431)       (8,088)
Foreign currency gain       2,236                2,236 
Gain on life settlement contracts   12,882    20,900    5,532    2,210        41,524 
Provision for income taxes   (4,727)   (9,136)   (1,113)   (320)   (1,030)   (16,326)
Equity in earnings of unconsolidated subsidiary – related party                   4,333    4,333 
Non-controlling interest   (5,551)   (9,007)   (2,384)   (953)       (17,895)
Net income  $25,988   $51,940   $5,037   $1,179   $11,201   $95,345 

 

The following tables summarize long lived assets and total assets of the business segments as of June 30, 2012 and December 31, 2011:

 

(Amounts in Thousands)  Small
Commercial
Business
   Specialty Risk
and Extended
Warranty
   Specialty
Program
   Personal
Lines
Reinsurance
   Corporate
and other
   Total 
As of June 30, 2012:                              
Property and equipment, net  $25,725   $29,084   $12,588   $2,911   $   $70,308 
Goodwill and intangible assets   182,165    161,453    22,591            366,209 
Total assets   2,497,782    2,398,983    1,212,625    159,549        6,268,939 
                               
As of December 31, 2011:                              
Property and equipment, net  $17,767   $30,811   $10,762   $2,213   $   $61,553 
Goodwill and intangible assets   123,976    167,782    22,858            314,616 
Total assets   2,150,824    2,482,018    912,476    133,429        5,678,747 

   

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16.      Subsequent Event

 

Acquisition of CNH Capital’s Insurance Agencies

 

In July 2012, the Company completed the acquisition of CNH Capital Insurance Agency Inc. and CNH Capital Canada Insurance Agency, Ltd., collectively known as “CNH Capital Insurance agencies,” from CNH Capital, the financial services business of CNH Global N.V. The acquisition will allow the Company to enhance and expand CNH Capital’s offering of equipment extended service contracts and other insurance products to Case IH, Case Construction, New Holland Agriculture and New Holland Construction equipment dealers in the United States and Canada. The Company purchased the CNH Capital Insurance agencies for approximately $34,000. Additionally, the Company entered into service and license agreements with CNH Capital whereby the Company will make future payments based on gross revenues of the CNH Capital Insurance agencies.

 

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

 

  The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q.

 

Note on Forward-Looking Statements

 

This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as “anticipate,” “intend,” “plan,” “believe,” “estimate,” “expect,” or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately, many of which are beyond our control. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, our estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with Maiden Holdings, Ltd., American Capital Acquisition Corporation, or third party agencies and warranty administrators, difficulties with technology or breaches in data security, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2011, and our quarterly reports on Form 10-Q. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

Overview

 

We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are underserved by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines and acquiring companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in four business segments:

 

·Small Commercial Business.  We provide workers’ compensation, commercial package and other commercial insurance lines produced by wholesale agents, retail agents and brokers in the United States.
·Specialty Risk and Extended Warranty. We provide coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans offered in connection with the sale of consumer and commercial goods, in the United States and Europe, and certain niche property, casualty and specialty liability risks in the United States and Europe, including general liability, employers’ liability and professional and medical liability.
·Specialty Program. We write commercial insurance for narrowly defined classes of insureds, requiring an in-depth knowledge of the insured’s industry segment, through general and other wholesale agents.
·Personal Lines Reinsurance. We reinsure 10% of the net premiums of the GMACI personal lines business, pursuant to a quota share reinsurance agreement (“Personal Lines Quota Share”) with the GMACI personal lines insurance companies.

 

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 We transact business primarily through eleven insurance company subsidiaries:

 

Company  

A.M.

Best Rated

  Coverage Type Offered  

Coverage

Market

  Domiciled
Technology Insurance Company, Inc. (“TIC”)   A (Excellent)   Small Commercial Business, Specialty Program and Specialty Risk & Extended Warranty   United States   New Hampshire

Rochdale Insurance

Company (“RIC”)

  A (Excellent)   Small Commercial Business, Specialty Program and Specialty Risk & Extended Warranty   United States   New York
Wesco Insurance Company (“WIC”)   A (Excellent)   Small Commercial Business, Specialty Program and Specialty Risk & Extended Warranty   United States   Delaware
Associated Industries Insurance Company, Inc. (“AIIC”)   A (Excellent)   Workers’ Compensation and Specialty Program   United States   Florida
Milwaukee Casualty Insurance Co. (“MCIC”)   A (Excellent)   Small Commercial Business   United States   Wisconsin
Security National Insurance Company (“SNIC”)   A (Excellent)   Small Commercial Business   United States   Texas
AmTrust Insurance Company of Kansas, Inc. (“AICK”)   A (Excellent)   Small Commercial Business   United States   Kansas
AmTrust Lloyd’s Insurance Company (“ALIC”)   A (Excellent)   Small Commercial Business   United States   Texas
AmTrust International Underwriters Limited (“AIU”)   A (Excellent)   Specialty Risk and Extended Warranty; Specialty Program   European Union and United States   Ireland
AmTrust Europe, Ltd. (“AEL”)   A (Excellent)   Specialty Risk and Extended Warranty   European Union   England
AmTrust International Insurance Ltd. (“AII”)   A (Excellent)   Reinsurance   United States and European Union   Bermuda

  

Insurance, particularly workers’ compensation, is generally affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Program segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality is muted by our acquisition activity.

 

We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our net income, return on average equity, and our loss, expense and combined ratios. The following summary provides further explanation of the key measures that we use to evaluate our results:

 

Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy’s cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.

 

Net Written Premium. Net written premium is gross written premium less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreements.

  

Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro-rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums, which are earned in subsequent periods over the remaining term of the policy. Our workers’ compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2012 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2012 and the other half in 2013. We earn our specialty risk and extended warranty coverages over the estimated exposure time period. The terms vary depending on the risk and have an average duration of approximately 23 months, but range in duration from one month to 120 months.

 

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Ceding Commission Revenues. Ceding commission is a commission we receive from ceding gross written premium to third party reinsurers. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. In connection with the Maiden Quota Share, which is our primary source of ceding commission, the amount we receive is a blended rate based on a contractual formula contained in the individual reinsurance agreements, and the rate may not correlate specifically to the cost structure of our individual segments. As such, we allocate earned ceding commissions to our segments based on each segment’s proportionate share of total acquisition costs and other underwriting expenses recognized during the period.

 

Service and Fee Income.   We currently generate service and fee income from the following sources:

 

·Product warranty registration and service — Our Specialty Risk and Extended Warranty business generates fee revenue for product warranty registration and claims handling services provided to unaffiliated third parties.
·Servicing carrier — We act as a servicing carrier for workers’ compensation assigned risk plans in eight states. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties.
·Management services — We provide services to insurance consumers, traditional insurers and insurance producers by offering flexible and cost effective alternatives to traditional insurance tools in the form of various risk retention groups and captive management companies, as well as management of workers’ compensation and commercial property programs.
·Installment and reinstatement fees — We recognize fee income associated with the issuance of workers’ compensation policies for installment fees, in jurisdictions where it is permitted and approved, and reinstatement fees, which are fees charged to reinstate a policy after it has been cancelled for non-payment, in jurisdictions where it is permitted and approved.
·Broker services — We provide brokerage services to Maiden in connection with our reinsurance agreement for which we receive a fee.
·Asset management services — We currently manage the investment portfolios of Maiden, ACAC and ACP Re, Ltd. for which we receive a management fee.
·Information technology services — We provide information technology services to ACAC and its affiliates for a fee.

 

Net Investment Income and Realized Gains and (Losses).   We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. We report net unrealized gains (losses) separately within accumulated other comprehensive income on our balance sheet.

 

Loss and Loss Adjustment Expenses Incurred.   Loss and loss adjustment expenses (“LAE”) incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.

 

Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses. These items are described below:

 

·Policy acquisition expenses comprise commissions directly attributable to those agents, wholesalers or brokers that produce premiums written on our behalf. In most instances, we pay commissions based on collected premium, which reduces our credit risk exposure associated with producers in case a policyholder does not pay a premium. We pay state and local taxes, licenses and fees, assessments and contributions to various state guaranty funds based on our premiums or losses in each state. Surcharges that we may be required to charge and collect from insureds in certain jurisdictions are recorded as accrued liabilities, rather than expense.
·Salaries and benefits expenses are those salaries and benefits expenses for employees that are directly involved in the origination, issuance and maintenance of policies, claims adjustment and accounting for insurance transactions. We classify salaries and benefits associated with employees that are involved in fee generating activities as other expenses.
·General and administrative expenses are comprised of other costs associated with our insurance activities, such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges.

 

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Gain on Investment in Life Settlement Contracts.  The gain on investment in life settlement contracts includes the gain on acquisition of life settlement contracts, the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. We determine fair value based upon the discounted cash flow of the anticipated death benefits, incorporating a number of factors, such as current life expectancy assumptions, expected premium payment obligations and cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain realized upon mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain on investment in life settlement contracts to our segments based on net written premium by segment.

 

Net Loss Ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and loss adjustment expense incurred to net premiums earned.

 

Net Expense Ratio. The net expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses less ceding commission revenue to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net loss ratio on a segment basis may be impacted period over period by a shift in the mix of net written premium.

 

Net Combined Ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net expense ratios. If the net combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.

 

Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income).   Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense and income taxes.

 

Return on Equity. We calculate return on equity by dividing net income by the average of shareholders’ equity.

 

 One of the key financial measures that we use to evaluate our operating performance is return on average equity. Our return on annualized average equity was 16.5% and 25.2% for the three months ended June 30, 2012 and 2011, respectively, and 16.8% and 24.7% for the six months ended June 30, 2012 and 2011, respectively. In addition, we target a net combined ratio of 95% or lower over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 88.9% and 90.3% for the three months ended June 30, 2012 and 2011, respectively, and 88.7% and 88.8% for the six months ended June 30, 2012 and 2011, respectively.

 

Critical Accounting Policies

 

Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. We have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the fiscal period ended December 31, 2011.

 

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Results of Operations

 

Consolidated Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Gross written premium  $637,438   $558,462   $1,239,125   $1,002,489 
                     
Net written premium  $391,589   $375,681   $751,366   $609,700 
Change in unearned premium   (57,595)   (127,399)   (103,348)   (161,080)
Net earned premiums   333,994    248,282    648,018    448,620 
Ceding commission – primarily related party   44,550    35,414    90,824    71,098 
Service and fee income (related parties – three months $6,932; $4,459 and six months $13,024; $7,898)   33,011    24,542    73,549    49,731 
Net investment income   16,344    13,167    30,862    27,359 
Net realized gain on investments   2,703    616    1,555    1,031 
Total revenues   430,602    322,021    844,808    597,839 
                     
Loss and loss adjustment expense   211,787    170,008    411,716    298,704 
Acquisition costs and other underwriting expenses   129,713    89,580    253,738    170,814 
Other   32,320    18,564    67,959    38,760 
Total expenses   373,820    278,152    733,413    508,278 
Income before other income (expense), income taxes and equity in earnings (loss) of unconsolidated subsidiary   56,782    43,869    111,395    89,561 
                     
Other income (expense):                    
Interest expense   (6,994)   (4,334)   (14,085)   (8,088)
Foreign currency (loss) gain   (2,455)   2,520    (2,034)   2,236 
Net gain on investment in life settlement contracts   1,961    22,638    2,051    41,524 
Total other income (expense)   (7,488)   20,824    (14,068)   35,672 
Income before income taxes and equity in earnings (loss) of unconsolidated subsidiary   49,294    64,693    97,327    125,233 
Provision for income taxes   11,742    7,289    22,919    16,326 
Income before equity in earnings (loss) of unconsolidated subsidiary and non-controlling interest   37,552    57,404    74,408    108,907 
Equity in earnings of unconsolidated subsidiary – related party   3,088    2,514    5,452    4,333 
Net income   40,640    59,918    79,860    113,240 
Non-controlling interest   (282)   (9,756)   (416)   (17,895)
Net income attributable to AmTrust Financial Services, Inc.  $40,358   $50,162   $79,444   $95,345 
                     
Net realized gain (loss) on investments:                    
Total other-than-temporary impairment loss  $(1,208)  $(345)  $(1,208)  $(345)
Portion of loss recognized in other comprehensive income                
Net impairment losses recognized in earnings   (1,208)   (345)   (1,208)   (345)
Other net realized gain on investments   3,911    961    2,763    1,376 
Net realized investment loss  $2,703   $616   $1,555   $1,031 
                     
Key measures:                    
Net loss ratio   63.4%   68.5%   63.5%   66.6%
Net expense ratio   25.5%   21.8%   25.1%   22.2%
Net combined ratio   88.9%   90.3%   88.7%   88.8%

 

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Consolidated Result of Operations for the Three Months Ended June 30, 2012 and 2011

 

Gross Written Premium. Gross written premium increased $78.9 million, or 14.1%, to $637.4 million from $558.5 million for the three months ended June 30, 2012 and 2011, respectively. The increase of $78.9 million was primarily attributable to growth in our Small Commercial Business and Specialty Program segments. The increase in Small Commercial Business resulted primarily from increases in workers’ compensation policy counts, the acquisitions of Majestic and BTIS in 2011 and rate increases in some of our key states. The increase in Specialty Program resulted primarily from programs developed from new underwriting teams we hired in 2010 and 2011.

 

Net Written Premium. Net written premium increased $15.9 million, or 4.2%, to $391.6 million from $375.7 million for the three months ended June 30, 2012 and 2011, respectively. The increase(decrease) by segment was: Small Commercial Business – ($8.9) million, Specialty Risk and Extended Warranty – ($12.9) million, Specialty Program – $33.9 million and Personal Lines - $3.8 million. Net written premium increased for the three months ended June 30, 2012 compared to the same period in 2011 due to the increase in gross written premium in 2012 compared to 2011 partially offset by an increase in our assigned risk business in our small commercial business segment for which we cede 100 percent.

 

 Net Earned Premium. Net earned premium increased $85.7 million, or 34.5%, to $334.0 million from $248.3 million for the three months ended June 30, 2012 and 2011, respectively. The increase by segment was: Small Commercial Business — $19.5 million, Specialty Risk and Extended Warranty — $32.0 million, Specialty Program — $30.8 million, and Personal Lines — $3.4 million.

 

Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby AmTrust receives a ceding commission between 30% and 31%, depending on the mix of business ceded, for all business except retail commercial package business, and 34.375% for retail commercial package business, for written premiums ceded to Maiden.  The ceding commission earned during the three months ended June 30, 2012 and 2011 was $44.6 million and $35.4 million, respectively. Ceding commission increased period over period as a result of increased premium writings.

 

Service and Fee Income. Service and fee income increased $8.5 million, or 34.7%, to $33.0 million from $24.5 million for the three months ended June 30, 2012 and 2011, respectively. The increase related to fee income of approximately $4 million produced from BTIS, which was acquired in December 2011, higher technology fee income from ACAC of approximately $3 million and fees generated by becoming a servicing carrier for workers’ compensation assigned risk plans in three additional states.

 

 Net Investment Income. Net investment income increased $3.1 million, or 23.5%, to $16.3 million from $13.2 million for the three months ended June 30, 2012 and 2011, respectively. The increase resulted primarily from having a higher average balance of fixed security investment securities during the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

 

Net Realized Gains (Losses) on Investments. We incurred net realized gains on investments of $2.7 million and $0.6 million for the three months ended June 30, 2012 and 2011, respectively.  The increase resulted from our decision to sell certain positions that had market values that exceeded our cost basis.

 

Loss and Loss Adjustment Expenses.   Loss and loss adjustment expenses increased $41.7 million, or 24.5%, to $211.7 million from $170.0 million for the three months ended June 30, 2012 and 2011, respectively.  Our loss ratio for the three months ended June 30, 2012 and 2011 was 63.4% and 68.5%, respectively.  The decrease in the loss ratio in 2012 resulted from lower current accident year selected ultimate losses as compared to selected ultimate losses from the prior accident year.

 

Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $40.1 million, or 44.8%, to $129.7 million from $89.6 million for the three months ended June 30, 2012 and 2011, respectively.  The expense ratio for the same periods increased to 25.5% from 21.8%, respectively, and impacted all segments. The increase in policy acquisition costs was the largest contributor to the increase in the expense ratio during the three months ended June 30, 2012, which was the result of a change in business mix as well the adoption of the new accounting standard for deferred acquisition costs during the first quarter of 2012.

 

Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiary. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiary increased $12.9 million, or 29.4%, to $56.8 million from $43.9 million for the three months ended June 30, 2012 and 2011, respectively.  The change in income from 2011 to 2012 resulted primarily from improvement of the combined ratio of the insurance business.

 

Interest Expense. Interest expense for the three months ended March 31, 2012 was $7.0 million, compared to $4.3 million for the same period in 2011.  The increase was primarily related to the issuance of an aggregate of $200 million of convertible senior notes during December 2011 and January 2012.

 

Net Gain on Investment in Life Settlement Contracts.   Gain on investment in life settlement contracts was $2.0 million compared to $22.6 million for the three months ended June 30, 2012 and 2011. During the three months ended June 30, 2012, we received a benefit of approximately $10 million from mortality events. The gain in the second quarter of 2011 was generated by the purchase of a large pool of distressed life settlement contracts. During the second quarter of 2012, we purchased a minimal amount of contracts.

 

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Provision for Income Tax. Income tax expense for the three months ended June 30, 2012 was $11.7 million, which resulted in an effective tax rate of 23.8%. Income tax expense for the three months ended June 30, 2011 was $7.3 million, which resulted in an effective tax rate of 11.3%.  The increase in our effective rate for the three months ended June 30, 2012 resulted primarily from earning a higher percentage of pretax income in countries with higher effective rates.

 

Equity in Earnings of Unconsolidated Subsidiary - Related Party. Equity in earnings of unconsolidated subsidiary - related party increased by $0.6 million for the three months ended June 30, 2012 to $3.1 million compared to $2.5 million for the three months ended June 30, 2011. The increase period over period resulted from higher contract and service fees reported by ACAC.

 

Consolidated Result of Operations for the Six Months Ended June 30, 2012 and 2011

 

Gross Written Premium. Gross written premium increased $236.6 million, or 23.6%, to $1,239.1 million from $1,002.5 million for the six months ended June 30, 2012 and 2011, respectively. The increase of $236.6 million was primarily attributable to growth in our Small Commercial Business and Specialty Program segments. The increase in Small Commercial Business resulted primarily from increases in workers’ compensation policy counts, the acquisitions of Majestic and BTIS in 2011 and rate increases in some of our key states. The increase in Specialty Program resulted primarily from programs developed from new underwriting teams we hired in 2010 and 2011.

 

Net Written Premium. Net written premium increased $141.7 million, or 23.2%, to $751.4 million from $609.7 million for the six months ended June 30, 2012 and 2011, respectively. The increase by segment was: Small Commercial Business - $32.3 million, Specialty Risk and Extended Warranty - $23.7 million, Specialty Program – $76.9 million and Personal Lines - $8.8 million. Net written premium increased for the six months ended June 30, 2012 compared to the same period in 2011 due to the increase in gross written premium in 2012 compared to 2011.

 

Net Earned Premium. Net earned premium increased $199.4 million, or 44.4%, to $648.0 million from $448.6 million for the six months ended June 30, 2012 and 2011, respectively. The increase by segment was: Small Commercial Business — $50.0 million, Specialty Risk and Extended Warranty — $83.0 million, Specialty Program — $59.6 million, and Personal Lines — $6.8 million.

 

Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby AmTrust receives a ceding commission between 30% and 31%, depending on the mix of business ceded, for all business except retail commercial package business, and 34.375% for retail commercial package business, for written premiums ceded to Maiden.  The ceding commission earned during the six months ended June 30, 2012 and 2011 was $90.8 million and $71.1 million, respectively. Ceding commission increased period over period as a result of increased premium writings. Additionally, effective April 1, 2011, we entered into a 40% quota share reinsurance agreement with Maiden covering our European medical liability business for which we receive a five percent ceding commission. Prior to April 1, 2011, we ceded this business to another reinsurer.

 

Service and Fee Income. Service and fee income increased $23.8 million, or 47.9%, to $73.5 million from $49.7 million for the six months ended June 30, 2012 and 2011, respectively. The increase related to fee income of approximately $11 million produced from BTIS, which was acquired in December 2011, higher technology fee income from ACAC of approximately $5 million, higher fee income of approximately $5 million from Warrantech from new programs and fees generated by becoming a servicing carrier for workers’ compensation assigned risk plans in three additional states.

 

Net Investment Income. Net investment income increased $3.5 million, or 12.8%, to $30.9 million from $27.4 million for the six months ended June 30, 2012 and 2011, respectively. The increase resulted primarily from having a higher average balance of fixed security investment securities during the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

 

Net Realized Gains (Losses) on Investments. We incurred net realized gains on investments of $1.6 million and $1.0 million for the six months ended June 30, 2012 and 2011, respectively. The increase resulted from our decision to sell certain positions that had market values that exceeded our cost basis during the six months ended June 30, 2012.

 

Loss and Loss Adjustment Expenses.   Loss and loss adjustment expenses increased $113.3 million, or 38.0%, to $412.0 million from $298.7 million for the six months ended June 30, 2012 and 2011, respectively.  Our loss ratio for the six months ended June 30, 2012 and 2011 was 63.5% and 66.6%, respectively.  The decrease in the loss ratio in 2012 resulted from lower current accident year selected ultimate losses as compared to selected ultimate losses from the prior accident year.

 

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Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $82.9 million, or 48.5%, to $253.7 million from $170.8 million for the six months ended June 30, 2012 and 2011, respectively.  The expense ratio for the same periods increased to 25.1% from 22.2%, respectively, and impacted all segments. The increase in policy acquisition costs was the largest contributor to the increase in the expense ratio during the six months ended June 30, 2012, which was the result of a change in business mix as well the adoption of the new accounting standard for deferred acquisition costs during the first quarter of 2012.

 

Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiary. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiary increased $21.8 million, or 24.3%, to $111.4 million from $89.6 million for the six months ended June 30, 2012 and 2011, respectively.  The change in income from 2011 to 2012 resulted primarily from improvement of the combined ratio of the insurance business.

 

Interest Expense. Interest expense for the six months ended June 30, 2012 was $14.1 million, compared to $8.1 million for the same period in 2011.  The increase was primarily related to the issuance of an aggregate of $200 million of convertible senior notes during December 2011 and January 2012.

 

Net Gain on Investment in Life Settlement Contracts.   Gain on investment in life settlement contracts was $2.1 million compared to $41.5 million for the six months ended June 30, 2012 and 2011. During the six months ended June 30, 2012, we received a benefit of approximately $10 million from mortality events. The gain in the first six months of 2011 was generated by the purchase of a large pool of distressed life settlement contracts. During the six months ended June 30, 2012, we purchased a minimal amount of contracts.

 

Provision for Income Tax. Income tax expense for the six months ended June 30, 2012 was $22.9 million, which resulted in an effective tax rate of 23.5%. Income tax expense for the six months ended June 30, 2011 was $16.3 million, which resulted in an effective tax rate of 13.0%.  The increase in our effective rate for the six months ended June 30, 2012 resulted primarily from earning a higher percentage of pretax income in countries with higher effective rates.

 

Equity in Earnings of Unconsolidated Subsidiary - Related Party. Equity in earnings of unconsolidated subsidiary - related party increased by $1.2 million for the six months ended June 30, 2012 to $5.5 million compared to $4.3 million for the six months ended June 30, 2011. The increase period over period resulted from higher contract and service fees reported by ACAC.

 

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Small Commercial Business Segment Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Gross written premium  $214,127   $174,607   $446,478   $315,323 
                     
Net written premium   104,270    113,221    223,160    190,872 
Change in unearned premium   (10,702)   (39,187)   (37,264)   (54,977)
Net earned premiums   93,568    74,034    185,896    135,895 
                     
Ceding commission – primarily related party   15,458    13,570    32,590    31,895 
                     
Loss and loss adjustment expense   60,305    49,927    119,529    86,690 
Acquisition costs and other underwriting expenses   42,165    31,653    85,095    66,409 
Total expenses   102,470    81,580    204,624    153,099 
Underwriting income  $6,556   $6,024   $13,862   $14,691 
                     
Key measures:                    
Net loss ratio   64.5%   67.4%   64.3%   63.8%
Net expense ratio   28.5%   24.4%   28.2%   25.4%
Net combined ratio   93.0%   91.9%   92.5%   89.2%
                     
Reconciliation of net expense ratio:                    
Acquisition costs and other underwriting expenses  $42,165   $31,653   $85,095   $66,409 
Less: ceding commission revenue – primarily related party   15,458    13,570    32,590    31,895 
    26,707    18,083    52,505    34,514 
Net earned premium  $93,568   $74,034   $185,896   $135,895 
Net expense ratio   28.5%   24.4%   28.2%   25.4%

 

Small Commercial Business Segment Results of Operations for the Three Months Ended June 30, 2012 and 2011

 

Gross Written Premium.   Gross written premium increased $39.5 million, or 22.6%, to $214.1 million from $174.6 million for the three months ended June 30, 2012 and 2011, respectively. A majority of the increase relates to an approximately nine percent increase in policy issuances in the first half of 2012 and rate increases in certain key states. In addition, approximately $16 million resulted from the Majestic acquisition in the third quarter of 2011. Approximately $18 million resulted from other acquisitions.

 

Net Written Premium.   Net written premium decreased $8.9 million, or 7.9%, to $104.3 million from $113.2 million for the three months ended June 30, 2012 and 2011, respectively. The decrease in net written premium resulted from an increase in our assigned risk business, for which we cede 100 percent of our gross written business, for the three months ended June 30, 2012 compared to the three months ended June 30, 2011, partially offset by an increase in gross written premium during the same period.

 

Net Earned Premium.   Net earned premium increased $19.5 million, or 26.3%, to $93.6 million from $74.1 million for the three months ended June 30, 2012 and 2011, respectively. As premiums written earn ratably over a twelve month period, the increase in net premium earned resulted from higher net written premium for the twelve months ended June 30, 2012 compared to the twelve months ended June 30, 2011.

 

Ceding Commission.   The ceding commission earned during the three months ended June 30, 2012 and 2011 was $15.4 million and $13.6 million, respectively. The ceding commission increased period over period as result of an increase in net earned premium, which was partially offset by a decrease in the allocation of ceding commission to this segment. The decrease in the allocation of ceding commission to this segment resulted from the decrease in the segment’s proportionate share of our overall policy acquisition expense in the second quarter.

 

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Loss and Loss Adjustment Expenses.   Loss and loss adjustment expenses increased $10.4 million, or 20.8%, to $60.3 million from $49.9 million for the three months ended June 30, 2012 and 2011, respectively. Our loss ratio for the segment for the three months ended June 30, 2012 decreased to 64.5% from 67.4% for the three months ended June 30, 2011. The decrease in the loss ratio in the three months ended June 30, 2012 resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years.

 

Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $10.5 million, or 33.1%, to $42.2 million from $31.7 million for the three months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 28.5% for the three months ended June 30, 2012 from 24.4% for the three months ended June 30, 2011. The increase in the expense ratio resulted primarily from a lower allocation percentage of ceding commission to the segment during the three months ended June 30, 2012 compared to the same period in 2011, the recognition of higher policy acquisition expense due to changes in business mix and the adoption of the new accounting standard for deferred acquisition costs in 2012 on a prospective basis.

 

Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income).  Net premiums earned less expenses included in combined ratio increased $0.6 million, or 10.0%, to $6.6 million from $6.0 million for the three months ended June 30, 2012 and 2011, respectively. This increase resulted primarily from a decrease to the segment’s loss ratio in the second quarter of 2012 compared to the second quarter of 2011.

 

Small Commercial Business Segment Results of Operations for the Six Months Ended June 30, 2012 and 2011

 

Gross Written Premium.   Gross written premium increased $131.2 million, or 41.6%, to $446.5 million from $315.3 million for the six months ended June 30, 2012 and 2011, respectively. A majority of the increase related to an approximately nine percent increase in policy issuances in the first half of 2012 as well as rate increases in certain key states. In addition, approximately $35 million resulted from the Majestic acquisition in the third quarter of 2011. Approximately $34 million resulted from other acquisitions.

 

Net Written Premium.   Net written premium increased $32.3 million, or 16.9%, to $223.2 million from $190.9 million for the six months ended June 30, 2012 and 2011, respectively. The increase in net premium resulted from an increase in gross written premium for the six months ended June 30, 2012 compared to the six months ended June 30, 2011, partially offset by an increase in our assigned risk business, for which we cede 100 percent of our gross written business.

 

Net Earned Premium.   Net earned premium increased $50.0 million, or 36.8%, to $185.9 million from $135.9 million for the six months ended June 30, 2012 and 2011, respectively. As premiums written earn ratably over a twelve month period, the increase in net premium earned resulted from higher net written premium for the twelve months ended June 30, 2012 compared to the twelve months ended June 30, 2011.

 

Ceding Commission.   The ceding commission earned during the six months ended June 30, 2012 and 2011 was $32.6 million and $32.0 million, respectively. The ceding commission increased period over period as result of an increase in net earned premium, which was partially offset by a decrease in the allocation of ceding commission to this segment. The decrease in the allocation of ceding commission to this segment resulted from the decrease in the segment’s proportionate share of our overall policy acquisition expense.

 

Loss and Loss Adjustment Expenses.   Loss and loss adjustment expenses increased $32.8 million, or 37.8%, to $119.5 million from $86.7 million for the six months ended June 30, 2012 and 2011, respectively. Our loss ratio for the segment for the six months ended June 30, 2012 increased to 64.3% from 63.8% for the six months ended June 30, 2011. The increase in the loss ratio in the six months ended June 30, 2012 resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years.

 

Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $18.7 million, or 28.2%, to $85.1 million from $66.4 million for the six months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 28.2% for the six months ended June 30, 2012 from 25.4% for the six months ended June 30, 2011. The increase in the expense ratio resulted primarily from the lower allocation of ceding commission to the segment during the six months ended June 30, 2012 compared to the same period in 2011, the recognition of higher policy acquisition expense due to changes in business mix and the adoption of the new accounting standard for deferred acquisition costs in 2012 on a prospective basis.

 

Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income).  Net premiums earned less expenses included in combined ratio decreased $0.8 million, or 5.4%, to $13.9 million from $14.7 million for the six months ended June 30, 2012 and 2011, respectively. This decrease resulted primarily from an increase to the segment’s expense ratio in the second quarter of 2012 compared to the second quarter of 2011.

 

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Specialty Risk and Extended Warranty Segment Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Gross written premium  $272,610   $265,502   $506,699   $493,250 
                     
Net written premium   172,259    185,178    313,420    289,725 
Change in unearned premium   (30,652)   (75,547)   (36,240)   (95,517)
Net earned premiums   141,607    109,631    277,180    194,208 
                     
Ceding commission – primarily related party   16,174    13,787    33,368    26,686 
                     
Loss and loss adjustment expense   85,628    76,053    169,071    133,477 
Acquisition costs and other underwriting expenses   44,038    31,658    87,123    58,306 
Total expenses   129,666    107,711    256,194    191,783 
Underwriting income  $28,115   $15,707   $54,354   $29,111 
                     
Key measures:                    
Net loss ratio   60.5%   69.4%   61.0%   68.7%
Net expense ratio   19.7%   16.3%   19.4%   16.3%
Net combined ratio   80.1%   85.7%   80.4%   85.0%
                     
Reconciliation of net expense ratio:                    
Acquisition costs and other underwriting expenses  $44,038   $31,658   $87,123   $58,306 
Less: ceding commission revenue – primarily related party   16,174    13,787    33,368    26,686 
    27,864    17,871    53,755    31,620 
Net earned premium  $141,607   $109,631   $277,180   $194,208 
Net expense ratio   19.7%   16.3%   19.4%   16.3%

 

Specialty Risk and Extended Warranty Segment Results of Operations for the Three Months Ended June 30, 2012 and 2011

 

Gross Written Premium. Gross written premium increased $7.1 million, or 2.7%, to $272.6 million from $265.5 million for the three months ended June 30, 2012 and 2011, respectively. The increase related primarily to growth in our European business, although European gross written premium was negatively impacted by approximately six percent as a result of fluctuations in currency rates.

 

Net Written Premium. Net written premium decreased $12.9 million, or 7%, to $172.3 million from $185.2 million for the three months ended June 30, 2012 and 2011, respectively. The decrease in net written premium resulted from an increase in the percentage of gross written premium ceded to reinsurers for the three months ended June 30, 2012 compared to the three months ended June 30, 2011, partially offset by an increase in gross written premium during the same period.

 

Net Earned Premium. Net earned premium increased $32.0 million, or 29.2%, to $141.6 million from $109.6 million for the three months ended June 30, 2012 and 2011, respectively.  As net premiums written are earned ratably over the term of a policy, which on average is 23 months, the increase resulted from growth in net written premium between 2010 and 2012.

 

Ceding Commission.   The ceding commission earned during the three months ended June 30, 2012 and 2011 was $16.2 million and $13.8 million, respectively.  The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense.

 

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $9.5 million, or 12.5%, to $85.6 million from $76.1 million for the three months ended June 30, 2012 and 2011, respectively. Our loss ratio for the segment for the three months ended June 30, 2012 decreased to 60.5% from 69.4% for the three months ended June 30, 2011.  The decrease in the loss ratio for the three months ended June 30, 2012 resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years and a change in business mix.

 

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Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $12.3 million, or 38.8%, to $44.0 million from $31.7 million for the three months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 19.7% for the three months ended June 30, 2012 from 16.3% for the three months ended June 30, 2011. The increase in the expense ratio resulted, primarily, from higher policy acquisition expense for the three months ended June 30, 2012 compared to the three months ended June 30, 2011 related to changes in business mix and the adoption of a new accounting standard for deferred acquisition costs in 2012 on a prospective basis.

 

Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income).   Net earned premiums less expenses included in combined ratio increased $12.4 million, or 79.0%, to $28.1 million from $15.7 million for the three months ended June 30, 2012 and 2011, respectively.  The increase was attributable primarily to an improvement in the segment’s loss ratio during the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

 

Specialty Risk and Extended Warranty Segment Results of Operations for the Six Months Ended June 30, 2012 and 2011

 

Gross Written Premium. Gross written premium increased $13.4 million, or 2.7%, to $506.7 million from $493.3 million for the six months ended June 30, 2012 and 2011, respectively. The segment experienced growth in Europe, while U.S. business was primarily flat. Additionally, European gross written premium was negatively impacted by approximately four percent as a result of fluctuations in currency rates.

 

Net Written Premium. Net written premium increased $23.7 million, or 8.2%, to $313.4 million from $289.7 million for the six months ended June 30, 2012 and 2011, respectively. The increase in net written premium resulted from an increase of gross written premium for the six months ended June 30, 2012 compared to the six months ended June 30, 2011, as well as the reduction in the percentage of our European medical liability business ceded to reinsurers from 80% to 40% commencing in the second quarter of 2011.

 

Net Earned Premium. Net earned premium increased $83.0 million, or 42.7%, to $277.2 million from $194.2 million for the six months ended June 30, 2012 and 2011, respectively.  As net written premium is earned ratably over the term of a policy, which on average is 23 months, the increase resulted from growth in net written premium between 2010 and 2012 as well as our retention of a higher percentage of net written premium related to our European medical liability business.

 

Ceding Commission.   The ceding commission earned during the six months ended June 30, 2012 and 2011 was $33.4 million and $26.7 million, respectively.  The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense. Additionally, during the six months ended June 30, 2012, we were party to a 40% quota share arrangement with Maiden covering our European medical liability business for which we receive a five percent ceding commission. During the first three months of 2011, we ceded this business to another reinsurer.

 

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $35.6 million, or 26.7%, to $169.1 million from $133.5 million for the six months ended June 30, 2012 and 2011, respectively. Our loss ratio for the segment for the six months ended June 30, 2012 decreased to 61.0% from 68.7% for the six months ended June 30, 2011.  The decrease in the loss ratio for the six months ended June 30, 2012 resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years and a change in business mix.

 

Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses increased $28.8 million, or 49.4%, to $87.1 million from $58.3 million for the six months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 19.4% for the six months ended June 30, 2012 from 16.3% for the six months ended June 30, 2011. The increase in the expense ratio resulted primarily from higher policy acquisition expense for the six months ended June 30, 2012 compared to the six months ended June 30, 2011 related to changes in business mix and the adoption of the new accounting standard for deferred acquisition costs in 2012 on a prospective basis.

 

Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income).   Net earned premiums less expenses included in combined ratio increased $25.3 million, or 86.9%, to $54.4 million from $29.1 million for the six months ended June 30, 2012 and 2011, respectively.  The increase was attributable primarily to an improvement in the segment’s loss ratio during the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

 

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Specialty Program Segment Results of Operations for Three and Six Months Ended June 30, 2012 and 2011(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
(Amounts in Thousands)  2012   2011   2012   2011 
Gross written premium  $121,878   $93,354   $226,516   $143,330 
                     
Net written premium   86,237    52,283    155,354    78,517 
Change in unearned premium   (15,369)   (12,145)   (24,825)   (7,609)
Net earned premium   70,868    40,138    130,529    70,908 
                     
Ceding commission – primarily related party   12,918    8,057    24,866    12,517 
                     
Loss and loss adjustment expense   47,826    28,362    88,020    48,067 
Acquisition costs and other underwriting expenses   34,985    18,314    64,924    30,626 
Total expenses   82,811    46,676    152,944    78,693 
Underwriting income  $975   $1,519   $2,451   $4,732 
                     
Key measures:                    
Net loss ratio   67.5%   70.7%   67.4%   67.8%
Net expense ratio   31.1%   25.6%   30.7%   25.5%
Net combined ratio   98.6%   96.2%   98.1%   93.3%
                     
Reconciliation of net expense ratio:                    
Acquisition costs and other underwriting expenses  $34,985   $18,314   $64,924   $30,626 
Less: ceding commission revenue – primarily related party   12,918    8,057    24,866    12,517 
    22,067    10,257    40,058    18,109 
Net earned premium  $70,868   $40,138   $130,529   $70,908 
Net expense ratio   31.1%   25.6%   30.7%   25.5%

 

Specialty Program Segment Results of Operations for the Three Months Ended June 30, 2012 and 2011

 

Gross Written Premium.  Gross written premium increased $28.5 million, or 30.5%, to $121.9 million from $93.4 million for the three months ended June 30, 2012 and 2011, respectively. A majority of the increase in gross written premium related to incremental growth of gross written premium on existing programs, particularly in workers’ compensation programs. Additionally, the segment benefited from new program offerings primarily in commercial automotive and general liability programs. The overall increase was partially offset by the curtailment or termination of certain programs as a result of our continued maintenance of our pricing and administrative discipline.

 

Net Written Premium.  Net written premium increased $33.9 million, or 64.8%, to $86.2 million from $52.3 million for the three months ended June 30, 2012 and 2011, respectively. The increase in net written premium resulted from an increase in gross written premium for the three months ended June 30, 2012 compared to for the three months ended June 30, 2011 as well as a reduction in the percentage of gross written premium ceded to reinsurers.

 

Net Earned Premium.  Net earned premium increased $30.8 million, or 76.8%, to $70.9 million from $40.1 million for the three months ended June 30, 2012 and 2011, respectively. As premiums written earn ratably over a twelve month period, the increase in net premium earned resulted from higher net written premium for the twelve months ended June 30, 2012 compared to the twelve months ended June 30, 2011.

 

Ceding Commission.   The ceding commission earned during the three months ended June 30, 2012 and 2011 was $13.0 million and $8.1 million, respectively.   The increase in ceding commission related primarily to an increase in gross written premium in this segment relative to our other segments during the three months ended June 30, 2012 as well as a continuing shift in the mix of the programs written during the periods.  For the three months ended June 30, 2012, we wrote certain programs that have a higher percentage of policy acquisition costs to earned premium than in the three months ended June 30, 2012 and, therefore, we allocated more ceding commission to the segment.

 

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Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $19.4 million, or 68.3%, to $47.8 million for the three months ended June 30, 2012 compared to $28.4 million for the three months ended June 30, 2011. Our loss ratio for the segment for the three months ended June 30, 2012 decreased to 67.5% from 70.7% for the three months ended June 30, 2011. The decrease in the loss ratio in the three months ended June 30, 2012 resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses from prior years.

 

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $16.7 million, or 91.3%, to $35.0 million from $18.3 million for the three months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 31.1% for the three months ended June 30, 2012 from 25.6% for the three months ended June 30, 2011. The increase in the expense ratio resulted, primarily, from higher policy acquisition expense for the three months ended June 30, 2012 compared to the three months ended June 30, 2011 as a result of changes in business mix and the adoption of the new accounting standard for deferred acquisition costs in 2012 on a prospective basis. In addition, the increase in the expense ratio was attributable to the allocation to this segment of a higher proportion of our unallocated expenses as a result of the increase in premium compared to the three months ended June 30, 2011.

 

Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income).   Net earned premiums less expenses included in combined ratio decreased $0.5 million, or 33.3%, to $1.0 million from $1.5 million for the three months ended June 30, 2012 and 2011, respectively. The decrease of $0.5 million resulted primarily from an increase in the expense ratio during the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

  

Specialty Program Segment Results of Operations for the Six Months Ended June 30, 2012 and 2011

 

Gross Written Premium.  Gross premium increased $83.2 million, or 58.1%, to $226.5 million from $143.3 million for the six months ended June 30, 2012 and 2011, respectively.  A majority of the increase in gross written premium related to incremental growth of gross written premium on existing programs, particularly in workers’ compensation programs. Additionally, the segment benefited from new program offerings primarily in excess and surplus lines, commercial automotive, and general liability programs managed by new underwriting teams hired in 2010 and 2011.

 

Net Written Premium.  Net written premium increased $76.9 million, or 98%, to $155.4 million from $78.5 million for the six months ended June 30, 2012 and 2011, respectively. The increase in net written premium resulted from an increase in gross written premium for the six months ended June 30, 2012 compared to for the six months ended June 30, 2011.

 

Net Earned Premium.  Net earned premium increased $59.6 million, or 84.1%, to $130.5 million from $70.9 million for the six months ended June 30, 2012 and 2011, respectively. As premiums written earn ratably over a twelve month period, the increase in net premium earned resulted from higher net written premium for the twelve months ended June 30, 2012 compared to the twelve months ended June 30, 2011.

 

Ceding Commission.   The ceding commission earned during the six months ended June 30, 2012 and 2011 was $24.9 million and $12.5 million, respectively.   The increase in ceding commission related primarily to an increase in gross written premium in this segment relative to our other segments during the six months ended June 30, 2012 as well as a continuing shift in the mix of the programs written during the periods.  For the six months ended June 30, 2012, we wrote certain programs that have a higher percentage of policy acquisition costs to earned premium than in the six months ended June 30, 2011 and, therefore, we allocated more ceding commission to the segment.

 

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $39.9 million, or 83.0%, to $88.0 million for the six months ended June 30, 2012 compared to $48.1 million for the six months ended June 30, 2011. Our loss ratio for the segment for the six months ended June 30, 2012 decreased to 67.4% from 67.8% for the six months ended June 30, 2011. The decrease in the loss ratio in the six months ended June 30, 2012 resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses from prior years.

 

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $34.3 million, or 112.1%, to $64.9 million from $30.6 million for the six months ended June 30, 2012 and 2011, respectively. The expense ratio increased to 30.7% for the six months ended June 30, 2012 from 25.5% for the six months ended June 30, 2011. The increase in the expense ratio resulted, primarily, from higher policy acquisition expense for the six months ended June 30, 2012 compared to the six months ended June 30, 2011 as a result of changes in business mix and the adoption of the new accounting standard for deferred acquisition costs in 2012 on a prospective basis. In addition, the increase in the expense ratio was attributable to the allocation to this segment of a higher proportion of our unallocated expenses as a result of the increase in premium compared to the six months ended June 30, 2011.

 

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Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income).   Net earned premiums less expenses included in combined ratio decreased $2.2 million, or 46.8%, to $2.5 million from $4.7 million for the six months ended June 30, 2012 and 2011, respectively. The decrease of $2.2 million resulted primarily from an increase the expense ratio during the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

 

Personal Lines Reinsurance Segment Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

 

   Three Months Ended June 30   Six Months Ended June 30 
(Amounts in Thousands)  2012   2011   2012   2011 
Gross written premium  $28,823   $24,999   $59,432   $50,586 
                     
Net written premium   28,823    24,999    59,432    50,586 
Change in unearned premium   (872)  &nb